The food poisoning scandal that has throttled the reputation of Chipotle Mexican Grill, Inc. (CMG) isn’t just leaving a bad taste in the consumer’s mouth.
Once considered unassailable due to its ravenous fan base, CMG stock began a largely unmitigated tumble last October. That was when the Centers for Disease Control and Prevention linked several cases of food-borne illnesses to Chipotle restaurants.
In response, CMG management has made a series of statements and promotions to address consumer fears. The question is: Will it be enough to save Chipotle stock?
On the surface of it, the trendy “fast fresh” restaurant has been hitting the right note given the circumstances.
Late last week, Chipotle announced a buy-one-get-one-free promotion for all nurses that show valid identification. Communications director Chris Arnold ramped up the sweet talk, noting that “[n]urses are selfless individuals who go above and beyond every day,” according to Business Wire. Coincidentally, CMG stock popped up 2% on the day of the announcement.
Can Marketing Save CMG Stock?
The BOGO special will likely be one in a series of efforts to win back consumers. Early in the year, CMG announced that it would boost its marketing budget to $50 million in the first quarter, or an increase of 300%. That’s critical since sentiment is split.
The Los Angeles Times reported that some customers would continue eating at Chipotle, so long as the prices stay reasonable. Others will take more convincing. With such critics in mind, CMG has also implemented a multi-million dollar food safety program across its supply chain to prevent future outbreaks.
But here’s the problem — BOGO isn’t cheap. One of the reasons why investors loved CMG stock is due to its profit margins. Excluding the scandal-induced figures, Chipotle stock buyers could depend on ever-rising margins.
Translation: The company could raise prices, and the hoards would still come knocking down their doors. In that way, CMG had the “it factor” of Starbucks Corporation (SBUX).
Not so over the last eight months. Gross margins in the fourth quarter of fiscal year 2015 slipped to 20%, a substantial erosion from the average 28% margins seen in the first three quarters of the year.
But in Q1 of fiscal year 2016, the rate fell to 7%. Looking at this from a different angle, cost of goods sold accounts for 93% of top-line sales.
With many other expenses still needing to be covered, this strategy — if it were to continue — would be the textbook definition of unsustainable.
Despite exceeding Wall Street consensus estimates for Q1, CMG stock tanked 6% in the markets the day following the earnings release. Investors recognize that Chipotle has to resort to some desperate measures. At the same time, they don’t want to see the company driven by price, but by brand.
That’s really the only viable option for CMG and Chipotle stock. Their above-average food quality means they can’t compete with the local taco shop down the corner. In addition, lower prices or margin-killing promotions won’t restore the pandemonium they regularly generated on any given workday.
Whatever Chipotle does, they need to get on it quickly and decisively.
Since the eight months after the initial outbreak, CMG stock is down more than 30%. In contrast, when the Yum! Brands, Inc. (YUM) owned Taco Bell had a food poisoning issue in 2006, YUM stock actually gained double-digits eight months after the event.
What made JACK’s turnaround possible was their marketing campaign, specifically, their comedic mascot. Through brilliant use of humor, the company was able to win back the public trust. In addition, they stayed true to their core business plan of delivering fast food at attractive prices.
In order to engineer their own turnaround, Chipotle has to find a way to bring back their customers without sacrificing the reason why investors bought CMG stock in the first place.
While the public relations outreach and the BOGO promotions have people talking, shareholders require efficient use of their dollars. So far, it’s not happening.
Until management can prove Chipotle can return to healthy profitability, CMG stock currently stands on very shaky ground.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.