Chipotle Mexican Grill, Inc. (NYSE:CMG) almost had Wall Street convinced that things had turned around. Almost. CMG stock had recovered some of its losses from more than a year’s worth of battering following a 2015 E. coli scandal, and management was enjoying a return of confidence in its ability to turn the ship around.
Recall that in 2015, Chipotle shares had soared to highs of more than $700. The company seemed unstoppable. The restaurant was opening up new locations left and right, and same-store growth was continuing mostly unabated. Customers were satisfied and believed they were getting a fresher, more sustainable product. Good for the environment meant good for customers meant good for shareholders.
But a couple days ago, CMG stock reeled amid customer reports that they had been sickened with norovirus after eating at a location in Virginia — claims that have since been confirmed. And now, the stock is tanking yet again after diners complained of rats (actually mice) in the restaurant, with one customer claiming that her meal was “ruined by rodents falling from the ceiling.”
Now come the questions. Has Chipotle done enough to ensure top standards in the supply chain? It’s hard to believe that, what with reports of 13 sick customers in Virginia, and a “structural gap” that allowed mice to get inside.
Meanwhile, investors really need to consider if a triple-digit earnings valuation on CMG stock is really worth it for a company that clearly has not put an end to its food-safety concerns.
Is It Different This Time Around?
After enough time has passed, consumers typically return to brands they historically used.
Even after a horrific incident involving cyanide-laced capsules of Tylenol in the early 1980s that killed seven people, Johnson & Johnson (NYSE:JNJ) managed to restore consumer confidence after costly recalls. JNJ did the right thing, as far as consumers were concerned, and today, is a trusted brand for reducing fevers and pain.
And Jack in the Box Inc. (NASDAQ:JACK) weathered the E. coli outbreak in 1993 after hundreds were struck ill four children died. That feels like a distant memory if a memory at all.
But we live in a time with far more options and more selective consumers that live in a world where social media broadcasts your mistakes with lightning-fast speed, ensuring that everyone knows about it, quickly, and typically with enough salt to poison a lot of mental wells.
Chipotle isn’t doing itself any favors by not having a perfect health record in the wake of its biggest disaster.
Bottom Line on CMG Stock
Even backing out the chaos of the past few days, Chipotle is no longer on the same growth trajectory that it was in the mid-2000s, and traffic trends remain weak, though marketing spend ballooned in an effort to retain customers. While it has tapered off, from 2015 to 2016, the increase was almost 50%, to $103 million.
And yet, during 2016, comparable-restaurant sales still declined more than 20%.
Turnarounds do take time, and Chipotle was making tangible progress. But even if Chipotle hadn’t just suffered a pair of flare-ups in the past few days, CMG stock in its current state doesn’t deserve to trade at more than 100 times trailing earnings, or even the more palatable 30 times forward estimates. Peers including Del Taco Restaurants Inc (NASDAQ:TACO), JACK, and Yum! Brands, Inc. (NYSE:YUM) all trade at forward P/Es around 20, and none of them are facing the same pressing questions into the cleanliness of their operations.
Not to mention, none of them have thrust the same high bar upon themselves.
One of the primary risks to Chipotle’s business, as outlined by the company itself, is that they “may not persuade customers of the benefits of paying [their] prices for higher-quality food.” Much of their success comes from customers believing in the value proposition.
A bout of norovirus and rodents falling from the ceiling are likely to have an adverse effect on that belief.
CMG stock is down double digits in less than a week, and those ripples should only continue as more doubt seeps in.
As of this writing, Luce Emerson did not hold a position in any of the aforementioned securities.