Is it 'a long road from here' for Guzman Y Gomez shares on the ASX?

piggy bank at end of winding road

The Guzman Y Gomez (ASX: GYG) share price dropped more than 7% on Friday as the market continued to digest the GYG valuation. Some investors are not convinced the Mexican food business is good value.

Earlier this week we learned that there was material short interest in the business, which implies some hedge funds believe the GYG share price is going to fall.

The believers of the business point to the company's growth ambitions for both Australia and overseas. In Australia alone, it wants to reach 1,000 Guzman Y Gomez locations over the next 20 (or more) years.

Some investors think the valuation is too expensive.

Caution is advised

According to reporting by the Australian Financial Review, Richard Hemming from Under the Report said the successful initial public offering (IPO) of Guzman Y Gomez was a win for the Australian investment banking and stockbroking community.

But, there's more to GYG being successful from here than just the IPO day. Hemming said:

The fact is that they've been lining up to IPO for years. It's in everyone's interest for them to generate a 30 per cent pop on the first day, which is what they've done,

But it's a long road from here at higher interest rates, which is why caution is required, certainly at current prices. The question is how much expansion you're paying for today.

If you're pricing it or valuing it expanding beyond Australia, there's a lot of competition and it will be compared against more mature and longer-lasting concepts. It might be that Mexican in Australia was a low-hanging avocado. One thing is for certain, after this IPO drought and with the amount of takeover activity, the bankers and private equity will need more floats.

Cyan Investment Management's Dean Fergie similarly questioned the valuation that investors were giving GYG. Fergie said:

I feel the bottom-line earnings numbers, even taking into account potential growth going forward, just don't stack up from a valuation perspective – I'm a fundamental bottom-line investor rather than a hype and excitement kind of guy.

What growth is Guzman Y Gomez expecting?

Those experts may not be a fan, but the business is expecting growth.

The business saw $759 million of global network sales in FY23 and GYG has forecast growth to $954.4 million in FY24 and $1.14 billion in FY25.

It made $3.7 million of underlying earnings before interest and tax (EBIT) in FY23, with expectations this can grow to $12 million in FY24 and $19.7 million in FY25.

In Australia, it had 171 restaurants in FY23, and the company expects this to grow to 195 restaurants in FY24 and 225 in FY25.

The business is expecting the earnings before interest, tax, depreciation and amortisation (EBITDA) to global network sales to improve in FY24 and FY25, reaching 5.3% in the 2025 financial year.

GYG has growing restaurant numbers, rising revenue and improving margins, which helps support the Guzman Y Gomez share price being at a higher level than a slow-growth business. However, time will tell whether the company can justify the high price tag it currently has.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.