Chipotle Mexican Grill’s (CMG, Financial) shares have been on a downhill run since the first safety issue at its restaurants in July 2015. The stock is down nearly 60% from its all-time high and 18% year to date. Also, the stock trades at a level not seen since 2013 and looks like it will not be able to turn things around anytime soon.
The burrito chain has experienced a huge decline in average visits, and its top line remains well below where it was before the food safety issue. Also, the drop in customers hurt its profitability with net income margins falling to just 0.6% in 2016, representing a decline of 10% compared to that in 2015. Although the burrito chain’s profitability has recovered somewhat this year, it still remains weakened.
Queso is one of the most popular menu items in the U.S. In the past, Chipotle avoided adding queso to its menu in order to prevent the use of industrial additives used in quesos. The burrito chain, though, launched the healthy queso nationwide last month but failed to impress consumers.
Chipotle introduced queso to compete efficiently against small competitors who have been serving queso with burritos and chips for years as well as to regain its lost customers. Before rolling out queso nationwide, Chipotle first began testing queso in around 350 stores in California and Colorado.
During the testing period, Chipotle’s queso received tepid reviews, which many said had a powdery and grainy texture. On the other hand, Del Taco Restaurants (TACO, Financial) also launched its new queso blanco – free of artificial flavors, colors or preservatives – last month. It has been getting good reviews mainly due to its smooth and creamy texture.
Moreover, Del Taco’s queso is available as an add-on for just 50 cents. Del Taco’s queso side order, without chips, costs $1 compared to Chipotle’s $2.10. As of now, it looks like Del Taco has won the queso war with Chipotle. To make matters worse, many customers have also claimed that Chipotle has degraded the quality of its chips.
As of now, Del Taco’s queso poses a direct threat to Chipotle, which makes things even more difficult for Chipotle at a time when it is already trying hard to regain its lost customers. Apart from this, the burrito chain will also face problems going forward due to weak industry trends.
Consumers are demanding high-quality products at lower prices, which in turn forces grocery stores to reduce their food prices in order to survive in the highly competitive environment.
As a result, same-store sales growth has been gloomy over the past few quarters. Foot traffic and profits at many restaurant chains have also declined. Moving ahead, the second quarter accounted for the sixth consecutive of negative same-store sales for the restaurant industry.
Summing up
Food safety scandals over the past couple of years have taken a toll on Chipotle’s share price. The burrito chain, though, is putting in a lot of effort to repair its damaged brand image. At present, it is necessary for Chipotle to improve its comps in order to recover profitability, and queso probably would not be the catalyst to make that happen. Also, the company’s operating expenses continue growing at a considerable pace.
Chipotle trades at a price-earnings (P/E) ratio of almost 65, suggesting it is still expensive keeping in mind the existing profitability level. If the burrito chain’s profitability recovers to 2015 levels, situations could change entirely, but that is not going to happen anytime soon as the company needs to do a lot of work to regain its lost customers.
I would recommend shareholders watch the stock from sideways and wait until the company’s path to profitability looks clear before initiating a position in the stock.
Disclosure: No positions in the stocks mentioned in this article.
