Strong results from IPO bolter not enough to change our view
Guzman's business has made an impressive start to the new fiscal year. We still have our doubts on valuation levels.
Mentioned: Guzman y Gomez Ltd (GYG), Chipotle Mexican Grill Inc (CMG), Domino's Pizza Enterprises Ltd (DMP), McDonald's Corp (MCD)
Guzman y Gomez (ASX: GYG) came to the public markets with a bang in June. At the time, our analysts said there was plenty to like about Guzman’s business model and its growth prospects. They just couldn’t get on board with the share price.
The company’s first earnings report since the IPO held little in the way of surprises. After all, Guzman provided a lot of information in the run up to their debut just days before the financial year ended.
Nonetheless, our analyst Johannes Faul said the results were impressive.
This was especially true in regard to GYG’s like-for-like sales growth of 8% for fiscal 2024 and 7% for the first few weeks of the new financial year. Crucially, this was enough to secure strong profitability and high returns on capital for Guzman’s franchises, who GYG claim enjoyed a cash-on-cash return of over 53% on their invested capital during fiscal 2024.
Happy franchisees and strong store economics underpin a healthy near-term outlook for store openings, which in turn are the key driver for revenue and earnings.
Easy pickings gone?
While GYG’s same-store sales growth has been impressive, Faul thinks it would be brave to forecast that they can continue to grow at a similar rate.
His reasoning? A lot of the low-hanging fruit – like the introduction of breakfast items and longer opening hours – has already been picked. As a result, he thinks like-for-like sales growth is more likely to slow to around 5%.
Where Faul and the market seem to differ more, though, is on how sure they are of Guzman’s long-term rollout. At current price levels, Faul thinks the market is taking a big chunk of management’s long-term target of 1000 Australian stores as a given – and is maybe even baking in some international success.
Strong returns for Guzman’s Australian franchisees in the past twelve month bode well for domestic store openings in the near-term. And based on these metrics, Faul thinks Guzman can roll out around 40 new stores per year for the next decade. He estimates that franchisees will average 24 of these stores, with the company operating the other 16.
Forecasting beyond that 10-year period is harder. Faul warns that Guzman’s brand is still relatively young and needs to prove that it can scale without impacting store economics.
As Guzman may have exhausted the most profitable catchments by that point, this is far from certain. To succeed, it will also need to fight off competition from several quick service peers with stronger brands including McDonalds (NYS: MCD), KFC and Domino's (ASX: DMP).
Big international presence a long way off
As for GYG’s international expansion, Faul stresses that it is very early days.
The rollout in Japan and Singapore has been slow, with 17 restaurants built in Singapore since 2013 and five in Japan since 2015. Faul says a gradual, measured approach makes sense, as it takes time to fine-tune the offering to suit new markets.
The company’s even smaller number US stores are currently making losses, and Faul expects them to keep doing so for the next decade.
He thinks it will be difficult for Guzman to grow meaningfully in the US given the strong competition it will face. Not only from the global QSR brands mentioned earlier, but from Wide Moat Mexican food chain Chipotle (NYS: CMG).
Fair Value and Moat rating unchanged
Faul maintained his Fair Value estimate of $15 per Guzman y Gomez share.
This reflects his assumption that the company can open 40 new Australian stores per year for the next decade and grow its revenue and profits at a yearly clip of 18% and 40% respectively.
Those numbers are nothing to sniff at – but at a current share price of over $35 markets seem to be expecting even more. The shares screen as materially overvalued versus our Fair Value estimate and currently have a one-star rating.
Faul’s uncertainty about Guzman’s rollout and store economics beyond the 10-year point precludes him from awarding the company a moat. After all, a Narrow Moat rating means our analysts thinks it is likely that a company can generate excess returns on capital for at least the next decade.
Faul says he will revisit his no-moat thesis, however, if he sees solid evidence that Guzman can maintain or even grow its brand strength and store profitability as the rollout progresses.
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Terms used in this article
Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.
Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.
Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.