Most readers who follow the stock market are well aware of Chipotle (CMG) and its recent struggles. CMG stock has been absolutely decimated since last fall, with shares plunging roughly 50% to $390 per share from its peak at $758 per share last year.
The catalyst, of course, was the spate of food quality issues that caused hundreds across the country to get sick. The CMG stock price took a severe beating as negative press and repeated incidents caused same-store sales to fall 30%.
But today, it’s not irrational to start thinking to yourself: “Just how low can shares go? Should I actually entertain buying Chipotle stock at these prices?”
Buckingham Research analyst John Zolidis answered that question in the affirmative today, initiating coverage of Chipotle with a “Buy” rating and a $547 price target for CMG stock, implying roughly 40% upside from current levels.
You may be able to divine my stance on that call by the title of this article, but allow me to highlight a few specific reasons why I think Zolidis and Buckingham are dead wrong about CMG stock.
CMG Stock: Not Even a Value Trap
Stocks that have fallen dramatically and appear to be cheap but could still burn shareholders are often referred to as “value traps.” In these cases, the metrics will tell you that the stock is extremely undervalued, enticing value investors to buy and ultimately suffer, as the stock gets cheaper and cheaper.
The Gap (GPS) and Kohl’s (KSS) might both be considered value traps at current levels, with shares of each retailer down between 40% and 50% over the last year. GPS has a price-to-earnings ratio of just 9.7, while KSS trades for only 12 times earnings. However, both are victims of the dying mall retail industry, and personally, I think they’ll keep getting cheaper.
CMG stock, on the other hand, has seen a similar meltdown in its share price, yet its metrics still show that it’s crazy expensive. Chipotle stock goes for 37 times earnings and 33 times forward earnings while carrying a price/earnings-to-growth ratio of 6.8. A reading below 1 is considered cheap.
Meanwhile, CMG fell 7% in the first quarter, analysts have said it could take years for the company to recover from its stumble and revenue is expected to fall 6.6% this year.
That’s not all. The company has been aggressively using its cash coffers to buy back more and more CMG stock — and since Chipotle stock has been plunging, this has done nothing but destroy shareholder value and makes the company less liquid.
To illustrate the emergent liquidity risk here, all one has to do is look at the burrito chain’s rapidly declining bank account. At the end of Q3 2015, CMG had over $959 million in cash and short-term investments. Fast forward to the end of Q1 and Chipotle has just $250 million in the bank, down 74% from two quarters prior.
In Q1, Chipotle earned operating cash flows of $61.7 million, while spending $583.8 million, or 9.5 times that amount, on stock buybacks. That sort of spending is clearly unsustainable and ultimately unwise.
When you add in the fact that Chipotle was already seeing same-store sales decelerate dramatically before the era of outbreaks, we have one very troubled company here. Why would anyone want to buy CMG stock?
The $547 price target is a joke, and I hope investors don’t take it seriously. While Chipotle may be able to claw itself back to a place of respectability in the long-term, I doubt CMG stock will be seeing anything near $547 for years.
There’s an old saying on Wall Street: “Don’t try to catch a falling knife.” I understand the temptation, but wait for things to smooth out — if they ever do — before even thinking about buying Chipotle shares.
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 email@example.com.