Chipotle: Keep This Amazing Growth Stock On Your Watchlist

When you think of the best growth stocks in the world, the tech-oriented Magnificent Seven stocks are probably the first that comes to mind. After all, this group is comprised of the most dominant businesses in the world. It's any wonder they have minted countless millionaires and even several billionaires over the years.

But there are quite a few non-tech growth stocks that have also been quite lucrative for shareholders in the past 10 years. The fast-casual Mexican restaurant company Chipotle (NYSE:CMG) is one such example: A $10,000 investment made in the stock 10 years ago would now be worth $43,000 today. That's considerably better than the $32,000 that the same investment amount in the S&P 500 index would be valued at today with dividends reinvested.

Until I saw the need to further build up my emergency fund, Chipotle, among other stocks, were on my watch list for this month. Let's examine its fundamentals, risks, and valuation to elaborate further on the buy case for the stock.

Chipotle's Fundamentals Jump Off The Page

Operating over 3,250 restaurants in the U.S., Canada, the U.K., France, and Germany, Chipotle is a leading player in the Mexican restaurant industry. This massive size and scale prove that the company's strategy of providing customers with great customer service and food that has no artificial flavors or preservatives is paying off.

Chipotle has had an excellent first half to begin 2023: The company's total revenue surged 15.3% higher over the year-ago period to $4.9 billion in the first half. What factors contributed to the Mexican restaurant chain's excellent operating results?

Chipotle's strategic moves in recent years continue to pay dividends. The company's investments in its digital sales platform have panned out very well, with nearly two-fifths of food and beverage revenue being generated digitally. Chipotle also surpassed 35 million reward members to conclude the first half of 2023. The latter is especially important because rewards programs are proven to improve customer engagement and spending. These factors are what led the company's comparable restaurant sales in the first and second quarters to respectively climb by 10.9% and 7.4%. Along with over 200 new restaurant openings in the last four quarters, this is what propelled the topline higher.

Chipotle's adjusted diluted EPS soared 55.5% over the year-ago period to $23.15 during the first half of 2023. The company's bigger revenue base and disciplined cost management helped its non-GAAP profit margin to expand by nearly 320 basis points to 13.2% for the first half. That explains how adjusted diluted EPS growth well exceeded revenue growth in the first half.

If you thought that Chipotle's days of solidly double-digit earnings growth were behind it, you'll be pleasantly surprised to learn otherwise. The analyst consensus is that the company's adjusted diluted EPS will compound at 24% annually over the next three- to five years. This is enough to earn Chipotle an overall growth grade of A- from the Seeking Alpha Quant system.

There is good reason to believe that analysts aren't just blowing smoke, either. For one, the company believes that it can reach over 7,000 restaurants in North America in the long term. This alone would represent a more than doubling over its current restaurant count. And it's not an unreasonable estimate when considering that restaurants are being enthusiastically welcomed everywhere they are opened: Chipotle hasn't closed a single restaurant since Q3 2022. The company's recent agreement with Alshaya Group to open its first franchised restaurants ever in Dubai and Kuwait in 2024 could be another growth opportunity.

Best of all, Chipotle had no long-term debt on its balance sheet and more than $500 million in cash and cash equivalents as of June 30. Along with solid free cash flow, the company should have no problem opening hundreds of restaurants each year for the foreseeable future (besides links included above, details sourced from Chipotle Q2 2023 earnings press release and Chipotle Q1 2023 earnings press release).

Risks To Consider

Chipotle has been and will likely continue to be a remarkable compounder. Like any business, though, the company has risks that investors should watch.

One notable risk to Chipotle in the near term is that student loan payments will resume on October 1 (just days after I am writing this article). A recent survey of 1,000 borrowers found that 60% would be dining out less often as a result of this development. This is significant because about one in six U.S. adults have student loan payments, which average between $250 to 300 each month. A dip in discretionary income for many of its customers could weigh on Chipotle's comparable restaurant sales growth moving forward.

Another risk that applies to the company both now and in the future is the possibility of food-borne illnesses resulting in declining sales and increased costs. This was the case at numerous restaurants between 2015 and 2018, which weighed on the stock price. A similar event could do just the same in the years to come (per page 9 of 91 of Chipotle's 10-K filing).

The Stock Is Cheap Enough To At Least Start Buying

Chipotle is a quickly growing business. However, it remains important that investors don't overpay if they want to achieve an attractive investment outcome. That's precisely why I will be using a valuation model to value shares of Chipotle.

The valuation model that I'll utilize is the discounted cash flows or DCF model, which has three inputs.

The first input into the DCF model is the last 12 months of adjusted diluted EPS. Chipotle's trailing 12-month adjusted diluted EPS is $40.95.

The next input for the DCF model is growth predictions. Remaining on the cautious side, I will assume 14% annual adjusted diluted EPS growth for the next five years - - barely half of the analyst consensus. I'll then assume a deceleration to 7% in the years that follow. Considering that global GDP has grown at around 3% to 4% annually for about the last decade (besides 2020 and 2021), I would argue this is a reasonable forecast.

The final input into the DCF model is the discount rate, which is the annual total return rate. Since I require 10% annual total returns, that is the input I will be using for the valuation model.

Based on these inputs for the DCF model, I get a fair value of $1,974.33 a share. This means that Chipotle's shares are priced 7.2% below fair value and offer a 7.8% upside from the current price of $1,831.21 a share (as of September 28, 2023).

Summary: Total Returns Should Be Robust Over The Long Run

Chipotle almost certainly won't match the nearly 16% compound annual growth rate that it has delivered in the past 10 years. But it doesn't have to for it to be a satisfactory investment.

Even if the company falls well short of the current analyst growth consensus and the valuation multiple contracts moderately from here, there is still a viable path to low- double-digit annual total returns for the next five- to 10 years. In the near term, the stock could fall further as macroeconomic pressure weighs on operating results. That is why I believe Chipotle is a cautious buy right now and could become a more compelling pick if it slides a bit further.