Chipotle Mexican Grill, Inc. (CMG) stock has been stuck between $400 and $500 for the better part of 2016. After losing 30% of its value in the last year — and another couple of percentage points after hours Tuesday — it is clear that shareholders are trying to hold out and see if CMG can recover from the E. coli breakout that spread into at least nine states, and has weighed on both earnings and Chipotle stock.
Unfortunately, the range that has been created in Chipotle stock won’t hold, and eventually, CMG is going to $200.
CMG Has Real Problems
One look at Chipotle’s recently announced earnings will unveil major problems at the company. Its comparable sales declined nearly 30% and its net loss went from a gain of $122.6 million last year to a loss of $26.4 million.
Therefore, it is kind of hard to take co-CEO Steve Ells seriously when he says, “our sales are on a gradual path to recovery,” or support his plan to expand as quickly as possible — 200-plus stores this year — to counter the rapid decline of comps and margins.
While we can certainly find strengths and positives in Chipotle’s earnings report, it is important to realize that investors are responding to CMG stock compared to earnings expectations.
In retrospect, there is nothing good about a double-digit decline in overall sales and significant margin pressure.
Nevertheless, investors fully expected the big losses in Q4, and anticipate a slight decline in overall revenue during 2016. But looking ahead, investors are just assuming that CMG can regain its lost luster, and catapult sales by 17% in 2017.
While that 17% increase would be compared to a slight decline in 2016, it would represent an all-time high in annual revenue, by a double-digit margin. That’s quite optimistic given how long the effect from Chipotle’s E. coli breakout has lasted, and that earning revisions have trended lower on a monthly basis for most of the last year.
Furthermore, investors need to remember that prior to the outbreak, CMG store traffic was already starting to slow substantially, if not peak. The company was obtaining high-single, low-double-digit same store sales growth by increasing menu prices. And consumers were willing to pay.
Nowadays, the market has changed.
Not only does a CNBC survey that was conducted this year suggest that 50% of people have stopped eating at Chipotle altogether because of the E. coli breakout, but CMG has completely abandoned the game of price hikes in favor of free burrito coupons. Ultimately, giving away food weighs on margins.
Why $200 for Chipotle Stock?
All things considered, I think it is fairly obvious that expectations for CMG are too high headed into 2017. Still, the company is expected to earn $6.12 per share this year and $13.20 next year, which represents a reduction of more than $6 and $3, respectively, for each of the next two years. Assuming that CMG can hit these targets, which I doubt, then it is currently trading at a stock multiple of 72 and 33 times 2016 and 2017’s respective EPS.
In comparison, Darden Restaurants, Inc. (DRI) has legitimate growth and trades at just 16x EPS for the fiscal year ending May 31, 2017. Albeit, there is no logical way to conclude that Chipotle stock is worth more than DRI, not when the EPS expectations for 2017 are likely too high.
If we apply the same 16x multiple to 2017 as DRI, then CMG would trade at $211 by the end of 2017. That is a far more reasonable price for a company that has so much turmoil and uncertainty around it. Granted, it may take some time for Chipotle stock to reach these levels, with the stock being oversold and many investors willing to bet on the company’s past.
But in the end, fundamentals drive long-term stock performance, and that does not bode well for Chipotle stock owners.
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Editor’s Note: The spelling of Chipotle founder and co-CEO Steve Ells was corrected. We apologize for the error.
As of this writing, Brian Nichols did not hold a position in any of the aforementioned securities.