- Health concerns could harm Chipotle Mexican Grill’s (CMG) reputation in the short-term.
- Non-recurring expenses put a dent in Chipotle Mexican Grill’s profitability for the next year.
- Patient long-term investors could benefit from the recent correction in the Chipotle Mexican Grill stock price.
Wow! Shareholders of fast casual restaurant chain Chipotle Mexican Grill (NYSE:CMG) recently saw the price of their shares decline an incredible 45% from its 52 week high. Concerns about CMG's supply chain (and related investigations) stemming from E.coli and norovirus outbreaks sent CMG stock stumbling. Does this mean CMG shares are a bargain? The short answer is yes. However, long-term minded investors will need to suffer through some short to immediate term storms and uncertainty. Let’s examine.
CMG's Brand Will Suffer In The Short-Term
Customers filled with fright over potential poisoning and illness will most likely want to shy away from the restaurant chain especially following reports of 120 sickened students at Boston College. CMG’s management believes that same store sales will come in at a 14.6% decline in Q4 2015. Criminal investigations surrounding a Chipotle Mexican Grill location in Simi Valley, California could also hurt customer traffic. This certainly provides evidence of the suffering of the CMG brand.
CNBC reports that Chipotle moved away from some of its “food with integrity” cooking processes to preserve food safety. This may actually cast doubt on “organic food” in general. The paradigm of healthy food in the national discourse may shift back to food with antibiotics and preservatives. If this happens then Chipotle Mexican Grill could lose its competitive edge.
Moreover, The Associated Press stated that Chipotle Mexican Grill Co-CEO Steve Ells said "the company will likely never know what ingredient was to blame for the E. coli cases.” If accurate, then serving food free of antibiotics and preservatives is no guarantee that consumers’ health will improve or even stay intact. This could also shake the public’s faith in its “food with integrity” program. Chipotle Mexican Grill needs to figure out a better way to keep its supply chain in check to better ensure the safety of its consumers.
Short-term fundamental risk
Non-recurring expenses stemming from fines, lawyers, cleanups, internal investigations, etc. could have a meaningful impact on CMG’s profit and cash flow. Chipotle Mexican Grill said this about the investigation by U.S. Attorney’s Office for the Central District of California, “It is not possible at this time to determine whether we will incur, or to reasonably estimate the amount of, any fines, penalties or further liabilities in connection with the investigation pursuant to which the subpoena was issued.”
However, as of the Q3 FY 2015, Chipotle sat on a rock solid balance sheet with $604 million in cash and equivalents. Moreover, the company possesses no long-term debt. If nothing else the company could take on some debt to help fund its operations during this difficult period.
Uncertain Market Price Risk
Chipotle Mexican Grill has always been regarded by Wall Street as a “growth company”. CMG's P/E ratio hovered above 30 for most of the time during the past five years (see chart below). Even now it trades at a P/E ratio of 25 versus 20 for the S&P 500 as a whole.
This means that its stock price has a lot more room to fall, especially if things are worse than generally anticipated. Uncertainty regarding non-recurring expenses casts doubts on valuation measures. Lower EPS readings due to non-recurring expenses could mean that valuations could expand even if the CMG stock continues to decline.
Financial History Reveals A Bright Spot
History offers indications that popular brands generally recover. CNBC cites analysts that say brands eventually recover even after companies see sales slump for as many as four quarters. Jack In The Box (NASDAQ:JACK) experienced an E. coli outbreak 23 years ago. Since then, Jack In The Box shares returned 963%, not including dividends. Rivals Yum Brands (NYSE:YUM) and McDonalds (NYSE:MCD) have also suffered from major food safety issues. This means that long-term investors could benefit from Chipotle Mexican Grill’s lower stock price and lock in a better return in the long run.
Long-term investors, noting the current volatility in Chipotle Mexican Grill stock, should try to see past CMG’s issues. The company still serves a quality product and strives to bring satisfaction to its customers. Value minded investors with a long-term mindset could be rewarded vastly; a recovery back to its 52 week high would represent a whopping 82% potential return. However, keep in mind this may take a couple of years to happen. Watch Amigobulls' CMG stock analysis video for a quick roundup of key fundamentals.