I have been very critical of Chipotle Mexican Grill, Inc. (NYSE:CMG) stock for a long time, and rightfully so. The long-term fallout from its E. coli breakout last year has been exactly what I expected.
When CMG stock was trading at $625 in 2015, I explained that it was headed to $400. When that happened, I went one-step further and used an analysis of downward revisions to earnings coupled with an inflated price-to-earnings ratio to support a thesis that Chipotle stock could tumble all the way to $200 by the end of 2017!
While the analysis still holds true today, there is one important element I missed in my previous analysis.
What’s Changed With CMG Stock?
Everything I predicted with CMG stock has come true. Most importantly, sentiment surrounding Chipotle stock could not be any more bearish, with it near 52-week lows despite a significant recovery in the market. This alone suggests the stock is preparing for a big move lower.
Therefore, given that all of the P/E multiple, investor sentiment and downward revisions to earnings factors I previously mentioned are correct, I could play it safe and stick with my original analysis that CMG stock will be $200 by 2017. Believe it or not, the price target would make a lot of sense.
However, I now think that despite these factors, CMG stock will not fall to $200. In fact, I figure it has one more big move lower, thereby creating new 52-week lows, and then Chipotle stock will begin to recover.
Previously, I spent so much time looking at earnings and how Chipotle’s much lower earnings per share would keep its P/E ratio well above the norm that I neglected its price-to-sales ratio. In many instances, price/sales are just as important as the P/E ratio for retail and institutional investors.
The reason is that investors are willing to accept the fact that earnings will be lower in periods of turmoil. Then, investors turn to revenue as a primary metric to value the company. The narrative is to look at revenue, ignore current margins and figure the company’s valuation in an “ideal” operating environment. In other words, it is a bet that margins will rise.
Therefore, when you look at a company like Chipotle that once had the fastest growth and some of the highest margins in the restaurant sector, it would be easy to see how some would view CMG stock’s 2.7x sales as an investment opportunity. This is especially true when McDonald’s Corporation (NYSE:MCD) is trading at 4.1x sales.
Regardless, things are going to be rocky for CMG stock short-term. This year, sales are going to decline roughly 7%.
Still, there is hope for a bit of a recovery given Chipotle’s new summer rewards program “Chiptopia”. The program, which started at the beginning of July and will go through September, will grant customers points based on the number of times they visit the fast-casual restaurant. Under the program, the greater the number of visits a customer makes with a purchase of $6 or more, the greater the rewards.
Unlike 2016, 2017 will be a different year as Chipotle’s comps will be very favorable for the company, allowing a return to top-line and margin growth.
As a result, CMG stock’s current price and performance relative to the market still suggests it will fall a bit lower, and after that, it will likely trade stagnant for a while.
However, as the fourth quarter approaches, and into next year, don’t be surprised if Chipotle stock starts to regain some of its appeal as price/sales and a return to growth come under focus.
As of this writing, Brian Nichols did not hold a position in any of the aforementioned securities.