The good news: Chipotle Mexican Grill, Inc. (NYSE:CMG) is up about 55% in eight months, clobbering the market and sitting comfortably in third place in the Best Stocks for 2018 contest.
The bad news: All of those gains came in the first half of the year. Chipotle shares heated up all the way through late August, then retreated all the way back to where they sat back at the start of June.
The … um, additional bad news: Several of InvestorPlace’s analysts have warned against buying the dip in CMG stock, and in fact, suggested selling. That latter call was largely prompted by news in August that Bill Ackman, who operates the Pershing Square hedge fund, had trimmed what was a 9.9% stake he had held since September 2016.
But before you go rushing out of Chipotle stock, here are a couple things to consider:
You Trim the Bushes, Don’t You?
Any experienced investor will tell you that you don’t always ride every last cent of your investment to the top. More conservative investors will lock in partial profits along the way, and in the event that one blockbuster holding shoots up so fast that it becomes an outsize part of your portfolio, you trim the fat.
Hence this passage from Reuters about Ackman’s CMG selling:
“He said the Chipotle position had grown to be more than 20 percent of his roughly $8 billion portfolio as the stock price appreciated and that it needed to be cut back. He has periodically trimmed positions as they became too big.”
Ackman wasn’t expressing anything bearish on Chipotle. He was just doing a little landscaping.
In fact, Ackman says he still “loves” CMG stock, telling Reuters, “Chipotle is in the very early stages of beginning to realize its potential.”
Chipotle Food Safety: Better Late Than Never
One of the biggest drivers of Chipotle’s losses since August came in the form of yet another foodborne illness outbreak, this time in late July. The CDC identified clostridium perfringens as the cause of nearly 650 reports of gastrointestinal sickness spawning from a single location in Ohio.
The selling started to pick up as more was learned about the illness, then intensified following a Wedbush downgrade. The analyst note included concerns that third-quarter comparable-sales would suffer because of the outbreak, as well as worries about profit margins and delays in menu upgrades.
When I first recommended Chipotle at the start of the year, I pointed out Chipotle’s extra short leash as it pertains to food safety, given all of its prior mishaps. That’s clearly still the case; CMG stock is off about 15% since its August peak, largely thanks to its latest flare-up.
But Chipotle has responded loudly to the Ohio incident, retraining hundreds of employees on food safety, adding software that helps the company’s field leaders monitor various aspects of the business (including food safety) remotely, and implementing quarterly food safety tests across its stores.
Wedbush may very well be right on the outbreak’s effects on Q3, but as for the longer-term, the analyst community has a few disagreements.
Jefferies, for instance, upgraded the stock to “Buy” in late July on more predictable metrics in “pricing and traffic-driven growth,” showing optimism in the chain’s ability to expand margins “back toward 20%+ levels.” In mid-August, Morgan Stanley upgraded CMG stock to the buy-equivalent “Overweight,” including this bullish note on the company’s turnaround plans:
“While still early days in the brand’s long-awaited recovery, there is increasing evidence that makes our bull case scenario more believable, including (1) a change in management, with an incentive plan designed to deliver the bull case in earnings (+$20 in EPS), (2) plenty of low hanging opportunities in marketing, product development and operational initiatives to drive sales, and (3) a more benign competitive environment.”
Those are reasons not to panic.
Caution is another thing.
Bottom Line on CMG Stock
CMG is first and foremost a momentum stock, so its fates have rarely been driven by value, other than perhaps at the bottom of its E. coli-driven dip in the second half of 2016. Still, critics of Chipotle’s valuations right now aren’t exactly wrong — this is a pricey stock. The company trades at 37 times next year’s expected earnings, and boasts a price/earnings-to-growth (PEG) ratio of 2.1 (where anything above 1 is considered overbought).
And while a few analysts do side with CMG stock, the truth is, the experts are quite bearish at the moment. Right now, CMG’s buy-hold-sell ratio is 7-23-5. That might seem middle-of-the-road, but remember: Wall Street analysts typically err to the buy side. So I read that as a fairly bearish grouping.
What’s most interesting about the analysts’ view on Chipotle, though, is the last the past six calls on it have been three buys and three sells — in other words, they’re at least starting to take stances. There’s just no real consensus about which way Chipotle is going.
I still believe in the Chipotle stock story just as much as I did on Dec. 31, 2017. The company needed to find the right leader — it did. It needed to work on expanding the menu — it is. And it needed to work on food safety — well, better late than never, I suppose.
But the stock could be frustrating in the near-term, especially depending on how strongly the latest illness headlines scared business away. I wouldn’t buy or sell here, but I’ll be watching for Q3 earnings – and may buy on any reactionary dip.