It wouldn’t be a stretch to say that Chipotle Mexican Grill, Inc. (NYSE:CMG) hangs on a precarious ledge. Nearly one year after Chipotle stock was brutalized following a food poisoning outbreak, company executives are desperately righting the ship. A number of promotions were introduced to help jimmy up foot traffic that was understandably decimated. To their credit, the fast-casual restaurant has pulled out all the stops, but will it be enough for CMG stock?
Aside from rectifying the health breaches, Chipotle’s first priority is to reestablish customer trust. Naturally, that means slashing prices and tempting offers to convince the public to give CMG a second chance.
So far, the strategy is working better than expected. Earlier in July, CMG introduced its “Chiptopia” loyalty program. Those that met the program’s purchasing criteria were given free catering in return. As a result, the company announced that 85,000 customers are set to receive their reward. Since Chiptopia’s rollout, Chipotle stock is up roughly 8%.
The Bullish Argument for Chipotle Stock
With all the troubles that CMG has absorbed, you would assume that the company books would be pressured, if not outright distressed. However, that’s not the case. Chipotle stock isn’t burdened with debt, so the company doesn’t have to worry about financing its way out of the hole. That discipline carries over into its cost controls, where management has prevented overhead from ballooning.
There’s also strong evidence that the sales drought for CMG stock is stabilizing. In the most recent second quarter of fiscal year 2016, revenue hit $998 million. This not only was a hair above consensus estimates, it also matched sales from fourth-quarter fiscal year 2015, where the food poisoning affect was first reflected.
Significantly, Q2 revenue was 20% higher than the prior Q1. Like many fast-casual joints, Chipotle stock benefits from seasonally consistent demand. The top-line growth further confirms that the promotions are having their desired effect.
CMG Stock Still Has Steep Challenges
The irony of course is that the promotions are having their undesired effect. Gross margins for Chipotle stock have slipped badly from the 26% rate that investors could count on like clockwork. More concerning is the fact that the most recent reading on gross margin is less than 16%. That compares very unfavorably to the 20% seen in Q4 of last year. When you strip away the accounting jargon, what you’re left with is sales growth at a high cost to profitability.
It’s no surprise, then, that CMG stock fell short of its Q2 earnings per share target. With operating and net margins falling off a cliff — in some cases, going into negative territory — investors can’t rely upon steady profits. And since the oft-cited price-to-earnings ratio is dependent upon earnings, Chipotle stock doesn’t look like such a great deal, despite the price chop.
But the real issue comes down to faith. Do investors believe that the worst is behind Chipotle stock? Or is the newfound optimism — CMG stock is up 5% over the last week-and-a-half — merely a bull trap?
The Biggest Question for CMG
The contrarian argument is obviously alluring. Since the outbreak first affected the markets, Chipotle stock shed 40% of value. For a company that has been a Wall Street darling for quite some time, the discount is tough to ignore. If we wanted to get technical, CMG stock could be forming a long-term, rounding bottom formation.
That would be very bullish indeed!
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But back in 1993, shareholders of Jack in the Box Inc. (NASDAQ:JACK) were likely saying the same thing following their food poisoning debacle. Those that felt the bottom was in dived into JACK stock after it had stabilized a few months after the outbreak. They would eventually learn a terrible lesson.
I’m not here to suggest that Chipotle stock will meet the same fate. Inarguably, the Jack in the Box incident was far more tragic and severe. It was also a very different time.
Nevertheless, you can’t ignore the possibility that CMG could experience additional volatility. The horizontal trading pattern experienced by Chipotle stock and JACK starting from the fifth month following their respective outbreaks is eerily similar.
The bottom line for CMG stock is that the company is fundamentally sound. The restaurant industry is experiencing broad headwinds. The fact that Chipotle is still very much in the fight is a tremendous credit to the organization. The discounted price, therefore, is a speculative, but smart risk.
However, don’t go overboard! As history shows, CMG stock still has a long way to go before it can earn investors’ confidence.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
