Why Is Chipotle A Great Long-Term Bet Despite Dull Quarterly Performance?

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May 11, 2015

Fast-casual food industry leader Chipotle Mexican Grill Inc. (CMG, Financial) was in the news earlier this week for making available on its website its guacamole recipe, but it made much bigger waves last week when it announced its decision to rid its menu of all GMO items, a goal it has been working on since early 2013. The only item to use artificial additives still is the tortilla, and Chipotle is developing a new recipe to fix that, too. However, this is expected to create supply problems for the company and will increase input costs. There are also growth concerns, based on the last quarter results and the guidance for the rest of the year set out by the management, which expects growth to slow down considerably. The stock price has fallen by close to 10% in the last two weeks. Does this mean that the company has fundamental problems or is the drop in share prices a good entry point?

A ripple effect

A week after the Chipotle announcement, the other industry bigwig, Panera Bread Company (PNRA, Financial) announced that it is purging artificial additives from its menu as well and is 85% done already. Even if there are associated cost and sourcing issues as a consequence, the two market leaders are already on board the non-GMO train, and it seems only a matter of time before many others follow suit, though it will be no easy task. Also, this move to serve food that is perceived to be healthy (since the jury about actual health benefits is still to come out) is bound to benefit the companies sooner rather than later, as is clear from the fact that even traditional fast-food superheavyweight McDonald’s Corporation (MCD, Financial) has announced plans to start cutting out human antibiotics from its poultry supply.

The cost of ethics

As an ethical stance, the decision to remove GMO ingredients from its menu is a laudable one and in sync with Chipotle’s stated commitment of serving “Food With Integrity.” The same can be said for its decision in January this year to suspend a pork supplier for not matching up to the company’s standards for the housing of animals. While the effect of a GMO-free menu is yet to be seen (and there will certainly be one), the pork issue led to a shortage of the meat, and the company was forced to pull carnitas from the menu at a third of its outlets, leading to a 2% reduction in comprehensive store sales, which in turn disappointed investors when the company announced its last quarterly earnings. This pork shortage, by the management’s own admission, is likely to persist through the year, and will consequently hurt sales.

Delivery and takeaway

The long queues at Chipotle show its popularity but the long waiting times also lead to some potential customers walking out without buying anything. The company is trying a two-fold approach to tackle this issue. One is the experimentation the company is doing with takeaway outlets, the kinds it has opened in Europe. The other, more important one perhaps, is the delivery option the company is now trying out. Perhaps taking a hint from a similar offering recently started by Starbucks Corporation (SBUX, Financial), Chipotle has tied up with Postmates for delivering its food in 67 cities, and the fee for delivery should also bring in additional revenue for the company.

Conclusion

While the company’s latest results disappointed many investors, viewed objectively, the company actually performed very well on all fronts. Its ethical stance on GMO may hurt it somewhat, and it may not be able to pass on increased costs to customers easily, but the move is certain to benefit it in the long term, especially given its mostly "millennials" target customer base. Its new delivery service should reap rich dividends, too. And all of this doesn’t even take into account the potential for the company to expand both domestically and internationally.

However, the market is often looking at the short term only, and the company’s guidance for comparatively slow growth this year will probably not see the stock performing very well in the next few months. Consequently, levels below the $620 point and specifically closer to the $600 make for a very good entry point in this stock, which is certain to yield great returns in the long term. We recommend a strong BUY on Chipotle.