Chipotle Mexican Grill, Inc. (NYSE:CMG) is bound to keep disappointing investors and the Street — as it did on June 20 — for a very simple reason: Many, if not most, investors, analysts and pundits think that Chipotle’s same-store sales will follow the same pattern as other restaurant chains that suffered food-borne illness outbreaks like Taco Bell in the U.S. and Kentucky Fried Chicken in China, but Chipotle is fundamentally different from those chains.
Investors should sell Chipotle stock. The shares are bound to keep dropping as the company’s results will continue to miss the Street’s overly optimistic forecasts.
The Big Problem for CMG Stock
Chipotle is different than other restaurant chains that dealt with foodborne illness outbreaks because its biggest selling point was and is the supposed healthiness of its food. Nobody who is worried about healthy eating goes to Taco Bell or Kentucky Fried Chicken very often. But many of Chipotle’s biggest fans were very concerned about healthy eating.
Since words like “E. coli” and “nonovirus” are the very antithesis of healthy eating, it’s going to take CMG much longer to win back those consumers than it took Taco Bell and Kentucky Fried Chicken to convince their devil-may-care devotees to return to their restaurants.
That’s certainly a big reason why Chipotle’s results aren’t yet close to where they were in 2015, before the foodborne illness crisis began. And it helps explain why the company has had to resort to spending more on marketing and promotions to lure consumers to its restaurant. That is, because the company can’t convince health-conscious consumers to return, it’s being forced to use more promotions and discounts to lure consumers who are more interested in value
So the valuation models that many analysts have constructed based on the experiences of Taco Bell and Kentucky Fried Chicken are about as valuable as burritos made a month ago.
But doubtlessly, the very high valuation of CMG stock (even after the decline of the last few days, it’s still trading at a very-high 35 times consensus 2018 earnings per share estimates) is largely based on these incorrect models. And many of the 2018 EPS estimates are probably based on the same flawed idea, so in reality CMG stock is probably trading at something like 45 times the company’s 2018 EPS outlook.
Of course, Chipotle is facing other difficult headwinds. Many pundits and analysts, including me, have pointed out that CMG stock is facing much tougher competition now than it has in the past.
For example, during a recent trip to New York City’s Union Square, I noticed that the Au Bon Pain there had an elaborate salad bar. Au Bon Pains didn’t have elaborate salad bars three years ago. And the small coffee shop in Newark, NJ I occasionally visit just put in a salad bar. Most small coffee shops didn’t have salad bars three years ago. And as I pointed out in a prior column, Panera Bread Co (NASDAQ:PNRA) has proclaimed that it is using “100% clean” ingredients, and McDonald’s Corporation (NYSE:MCD) last year committed to serving only chicken that was raised without “antibiotics that are important to human medicine.”
Many analysts and investors think that Chipotle’s recovery will emulate the rebounds of Taco Bell and Kentucky Fried Chicken, but CMG’s healthy, premium brand is very different from the low-cost, junk-food model of the other two chains. Consequently, Chipotle will have to greatly increase its marketing and promotion spending in order to attract more value consumers, and its same-store sales numbers won’t recover as quickly as the Street and bullish investors anticipate.
Investors should stay away from this troubled brand, which is also facing much more intense competition than in the past, and they should sell CMG stock.
As of this writing, Larry Ramer did not own any of the stocks named.
