Buy Burrito Chain's Breakout for a Chance at Double-Digit Profits

Fast-food burrito chain Chipotle Mexican Grill (NYSE: CMG) is approaching an important technical juncture as it nears its all-time high of $442.40 set in April 2012. The stock bears careful watching to see if it can break above this resistance, and from there move significantly higher. If CMG was to take out that resistance level, it would create an enormous long-term base with an ultimate price target in the mid-$600s.

CMG has witnessed explosive growth. The share price doubled on the stock's first day of trading in 2006, from $22 to $44, and has now appreciated a whopping 1,750% from its IPO price.

When I last entered a position in CMG in July 2011, shares were priced at about $316. My target of $377 was reached in early 2012, giving traders a gain of almost 20% in about seven months. Ultimately, my target, set by using the measuring principle, turned out to be too conservative. The stock reached $442.40 a couple of months after I sold. Traders who bought CMG when I suggested and exited near the peak made 40% in less than a year.

The current technicals and fundamentals tell me another profitable trading opportunity could be on the horizon.

The stock's gains have been, and continue to be, driven by aggressive expansion. In 1993, Chipotle started out as a single burrito restaurant in Denver. Today, there are over 1,500 outlets across the U.S.

During the first six months of the year, 92 new Chipotle restaurants opened. Over the remainder of the year, another 70 to 90 restaurants are planned. The increased store presence -- combined with a growing hunger for healthy, fresh, fast food -- should drive future profits.

The technical picture for CMG is bullish.

CMG Stock Chart

Rising off an August 2010 low of $141.01, the stock formed a major uptrend line, surging to an all-time high of $442.40 in April 2012. Unable to sustain the peak, shares receded. In June 2012, the major trendline broke and an intermediate downtrend line formed.

By October 2012, the stock hit a low of $233.82, a level last seen in late 2010. Finding support here, shares began a slow, steady climb. A new major uptrend line formed, one which is still intact.

In April 2013, CMG successfully challenged resistance at $347.94, which is now major support. Nearly simultaneously, it broke the downtrend line.

After the breakout, shares stalled between $350 and $375 for much of the spring of 2013. In June, the stock tested $350 support, which also marked the intersection of the major uptrend line. CMG has been on a steady climb since.

On Aug. 1, shares hit a 52-week high at $418.23 -- a historical resistance level established around the same time last year when shares touched $419.69. Currently, the stock is trading slightly below this 52-week high.

If shares can successfully challenge nearby resistance at $419.69, CMG will bullishly break a small ascending triangle, marked by the intersection of the uptrend line and a small shelf of resistance that is now about three weeks old. If this level is penetrated, a test of the $442 peak seems all but inevitable.

Using the measuring principle, we can derive a target of $650.98. This is obtained by adding the height of the base ($442.40-$233.82 = $208.58) to the breakout level ($442.40+$208.58 = $650.98). The measuring principle projects a minimum target that should be achieved over time, but a more conservative price target of $549.95 could be reached by early next year.

The bullish technical outlook is supported by strong fundamentals.

For the upcoming third quarter, scheduled to be reported in mid-October, analysts project increased customer traffic will push revenue up 17% to $817.96 million from $700.53 million in the comparable year-ago period.

For the full 2013 year, analysts expect increased restaurant traffic due to new store openings will drive up customer buying resulting in $3.18 billion of annual revenue. This number would be a 16.5% increase from last year's $2.73 billion in sales.

The earnings outlook is equally solid. For the upcoming third quarter, analysts anticipate earnings will rise 22% to $2.77 per share from $2.27 in the comparable year-ago period. Analysts expect full-year 2013 earnings will rise 21% to $10.59 per share from $8.75 last year.

Although the burrito mega-chain is richly valued, the company is financially strong with $483.8 million in cash and no long-term debt. This liquidity gives the company the ability to continue expanding without straining the balance sheet.

Risks to consider: In the most recently reported quarter, Chipotle's food costs accounted for 33% of total revenue. This percentage was a 100-basis-point increase from the comparable year-ago period and was attributed to higher commodity costs. A continued increase in commodity costs could chip away at Chipotle's profits. However, some analysts believe food product costs could soon reverse, and that would mean even stronger margins for the company.

Recommended Trade Setup:

-- Buy CMG on a break above $446.05, above $442.40 resistance
-- Set stop-loss at $385.95, where the trendline in force from the October 2012 bottom would be broken
-- Set initial price target at $549.95 for a potential 23% gain by early 2014

Traders should continue to monitor the shares if they approach this level and, if appropriate, set a higher price target to maximize gains.

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