Struggling fast-casual chain Chipotle Mexican Grill, Inc. (NYSE:CMG) is replacing its current CEO (who is also the founder). The market likes the move. In an off-day for the market, CMG stock is up 3% on the news. Its an interesting move upward for a much-maligned stock.
Clearly, investors are fed up with the current turnaround strategy. They are hopeful that a new CEO can finally energize the turnaround shareholders have been waiting 2 years for.
But does this renewed hope make Chipotle a buy? Far from it. A new CEO can’t fix the problems plaguing CMG stock. Plus, it is still overvalued considering the company has lost its luster.
Overall, I think this move is nothing more than a head-fake. I say fade the rally. Chipotle looks more like the next Subway than a rebound story in the making.
A New CEO Can’t Fix Chipotle’s Problems
The positive price action movement in CMG stock says one big thing: investors don’t have much faith in founder and current CEO Steve Ells leading a Chipotle turnaround.
Who can blame them? It has been more than 2 years since an E. coli breakout which sank CMG stock, and the fast-casual chain has yet to show signs of anything resembling a turnaround.
That isn’t usual. Chains like Yum! Brands, Inc.’s (NYSE:YUM) Taco Bell bounced back from similar outbreaks in a much shorter time frame. Today, not many consumers remember that Taco Bell had an E. coli outbreak in 2006.
Naturally, investors have grown weary of the current turnaround plan at Chipotle and are excited to hear that new strategies may come forward with a new CEO.
Unfortunately for Chipotle shareholders, management isn’t the problem here. In many circles, Chipotle is viewed as the Bubonic plague of the food industry. The big E. coli outbreak in 2015 gave the restaurant that reputation, and a few minor health-related incidents since have kept that reputation around 2 years later.
The real kicker (and the big difference from Taco Bell) is that Chipotle’s slogan was “Food with Integrity.” Taco Bell is a fast-casual chain widely known to serve food of questionable quality. An E. coli incident at Taco Bell isn’t expected, but it certainly doesn’t kill the company’s image. People buy Taco Bell because it tastes good and is cheap — not because its good for them.
But one of the main reasons people ate Chipotle in such great volumes was because it was supposed to be good for you. After two years of health-related incident after health-related incident, its tough for consumers to believe that Chipotle still serves food that is good for you.
In other words, CMG’s reputation appears to have suffered irreparable damage. A new CEO can’t fix that. Nor can a new CEO fix the fact that said health-conscious consumers have moved on to other health-oriented fast-casual chains. Just think of how popular popular acai bowls, poke bowls, chicken sandwiches and sushi burritos have become recently.
Regardless of who is that helm at Chipotle, a turnaround is unlikely to materialize.
CMG Valuation Still Doesn’t Make Sense
The only other reason to buy CMG stock, then, is valuation.
But CMG is a far stretch from being fairly valued.
CMG stock trades at 32x the consensus fiscal 2018 earnings estimate. That multiple is about as big as it gets in the established quick service restaurant space.
Considering comparable sales growth is marginally positive while lapping huge declines, margins are still under significant pressure, and revenue growth is slowing dramatically, CMG stock does not deserve the richest valuation in the established quick service restaurant space.
Bottom Line on CMG Stock
Investors are excited about the prospects of getting a new CEO at Chipotle to shake things up and maybe kick-start a real turnaround.
But a new CEO can’t fix the problems plaguing CMG stock. A new CEO can’t quickly mend Chipotle’s hugely damaged reputation, nor convince everyone to stop eating poke.
What is the most likely outcome for CMG? Subway.
Like Chipotle, Subway was once a red-hot, health-oriented fast-casual chain with huge unit growth potential and a great value proposition. But Subway eventually lost its favor among consumers. Low-cost Subway sandwiches were replaced by low-cost Chipotle burritos. Now, low-cost Chipotle burritos have been replaced by low-cost poke and super-food bowls.
Subway is still in decline today, 5 years after same-store sales started to dip into negative territory.
I think Chipotle follows a similar trajectory. If so, CMG stock will only keep falling.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
