5 reasons I'd throw Guzman y Gomez shares in the bin like a bad burrito

Could this be the most overvalued stock on the ASX?

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Guzman Y Gomez Ltd (ASX: GYG) shares have been in the spotlight over the past few weeks following the quick service restaurant operator's highly successful initial public offering (IPO).

The Mexican food chain rocketed as much as 36% on day one to a high of $30.00 after listing on the Australian share market at $22.00.

This gave the company a mouth-watering market valuation of $3 billion at the time.

But while some investors may have a taste for Guzman Y Gomez shares, I am avoiding them like a bad burrito right now. Let's take a look at five reasons why I think investors should put its shares in the bin.

Reason 1: Guzman y Gomez shares are overvalued

Guzman Y Gomez shares are trading on mind-boggling multiples.

According to its prospectus, revenue is expected to be $339.7 million in FY 2024, with a profit after tax of $3.4 million. Then, revenue of $428.2 million is forecast for FY 2025, with a profit after tax of $6 million. The latter will mean a profit margin of just 1.4%.

Based on its current market capitalisation of $2.93 billion, this means its shares are trading at ~488x estimated FY 2025 earnings.

As a comparison, KFC restaurant operator Collins Foods Ltd (ASX: CKF) is trading at 16.8x estimated FY 2025 earnings, according to analysts at UBS.

Reason 2: Guzman y Gomez has no moat

I'm not afraid to invest in companies with high price-to-earnings multiples (P/E ratios).

For example, one large holding in my portfolio is Pro Medicus Limited (ASX: PME). You will find that it trades on one of the highest P/E ratios. However, it has a wide moat, an unmatched platform, high margins, a huge market opportunity, and large long-term contracts with locked-in revenue.

Guzman Y Gomez has no moat, lots of competition, tiny margins, and no guarantee that customers are going to come back week after week, let alone year after year. In light of this, I don't believe for a second that it justifies trading on such high earnings multiples.

Reason 3: Its growth plans look too ambitious

Some investors argue that Guzman Y Gomez shares deserve to trade on high multiples because of its ambitious growth plans. But I would argue that these plans are too ambitious.

The company has an aspiration to open 1,000 restaurants in Australia. This compares to the 185 restaurants that it operates across the country today.

However, McDonald's only has 970 restaurants in Australia today. I don't believe Guzman Y Gomez could get anywhere near that number and still generate good returns on store openings. McDonald's is a force of nature, with a menu that offers something to everyone at any time of the day. I don't believe you can say the same for Guzman Y Gomez's menu.

While I think it still has a decent growth runway, I believe there will come a point (sooner than it thinks) when it starts to cannibalise sales.

Reason 4: US expansion could be a flop

Another reason that investors believe Guzman Y Gomez shares justify a premium valuation is its US expansion. But I think investors should be very wary about this expansion and place little to no value on it until it has demonstrated this in the highly competitive market.

At present, it has a handful of stores in the US, and they are all loss-making. I have doubts they will be able to scale to a level that generates meaningful profits, especially given the competition it faces over there. Chipotle is essentially the Guzman Y Gomez of the United States and has approximately 3,400 restaurants across the country.

And that's just Mexican food competition. The United States has more fast food options for consumers than you can shake a fork at.

Reason 5: Conflicted bullish broker?

Guzman Y Gomez shares have been roaring higher in recent sessions after analysts at Morgans initiated coverage with an add rating and $30.80 price target.

While Morgans was not named in the company's prospectus, the AFR is reporting that the "broker quietly co-led the company's IPO, with its junior sell-side analyst even getting his slice."

In light of this, I would not place much weight on this recommendation. Instead, I would focus more on Ord Minnett's valuation of $15.00.

Conclusion

Overall, I think Guzman Y Gomez shares are vastly overvalued at current levels and could be destined to crash deep into the red once the hype dies down and if its growth plans start to falter.

In light of this, I plan to wait until its shares are trading in or around the $7 to $10 mark before considering an investment.

Motley Fool contributor James Mickleboro has positions in Collins Foods and Pro Medicus. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Chipotle Mexican Grill and Pro Medicus. The Motley Fool Australia has recommended Chipotle Mexican Grill, Collins Foods, and Pro Medicus. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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