Morgan Stanley:

D/G on Spicy Valuation

What’s Changed Rating Overweight to Equal-weight Price Target $195.00 to NA

Bottom line: After a spectacular 12-month run of 200%, we are downgrading shares of CMG to Equal-Weight from Over Weight as the stock is now close to our bull case (39x our ’11 bull case EPS of $7.50, or $293) and well above our base case of $218, biasing the risk/reward to the downside. While we believe fundamentals remain strong, at 37x our 2011 estimate and 18x forward EBITDA, this optimism appears reflected in shares; with valuation increasingly driven by scarcity value for growth rather than fundamentals alone, increasing risk of sudden revaluation should current momentum even nominally shift.

Why now? With a ~$8 b market cap, equivalent of a PNRA, CAKE, PFCB, TXRH and BJRI combined, valuation has become decoupled with fundamentals, in our view. The stock requires continued improvement in margins & comps, which, given the prospect for greater inflation in ‘11 and tougher comparisons, may not materialize to the extent demanded by this valuation.

Key debates for CMG in ‘11: 1) Whether CMG has ample future growth to justify valuation–we see it getting closer to 50% penetration in ’11. 2) Whether margins can continue to expand—we see small improvements from here, with risk from food inflation. 3) What level of fundamental performance is discounted in the stock? – We think the market may already be discounting $10 in EPS within the next two years, a bull case scenario.

Where we could be wrong: .Improving returns through smaller prototype could keep multiple at sustained elevated levels; SSS momentum could continue despite tougher compares with marketing & loyalty programs; prospects for international and a second concept could sustain growth longer than we had forecasted.


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