Chipotle (CMG) revitalized the American quick service food industry and paved the way for the rise of the fast casual restaurant. Once a lowly subsidiary of McDonald’s (MCD), Chipotle emerged as a dominant player in its own right. The company now hails with 2,000 stores and has become a leading restaurant brand.
But the company has hit hard times recently. A massive food safety scandal has hit Chipotle, sending customers fleeing. Year over year sales have fallen as much as 30% in the aftermath. CMG stock has gone with it, dropping several hundred points from last year’s highs. Has the company fallen far enough for investors to buy now for the turnaround?
CMG Stock: Pros
Excellent Historical Performance: It’s easy to discredit Chipotle due to its recent struggles. But that would unfairly lose sight of the company’s outstanding performance over the past decade and longer. For the past 10 years, revenues have grown at 21% a year compounded. That’s outstanding!
Even more impressive, EBITDA has grown at 29% compounded annually, and operating income at a jaw-dropping 35% yearly. Put another way, since 2005, EPS grew from $1.43 a share to $15.10 a share. That’s a more than 10x increase. Net income went from $38 million in 2005 to $476 million in 2015. Sales grew from $628 million to $4.5 billion. When you think of a successful growth company, you could hardly pick a better example than CMG stock.
Fantastic Balance Sheet: While Chipotle is going through a rough patch, things could be worse. For one, CMG has a fantastic balance sheet. The company has no debt whatsoever. Against that, the company has almost $700 million in cash and marketable securities. Against the company’s market cap, the cash isn’t a huge portion of assets, but still, for a company going through a crisis, having some savings and no creditors to worry about is an enviable position.
As the company considers various strategies to repair its brand, it won’t be limited by financial capacity. If the company wants to spend heavily on food safety, advertising, giveaways, or whatever else, it has the funds. And on the financial side of the ledger, it has the capacity to execute a significant share buyback should CMG stock reach a compelling price.
International Potential: At this point, Chipotle only has a couple dozen international locations out of its massive store base. And most of these are in Anglophone countries such as Canada and the United Kingdom. So far, Chipotle has had fairly slow sales abroad, particularly in England.
CMG has blamed this on a lack of awareness for the company’s brand and a general unfamiliarity with Mexican food outside of the Americas. However Mexican food as a cuisine is very trendy in global upper class circles at the moment. The market is wide open for the first chain that popularize the concept outside of the Americas. And Chipotle’s domestic problems with food safety are less of a concern abroad.
CMG Stock: Cons
The Food Safety Scandal: All the pros are good and well, but we can’t avoid the elephant in the room. CMG stock has fallen for one main reason: people are scared to eat at their restaurants. The company has had an ongoing series of food safety events where customers or employees have gotten ill. These started last fall and have continued, with the most recent occurring as recently as March. It’s unclear what part of the supply chain is contaminated, and when Chipotle will finally be able to resolve the problem once and for all.
In the meantime, Chipotle sales have been down 25% to 30% versus last year as the scandal drags on. At first, analysts had forecast a speedy recovery for Chipotle sales and CMG stock. But as new incidents continue and sales figures remain in the dumps, it’s becoming more clear that this scare is not just a quickly-passing issue. Chipotle is trying various measures such as higher safety standards, improved employee training, and free product giveaways to rehabilitate the brand and bring back customers. But so far, progress has been slow.
Chipotle Isn’t Profitable Anymore: Chipotle had been notable for being among the country’s most profitable restaurants. Its consistent 20% return on equity ratio put it into an elite tier of fast-growing companies. But, naturally, a 30% drop in sales is hard to shake off.
The company now anticipates losing a dollar or more per share in the current quarter. This is a far cry from the $4 or so per quarter the company used to earn. Banking firms such as Wedbush predict CMG won’t be able to complete its turnaround until 2018. Far from just one bad quarter, 2016 appears to be a lost year for the firm, as far as generating profits or shareholder value go. Not only are sales down big, the company also faces higher costs for food safety, burrito giveaways, and labor costs, among others.
Chipotle Has An Identity Crisis: Chipotle’s special sauce, so to speak, was that it was known for better ingredients. It had many organic or at least more humanely-produced ingredients. This has been an issue before. Previously, Chipotle had issues stocking enough carnitas meat produced in a way appropriate to the brand’s higher standards.
However, the company now faces not just a meat shortage, but an identity crisis. Chipotle built its reputation with younger consumers on being different from the rest of the fast food industry. Now, to avoid sickening any more customers, CMG is consolidating the supply chain. That means less local produce and a more centrally-organized food system. The big edge that made Chipotle unique may be gone. What worked for a chain of 20 or 200 restaurants may not scale at 2,000. If Chipotle does try to maintain its more natural and ethical ethos, its food costs are likely to rise sharply.
Chipotle Stock: Verdict
There’s too many unknowns to buy CMG stock with confidence. The company has done great in the past. However, the ongoing food safety crisis is a company-defining event. And it’s simply too early to tell if Chipotle will come through this scandal with its soul and reputation intact. If you want to take a shot on things going well, I’d wait for CMG stock to fall to $400/share before buying.
At the time of this writing, Ian Bezek didn’t have a position in any stocks mentioned. You can reach him on Twitter at @irbezek.
More From InvestorPlace:
