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Harsh Jain
Harsh Jain
Articles (219) 

Chipotle's Turnaround Chances Are Very Slim

The company trades at a high price-earnings ratio, suggesting it is expensive

July 14, 2017 | About:

Chipotle Mexican Grill’s (NYSE:CMG) downturn started after reaching its all-time high two years ago. The company’s shares were moving upward at a rapid rate, but the outbreak of E. coli reversed its movement. While the company was repairing its damaged brand image, it was hit by another outbreak of norovirus.

Several issues related to food safety at Chipotle confronted the core of its mission statement: “Food with integrity.” Although several other restaurants have also faced food safety-related issues, the situation is completely different in Chipotle’s case as its business was built mainly on the food safety model.

After disappointing shareholders in 2016, the stock was off to a good start this year, surging nearly 32%. The stock, though, has sagged once again and is up just 5% year to date. The burrito chain has lost many of its customers due to food safety issues. Moreover, the company’s profits plunged 95%.

In spite of Chipotle’s long-term growth potential and high restaurant-level returns, the company’s concerns related to lower sales as well as earnings are not over and could continue hurting it for some time.

When Chipotle was hit by the outbreak of E. coli, norovirus and salmonella, its primary focus was to improve its food quality. The restaurant chain took various safety measures to improve its food quality and has been successful in implementing those measures.

The company now faces the challenge of winning back consumers. The burrito chain expects to inaugurate 190 to 210 new restaurants this year with full-year comparable sales in the high single digits.

Furthermore, the company also is spending massively on marketing and promotion in an effort to drive sales. It expects its marketing and advertising costs to surge in the range of 20 to 30 basis points in the current quarter compared to its previous quarter, accounting for 3.6% to 3.7% of sales.

On the other hand, the company expects its food costs to account for 34.2% of its overall sales, up from 33.8% during the first quarter. In all, the final result of overall shrinking margins has left several analysts scrambling to pull their earnings targets.

Apart from this, Chipotle also is aggressively focusing on digital orders which appears to be a smart move. In February, the company introduced “smarter pickup times” service, enabling consumers who order digitally to get shorter and more precise pickup windows. Most significantly, its digital orders surged almost 54% in the first quarter compared to a year ago.

Summing up

Although the company’s sales have started to recover, it is still early. It is likely that the company’s comparable same-store sales will continue to move upward (not so fast), but the same does not apply to the bottom line.

The company’s marketing and promotion costs carry on rising which will further pressure earnings in the following quarters. As a result, it will take several years of robust growth for Chipotle to return to where it was before the outbreak of E. coli.

Moreover, the stock trades at a high price-earnings (P/E) ratio of almost 122, considerably greater than the industry’s average of 33 (ttm). Also, Chipotle’s P/E ratio is higher than other players in the restaurant industry.

I would recommend that shareholders watch the stock from the sidelines until and unless it gets back to the same earnings growth mode as before the food safety crisis.

Disclosure: No position in the stock mentioned in this article.

Rating: 4.0/5 (1 vote)



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