There are few places that I could eat quite literally every day of my life. Chipotle Mexican Grill, Inc. (CMG) is one of them. I can almost smell the steak grilling as I write this … that said, Chipotle stock has seen better days.
CMG traded hands at over $750 per share in October of last year. Today, it trades for barely half that.
Between a health scare, sagging earnings and an inflated stock price, CMG stock didn’t have much of a chance.
Adding insult to injury, Chipotle is now being sued by a group of shareholders claiming that the company’s stock repurchase plan intentionally inflated the stock price for the benefit of company insiders.
Regardless of whether the case has merit, whenever a “story stock” has its narrative unravel, things tend to get ugly. And Chipotle was the ultimate story stock: A health-conscious restaurant on the front end of the “fast casual” dining trend serving “food with integrity.”
So what’s the story? What changed Chipotle stock from a Wall Street darling to a soggy tortilla, and is there any hope for a turnaround? Let’s take a look.
Three Things Weighing on Chipotle Stock
Health Scare
I love Chipotle’s enormous burritos enough to risk an E. coli infection. But then, with as much travelling as I’ve done in South America, I could probably swallow a hand grenade and not get indigestion, so I may be a little outside of the mainstream here.
Most restaurants could pretty easily survive an isolated health incident. Most diners are understanding enough to know that, given enough restaurants and enough time, something like this is bound to happen occasionally.
The problem is that Chipotle’s health woes just never seem to end. There were multiple incidents spanning the better part of six months. That’s a little harder to swallow (pun absolutely intended).
Making it worse, Chipotle is under criminal investigation over the incidents … so this promising to drag on for a lot longer.
Earnings Shortfalls
Due in no small part to the health concerns, Chipotle stock has had some major earnings misses of late. In the first quarter, Chipotle reported its first quarterly loss in its entire history as a public company … and it reported lower same-store sales for the second quarter in a row. Comparable store sales last quarter were down a gut-wrenching 29.7%, and food testing and cleanup ate up fully 35% of revenues.
Looking forward, there is no immediate cause for optimism. The consensus analyst estimate for this coming quarter is just $0.96 per share. The consensus estimate for full-year 2016 is $4.72. To put that in perspective, CMG stock earned $15.10 per share in 2015. Analyst see earnings rising back to $11.82 next year, but it’s safe to say that Chipotle’s profit machine is broken at the moment.
Inflated Stock Price
Whenever a stock is priced for perfection, you’re likely to be disappointed because nothing ever quite seems to go as expected in the real world. And that’s essentially where CMG stock was. For most of 2014 and 2015, CMG stock traded at 5 to 6 times sales. That’s an astronomical valuation for a restaurant stock.
As point of comparison, consider that McDonald’s Corporation (MCD) — the largest and best-run restaurant company in the world — has spent most of the last decade trading between 2 and 4 times earnings. But even that understates Chipotle’s valuation because McDonald’s is mostly a franchiser rather than an operator, and franchisers tend to trade at a higher multiple.
The good news here is that Chipotle stock’s valuation has been taken down a few notches after the recent stock price collapse. Today, CMG trades at a little less than 3 times sales … while this by no means guarantees that we’ve seen the bottom, I would say that a patient investor would likely do well buying here, though I don’t necessarily see the stock turning around tomorrow.
On an earnings basis, CMG stock still looks a little rich, trading at 37 times earnings. But remember, earnings are massively depressed after two truly horrendous quarters.
It will take several quarters for Chipotle’s earnings to normalize, but if you believe in the trend towards fresh and fast-casual food, Chipotle stock might be worth buying on dips.
Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. As of this writing, he did not hold a position in any of the aforementioned securities.
