Amid weak same-store sales growth, I recommended investors avoid Chipotle Mexican Grill (CMG, Financial) a few weeks ago. I argued that the stock will continue to fall due to the weak performance and overvaluation, and that there will be a better entry point for patient investors.
The recent E. coli outbreak has put more downward pressure on Chipotle’s stock as it is now trading at around $500, 20% lower than when I recommended investors to wait. Although the stock has plunged considerably, I think Chipotle still may have 10% downside potential and investors should continue waiting before buying into the stock.
Earnings will be painful
The recent E. coli outbreak will have a huge negative impact on the company’s earnings and sales in the short term. As a result, the stock could still fall about 20% in the next three to six months.
The company will see a slowdown in traffic and may fail to meet the estimates that justify its current valuation. Customers will avoid eating at Chipotle until the company deals with the recent fiasco, and this will ultimately lead to slashing of estimates and falling same-store sales in the coming months.
However, the woes are short term, and long-term investors should use Chipotle’s underperformance as an opportunity to open up a long position in the stock. Given Chipotle’s focus on quality, I expect the company to come out of the recent fiasco. While the recovery will take time, I have no doubt that it will happen.
Chipotle has a lot of room to expand and has just started expanding its wings over the international market. The company’s focus on healthy eating fueled its meteoric rise over the last 10 years, and with the company expanding internationally, I can see the stock moving higher in the long term.
Overvalued
Despite the great long-term outlook, Chipotle’s short-term woes will continue pushing the stock lower. Even after the recent plunge, Chipotle is trading at a premium valuation. Investors have priced in years of growth into the current price as the stock is trading at a trailing P/E of just under 30.
However, due to the latest outbreak, I expect Chipotle’s same-store sales to fall considerably in the upcoming quarter and this will not do well with the Street. Hence, investors should wait for a few more months before buying Chipotle, as I expect the stock to offer an even more attractive entry point in the near future.
Conclusion
Although the long-term prospects of the company look good, I think the stock has more downside to offer and will continue falling for a few more months. Hence, patient investors should wait for a better entry point and avoid the stock for the time being.
