Best Stocks for 2018: Chipotle Mexican Grill, Inc. Still Has a Chance

The best stock of 2018 will come from the vomitorium

CMG stock - Best Stocks for 2018: Chipotle Mexican Grill, Inc. Still Has a Chance

Editor’s note: This column is part of our Best Stocks for 2018 contest. Kyle Woodley’s pick for the contest is Chipotle Mexican Grill, Inc. (NYSE:CMG). This article was updated on Dec. 20.

Chipotle Mexican Grill, Inc. (NYSE:CMG) might be one of the highest-potential stocks of its kind in 2018. But if you decide to roll the dice on CMG stock, you’ll want to have a bottle of Tums at your disposal.

The path forward ain’t easy.

Where Chipotle Went Oh So Wrong

Let’s start with a damage report. Chipotle stock is off by about 60% from its 2015 peak, including a 16% year-to-date loss that actually looks much worse when you consider it had been rallying for the first few months of 2017.

The initial spark was actually a disappointing third-quarter report, Oct. 20, that showed a deceleration in same-store sales — what now is a forgettable speck compared to what developed over the next two weeks. A massive E. coli outbreak that spanned nine states, sickened 64 people and led to the closure of dozens of stores wasn’t the start of the company’s food-safety problems, but it was the trigger that opened the media’s eyes to just how rampant Chipotle’s problems were becoming.

When you fold in three sickness outbreaks during the summer, as well as a norovirus outbreak in December, nearly 500 people fell seriously ill by eating in Chipotle’s restaurants in 2015.

CMG has since tried to reshuffle the deck in its favor, with various front-end comeback ploys such as three-month loyalty rewards promotion called Chiptopia, the addition of chorizo to its menu (which it ditched in lieu of offering queso — apparently an either/or proposition), and of course the aforementioned queso, which has so far failed to reinvigorate interest in the struggling burrito chain.

Meanwhile, in the background, CMG worked on reinventing its leadership by adding four new board members and ousting co-CEO Monty Moran in December 2016.

That left the other co-CEO (and founder) Steve Ells, in charge — for roughly another year, at least. Ells stepped down in 2017, leaving the company rudderless as it still tries to discover the magical growth formula that made it a 33-bagger from its 2006 initial public offering through its 2015 highs.

Enter the bull case for CMG stock.

Chipotle Stock Has a Chance to Fix Itself

Give Ells credit where it’s due: The blueprint he drew up for Chipotle — a paradoxically “healthy” fast-casual chain with thousand-calorie burritos — was sheer genius, playing to people’s egos as well as their stomachs. He also harnessed our laziness, pointing people toward tight menus that frequently up in price, without providing “dollar menu” alternatives or other cheaper options.

But he also prevented CMG from making the wholesale changes necessary to give the company a fighting chance at a legitimate, long-term comeback.

He didn’t prevent all change, of course. While the rewards program wasn’t a huge departure from Chipotle’s occasional burrito giveaways, the introduction of chorizo and queso was. Any new menu item is a big step for CMG stock and the company — the 2014 rollout of sofritas marked the company’s first truly new menu addition since the restaurant’s founding in 1993.

But Chipotle frankly needs more testing, and more changes, more quickly than the company previously has been comfortable with. Sofritas were a success that live to this day, but with chorizo out and queso on the ropes, we’re still really looking at only one significant menu improvement over the past few years. Even seasonal items would be a refreshing change for Chipotle stock and its customers — just something fresh to lure former and new patrons alike back through the doors.

The introduction of drive-throughs would also be a welcome addition. They drive the majority of sales at fast-food chains, and lacking the option can be a deterrent.

CMG stock also seems to have a culture problem.

The company suffered another norovirus outbreak this July that prompted more selling in Chipotle stock, as people thought the company had another food-safety problem on its hands. It did, but not because of the food-sourcing issue largely blamed for 2015’s health incidents — instead, it was chalked up to a manager ordering employees to work even while sick.

This came a few months after executives acknowledged a problem that hasn’t gotten a ton of media attention: customer service was lacking, with restaurants plagued by slower throughput and messy stations.

Chipotle stock has a nagging strike against it thanks to its dreadful string of high-profile outbreaks in 2015 — a memory that flares back up anytime something similar goes wrong at a CMG restaurant. In other words, it has less room for error than other restaurants. It can’t afford unrelated problems, such as low interest due to stagnant menus, or sub-optimal employees turning customers further off the brand.

CMG Stock: Nothing’s Guaranteed, But …

Chipotle stock is very much playing from behind, and any investor is going to have to deal with immense volatility. Any future food-safety incident will see far wider social and media coverage than it would if it happened to another restaurant. Consider examples such as the Dec. 20 dip in CMG amid reports of a possible illness outbreak in Los Angeles, as well as July’s struggles after Chipotle was hit by a norovirus outbreak and video of rodents falling from a restaurant’s ceiling.

However, at this point, hope has been all but priced out of CMG stock at a time when it has perhaps more open-ended hope than it has since 2015.

For all of its problems, analysts still believe the company is on pace to finish the year with 15% sales growth and a massive rebound in profits, from 77-cents-per-share to $6.66. They see that continuing in 2018, too, projecting still-favorable 9% top-line growth and 40% profit expansion. Meanwhile, CMG stock is trading at 2 times sales — less than the S&P 500 right now, and cheaper than it has been since 2010.

The key to all of this is new leadership. While a willingness to innovate and try new things aren’t a guaranteed cure for what ails Chipotle, the past couple of years have proven that a glacial rate of change certainly won’t do the trick. Whoever comes in has to be ready to ruffle feathers.

But if a new CEO is successful in lighting the spark, there’s upside aplenty. For as optimistic as analysts’ estimates seem, they’re not — 23 of the 35 analysts covering CMG stock have “hold” calls, and another five say the stock is a “sell.” That’s as bearish as the typically buy-friendly Wall Street community gets.

An operational turnaround wouldn’t just make Chipotle stock look organically better, but it could also prompt a wide swing in analyst perception, fueling rapid share gains for 2018 and longer.

Kyle Woodley is the Senior Investing Editor at Kiplinger.com, and he can be reached at kwoodley@kiplinger.com. As of this writing, he was long CMG.


Article printed from InvestorPlace Media, https://investorplace.com/2017/12/best-stocks-for-2018-chipotle-mexican-grill-inc-still-has-a-chance/.

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