Thanks to the emergence of the Millennial generation and its subsequent societal and workplace shifts, the fast-food industry has become even more complex and competitive. Old rules simply don’t apply, which partially explains why Chipotle Mexican Grill (NYSE:CMG) has surged in the markets. Since the start of 2019, the Chipotle stock price has nearly doubled.
What makes the tremendous momentum in CMG stock all the more remarkable is its recovery from almost certain disaster. Back in late 2015, the fast-casual restaurant suffered a health crisis from a food-poisoning outbreak. It shattered what had been up to that point a sterling reputation. Worsening matters, the outbreak launched a federal investigation.
That’s behind the company now, as you can see from the Chipotle stock price. After concerted efforts to win back consumer trust – including margin-killing discounts and special offers – CMG gradually entered back into customers’ good graces.
Honestly, I shouldn’t have been so surprised. As we saw from the massive Equifax (NYSE:EFX) data breach, Americans are willing to forgive almost anything.
But like any good company, Chipotle is not satisfied with merely recovering from disaster. Instead, management is now targeting a platform that has long been a staple of the fast-food business: the drive-thru. If implemented successfully, it could spark a new leg up for CMG stock.
I think it’s a brilliant idea. Anecdotally, McDonald’s (NYSE:MCD) has made their drive-thrus more attractive and efficient. In my opinion, they’re lightning-quick. What’s not anecdotal is how much McDonald’s invested in their drive-thru business.
Similarly, CMG could deliver efficiencies in the drive-thru and pick-up window platforms, which could then drive up the Chipotle stock price. But with the already dramatic valuation bump, is this rally still viable?
Stagnation a Worrying Factor for Chipotle Stock
From a purely strategic perspective, you’ve got to like what management is doing. Implementing both drive-thrus and pick-up windows for online orders will compete directly against traditional fast-food establishments, knocking out their key advantage. After all, Chipotle arguably beats them in taste and health; bringing added convenience to the table makes fast food increasingly irrelevant.
Sometimes, though, the investment narrative doesn’t always align with positive, smart strategies. That’s the case with CMG stock. Despite a remarkable turnaround effort and continued innovations, CMG represents a “three-quarters” investment: all of 2019’s gains between January through September.
It’s curious, then, that the bulls are having trouble pushing the Chipotle stock price beyond the $840 level. Rather than blaming irrational trader psychology, I believe this resistance area has a fundamental explanation.
Back in 2006 – the year of its initial public offering – Chipotle’s total revenue (including global sales) was equal to 0.23% of U.S. restaurant and eatery sales. By 2015, this metric was an impressive 0.83%. For perspective, McDonald’s U.S. sales in 2018 only took 1.2% of domestic restaurant sales. Clearly, Chipotle was challenging everyone in the space, bolstering the case for CMG stock.
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But in 2016, the fast-casual eatery absorbed substantial fiscal pain from the food poisoning epidemic. As a result, the company’s total revenue slipped to 0.68% of U.S. restaurant sales.
To be fair, 2019 is on track to be a record sales year for Chipotle stock. Therefore, it’s possible that the company’s revenue is back to equaling 0.83% of total domestic sales. But it would also mean four years of unnecessary stagnation.
Additionally, as Chipotle attempts to expand its footprint, it must deal with the law of large numbers. That means investments in growth will yield smaller percentage gains. And that’s where I worry about the competition.
Fast Food (or Fast Casual) Is a Tough Business
Don’t get me wrong: Chipotle’s recovery story should be covered in every business class. Further, management is doing exactly what they should. But the reality is that proving the doubters wrong (like me) was the easy part. Now, they’re back to the year 2015, minus the health crisis. How can they grow from here?
Although the common assumption is that millennials eschew fast food for healthier fare, I think the matter is more nuanced. Millennials are diagnosed with obesity-related cancers at an alarming rate, so they’re not nearly as healthy as they think. This also suggests that convenience, not health, is the motiving factor for young eaters.
If that’s the case, I wouldn’t bank too heavily on CMG stock. Simply put, competition in the fast food or fast casual space is fierce. You have names like Yum! Brands (NYSE:YUM), Domino’s Pizza (NYSE:DPZ) Jack in the Box (NASDAQ:JACK) and El Pollo Loco (NASDAQ:LOCO), among many others competing for consumer dollars.
Some of these names may offer better upside because of their lack of heightened expectations. For instance, LOCO is an interesting idea because it serves healthier food than your typical fast food joint. They also have generous portions, making them better value picks for the consumer.
Ultimately, I appreciate what Chipotle has done. I’m sure many books will be written about their exploits. But the real work starts now. Given the high probability that the good news is priced in, I’m going to let Chipotle stock cool down.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
