Its burritos I find to be delicious. Its stock, however, I wouldn’t touch with a 10-foot pole. After markets closed on Friday, Chipotle Mexican Grill, Inc. (CMG) announced that customers were abandoning the chain en masse after the most recent spate of E. coli outbreaks.
That’s all, folks … CMG stock is done. Fin. Over. The end.
Once one of the best growth stocks in the market, CMG shares have entered meltdown mode, cratering 30% in less than two months.
Here’s why that decline is only the beginning of a much longer, more severe one.
A Chronology of Events
First, in mid-October, CMG posted disappointing third-quarter earnings. Shares took a single-day, 7% hit.
It was here that Chipotle’s remarkable, multi-year run truly became visible: In particular, the rising cost of labor and rising minimum wages were already forcing Chipotle to raise menu prices, and with labor costs set to increase even more, CMG’s economics were quickly becoming untenable.
Then, in early November, reports of E. coli began surfacing in Washington state and Oregon; the outbreak was linked directly to Chipotle. In the following weeks the number of infected ballooned from 19 to a current count of 52. It was just two states at first — now, it’s nine.
Naturally, the media took notice, as did consumers and investors; and CMG stock has been in steady free fall throughout the coverage. But we had little insight into just how severely this was hitting Chipotle’s business.
On Friday, that changed: The burrito chain said that same-store sales fell by as much as 20% after the initial cases were reported, and that same-store sales could slump between 8% and 11% in the fourth quarter as a result.
CMG was already suffering through a swift and worrisome deceleration in same-store sales: Q3 2015 same-store sales rose an anemic 2.6% vs. the red-hot 19.8% growth seen in Q3 2014.
While I’m sure Chipotle can eventually get to the bottom of the E. coli outbreak and eventually restore public confidence in its food, that will take a while. Yum! Brands (YUM) and McDonald’s (MCD) are still feeling the ripple effects in China from a food-sourcing scandal, in which one of their major suppliers was selling expired food.
With Chipotle now trading at 27 times forward earnings, though, even a leveling-off in same-store sales wouldn’t do much to restore CMG’s longer-term woes. As I noted in October, rising labor costs literally give the company a growth ceiling, as the company must either force the higher costs upon the consumer or reduce its workforce.
Chipotle, which uses an assembly line model to process customers more efficiently, certainly isn’t cutting its workforce, and in September hired 4,000 workers in a single day.
With that in mind, Chipotle’s multiple must necessarily contract for CMG stock to be an attractive buy for investors, who may be plagued with several quarters — and perhaps years — of same-store sales declines and earnings disappointments.
As of this writing, John Divine did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @divinebizkid or email him at firstname.lastname@example.org.