Should I buy Guzman Y Gomez shares on the ASX?
A young woman holds a red chilli in front of her mouth with eyes wide open looking happy about the Hot Chili share price today
Everything there is to know about Guzman Y Gomez Ltd (ASX: GYG) is out of the bag following its ASX debut. Having leapt from its initial public offering (IPO) price of $22 to $29.29, are Guzman Y Gomez shares a worthy addition to the portfolio or a skippable meal?
The Mexican-inspired fast-food company unquestionably made a splash in the Australian share market last week. A strong appetite among investors for GYG shares has pinned a $2.9 billion market capitalisation to the newcomer. Is all the excitement backed up by the numbers?
Let's unwrap this burrito.
Bull case for Guzman Y Gomez shares
The argument for investing in GYG is dominated by the company's growth story.
It is indisputable that the quick-service restaurant (QSR) brand has exploded in popularity since opening its first store in 2006. Today, GYG has 210 stores across Australia, the United States, Singapore, and Japan, with the majority located down under.
At a price-to-earnings (P/E) ratio of approximately 744 times 12-month trailing earnings, GYG is hardly cheap by this measure. However, an earnings multiple is usually unhelpful in valuing high-growth businesses — and if you believe the GYG story, high growth is what we have on the table.
As outlined in the prospectus for the Guzman Y Gomez shares, the company plans to execute a significant expansion, reaching 1,000 GYG stores. This would roughly equate to a fivefold increase in its store network.
Another big factor in the bullish camp for GYG is its royalty potential. As the company's franchised stores increase, GYG's margins could improve dramatically.
Franchise fees, which are royalties derived from monetising the brand, are highly profitable.
Hard to stomach valuation
The investment case for Guzman Y Gomez shares is not all sunshine and churros. Indeed, the elephant in the room is the company's high valuation.
As shown below, GYG already has a market capitalisation of more than twice that of KFC operator Collins Foods Ltd (ASX: CKF) and about 85% of Domino's Pizza Enterprises Ltd (ASX: DMP). Notably, GYG operates about half as many stores as Collins Foods and approximately 5% of Domino's footprint.
To be fair, Guzman Y Gomez is growing much faster than its peers. However, as Ben Williamson of InvestorHub notes, the next chapter of growth is somewhat uncertain. He said:
GYG's high valuation, coupled with significant challenges in international markets, such as competition from the likes of Chipotle in the US and reliance on rapid expansion for growth, poses risks.
The share price could remain stable if the company meets its aggressive growth targets and successfully navigates competitive pressures, yet if these targets are not met or if international operations continue to struggle, the share price may face downward pressure.
Likewise, IG market analyst Hebe Chen highlights an absence of proven economies of scale from the company's recent growth:
It's notable that [Guzman Y Gomez's] recent growth hasn't yielded much in terms of economies of scale; operating profit remains low, even in the industry's standard, as expenses rise in line with income.
Taking a bite?
GYG wields a strong brand in Australia, painstakingly constructed over the past 18 years. In my view, leveraging this asset through growth in franchised stores is necessary for Guzman Y Gomez shares to grow into their current valuation.
Still, a lot must go right for the company to achieve its ambitions. Moreover, if growth in the US plays a major role in its expansion, then there's the consideration of a formidable competitor in Chipotle Mexican Grill Inc (NYSE: CMG).
Ultimately, this newly listed ASX share is a little too spicy for my current taste.
Should you invest $1,000 in Guzman Y Gomez right now?
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Motley Fool contributor Mitchell Lawler has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended Chipotle Mexican Grill and Domino’s Pizza Enterprises. The Motley Fool Australia has recommended Chipotle Mexican Grill, Collins Foods, and Domino’s Pizza Enterprises. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.