After multiple food-poisoning scandals, I couldn’t confidently see a case for Chipotle Mexican Grill (NYSE:CMG) to recover. Obviously, I was wrong. Chipotle stock is one of the strongest publicly traded companies this year, having soared 67% since the beginning of January. So why then am I still bearish on its prospects?
In fact, a couple days ago, I discussed my three reasons to sell CMG stock. Contrary to initial gut reactions on the internet, I don’t have anything against Chipotle. I love their fresh ingredients and lightning-quick service. It’s a great place to placate your hunger when you’re tight on time.
But these factors don’t make Chipotle stock a reasonable investment at current prices. Again, shares are up 67% year-to-date. Without any context, you instinctively recognize that CMG needs a fresh batch of supportive evidence to justify the risk.
This is where I’m hesitant in recommending CMG stock. Although the underlying company’s recovery efforts are nothing short of supremely impressive, the markets don’t run indefinitely on past achievements. As things stand, shares are technically overheated. Fundamentally, no clear justification exists to support such a premium.
Nevertheless, Chipotle stock continues to defy gravity, attracting more buyers to its cause. Still, I’d urge caution. Here are three additional reasons why I’m not convinced on the fast-casual eatery’s prospects:
Growth? What Growth?
Back during the immediate aftermath of the food-poisoning controversies, Chipotle stock belonged decisively in the speculation category. However, the company eventually attracted fundamental investors with its strong growth trajectory.
In the first quarter of 2016, revenue dipped to an alarming, multi-year low of $834.5 million. But for its most recent fiscal report in Q4 2018, CMG boasted $1.23 billion in sales. From the lows, this surge represents a growth rate of 47%.
Without any context, that’s an impressive performance. But what takes the shine off this coating is that CMG stock was on a clear, upside trajectory prior to the scandals. In Q3 2015, the fast-casual restaurant rang up $1.22 billion in sales. If we use this figure as a comparative baseline, then Q4 2018’s revenue haul was up less than 0.7%.
In other words, Chipotle is only substantively growing compared against the crisis framework. But against the normal framework, the company spent three years getting back to even ground.
Don’t get me wrong: management did an excellent job keeping the organization afloat. But I doubt Wall Street will continue driving up CMG stock based on a return to business as usual.
Industry Headwinds Will Slow Chipotle Stock
A natural comeback against my last point is that management needed time to rehabilitate their brand’s image. Moving forward, this is where they will start putting meat on the table.
I appreciate this argument. Furthermore, I’d be willing to give it credibility if it weren’t for the fact that the restaurant industry itself is under pressure. According to experts in the field, the entire restaurant segment will likely grow but at a slower pace.
In particular, fast-casual and quick-service restaurants may notice a slowdown from 5.1% growth in 2018 to 4.9% this year. While individual names could upset this dynamic in either direction, the forecasted deceleration aligns with broader sector trends.
For example, retail sales in restaurants and other eating places totaled $54.4 billion in December 2018. This represented year-over-year growth of 4.5%. But in December 2017, restaurant revenues increased by more than 4.7% YOY.
Yes, these are small percentage declines. But it’s in the granularity where you find the real narrative. Right now, the data is telling us that Chipotle’s industry is steadily slowing. Thus, it’s a great time to sell Chipotle stock into strength before everyone else catches on.
CMG Stock Is Vulnerable to a Recession
Personally, I don’t want to expound upon my final point because it makes me look like a negative Nancy. But in the interests of covering all angles, I must address the pink elephant in the room.
Chipotle’s turnaround efforts are not only impressive, but inspiring. The company employs many people, providing vital opportunities across the nation. That said, nothing occurs in a vacuum. To paraphrase Sir Isaac Newton’s scientific work, for every action, there is a reaction.
In Chipotle’s case, the leadership team did everything necessary to jumpstart traffic and boost sales. Unfortunately, though, that move comes at a cost to profitability. Just look at gross margin or net margin from full year 2015 to 2018: you can fit the Grand Canyon in those gaps.
I’m not second-guessing management as their decision was the only viable one. But it doesn’t take away from the fact that if a recession strikes, Chipotle stock is in trouble. After all, competitors like McDonald’s (NYSE:MCD) or Domino’s Pizza (NYSE:DPZ) spent the last three years growing their businesses, not recovering from a crisis.
I genuinely hope that we don’t fall into an economic downturn because it does none of us any good. Still, it’s a real possibility, which is another reason to sell CMG stock at its current premium.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
