Should You Buy Chipotle Mexican Grill, Inc. (CMG) Stock? 3 Pros, 3 Cons

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Chipotle Mexican Grill, Inc. (NYSE:CMG) announced its third-quarter results last week. Depending on who you listened to, they were both good and bad. Chipotle stock holders certainly didn’t think much of earnings, considering they sold off in a hurry.

Should You Buy Chipotle Mexican Grill, Inc. (CMG) Stock? 3 Pros, 3 Cons

So, who’s right?

That’s a trick question, of course, because we all know earnings are a subjective matter and seriously open to interpretation.

If you have owned Chipotle stock since before the E. coli break last November, and you still hold, you’re naturally going to buy into what co-CEO Steve Ells had to say both in Chipotle’s press release and earnings conference call. You just are.

And if you’ve been shorting CMG stock since the outbreak, you’re going to be as skeptical about its Q3 report as you would if someone gave you a three-dollar bill. You just are.

At the end of September, I included Chipotle stock in my list of 7 Make-or-Break Earnings Reports Coming in October. I essentially argued that investors would be looking for some kind of sign that declining sales are coming to an end. They also wanted to see that Chipotle had a plan beyond begging customers to trust them.

As the action post-earnings has shown, CMG is finding it incredibly difficult to gain any upward momentum. Since announcing its earnings after the market closed Oct. 25, Chipotle stock has lost 11% of its value and is trading at its lowest point since May 2013.

With that encouraging lead-in, here are three pros and three cons to consider before buying into CMG stock.

Chipotle Stock Pros

Better Valuation: Forget for a moment that Chipotle’s margins haven’t been shredded like a bad piece of Swiss cheese. Now, consider where its stock was a year ago before the one-two punch hit it square in the gut.

First, Chipotle delivered its Q3 2015 earnings report on Oct. 20, and that included the worst quarterly sales growth in over two years. Only two days later, the E. coli outbreak hit the news, and things went from bad to worse.

At the end of September 2015, Chipotle stock had a price-to-sales ratio of almost 5 — nearly double where it sits today. Over the past five years, CMG’s P/S ratio has never been this low. In fact, in March 2014, Chipotle traded at nearly 6 times sales while McDonald’s Corporation (NYSE:MCD) could barely muster 3.5 times sales. Today, McDonald’s P/S ratio is 3.9 and Chipotle’s on the outside looking in with a P/S ratio of just 2.8.

From a sales perspective, Chipotle stock is certainly cheaper. While a lot of that is a function of declining comps, don’t overlook it. When its comps go positive, its earnings will take flight.

Bye Bye, ChopHouse: Co-CEO Steve Ells announced last week that Chipotle was ending its Asian food experiment in order to focus on burritos, burgers and pizzas. In August, I suggested that ShopHouse, along with Tasty Made and Pizzeria Locale, made good distractions for a company that has been forced into a siege mentality as a result of the E. coli scare.

The decision to put ChopHouse up for sale doesn’t change my opinion. Chipotle clearly has decided that if it was going to bet on future growth concepts, its pizza and burger brands had a much better chance of success.

Admitting when you’re licked and moving on is a big part of growing a business. Some things work, and some don’t.

ChopHouse obviously didn’t.

Comparable-Store Sales, Transaction Declines Slowing: You have to walk before you can run. As many have mentioned in recent months, Chipotle has to regain the trust of both customers and investors. That’s not an easy process, and it won’t happen overnight.

Its monthly comparable-restaurant sales in September declined by 20.1% — a big improvement over January’s decline of 36.4%. At the same time, its September comps decreased by 13.4%, 20.3% better than in January.

The trend is your friend, as they say. Barring any major setbacks on food quality issues, it’s possible we could see positive monthly comps before the end of the year. Regardless, it’s a big step in the right direction.

Whether investors choose to buy into Steve Ells’ assertion that “people are feeling better about the brand” is another thing altogether.

Chipotle Stock Cons

Negative Monthly Comps: Chipotle has suffered four consecutive quarters of comps, and a fifth hangs in the balance. That’s not great news for a restaurant concept that as recently as Q1 2015 was still generating double-digit quarterly comps (and whose stock seemed headed to $1,000).

The naysayers rightly point out that despite CMG introducing a completely overhauled food safety program, it’s only one food scare away from a stock price under $100. That’s a lot of pressure for a company that’s trying to reignite growth in its biggest concept.

Chipotle can’t afford to make any mistakes over the next 12 to 24 months if it wants its turnaround to stick.

Early Reviews Not Good: As mentioned earlier, Chipotle has put ChopHouse and its 15 locations up for sale so it can concentrate on its three remaining brands. That includes Tasty Made, whose first location opened Oct. 25 in Lancaster, Ohio.

Tasty Made is trying to be old school selling just burgers, fries, shakes and sodas. However, the early reviews on its food and concept are anything but encouraging. Customers have taken issue with everything from the price of a meal (expensive) to the size of its milkshakes (small) to the lack of healthy sodas (Coke, etc.) to the taste of its burgers (mediocre).

While Tasty Made’s branding is bright and energetic, if it doesn’t get its act together when it comes to the product offering, it’s possible that Chipotle won’t even open 15 locations (number of ChopHouse locations) before it has to pull the plug on another of its pilot projects.

Earnings a Little Light: Last year in the third quarter, Chipotle reported operating income of $235 million on $1.2 billion in revenue. For the entire 2015, despite a fourth-quarter 14.6% decline in comparable-restaurant sales, CMG managed to deliver its best year yet in terms of operating income and revenue, $754 million and $4.5 billion, respectively.

Yet investors can’t help but notice that earnings — the basis for setting stock prices — fell off a cliff.

For the trailing 12 months through Q3 2016, Chipotle’s operating income was $108 million, one-eighth the amount generated in fiscal 2015. That’s the same amount as it generated in 2007 … but on $1.1 billion in revenue, not $3.9 billion.

Chipotle’s earnings have sprung a big leak, and no amount of public relations is going to change that.

Bottom Line for CMG Stock

I find it hard to believe that Americans are going to stop eating burritos at Chipotle. Maybe they won’t be as over-the-top about the brand and will sample the competition, but in the end, if Chipotle has cleaned up its act from a food safety perspective, the profits will return.

And when they do, Chipotle stock will no longer be selling for less than $400.

Should you buy CMG? I’d say yes, with the caveat that you treat this as a speculative purchase and not a blue-chip stock.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.


Article printed from InvestorPlace Media, https://investorplace.com/2016/11/chipotle-mexican-grill-inc-cmg-stock-3-pros-3-cons-iplace/.

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