- $50 million was pumped into marketing and promotion in the first quarter with more to come. The company only made $67 million net income in Q4.
- The "Better Burger" initiative is a distraction at present. Chipotle needs to re-build its brand, not sell more menu listings.
- The long term technical chart looks ugly. If the stock were to break $400, the bears would be out in force.
Many investors believed that the bad run Chipotle Mexican Grill (NYSE:CMG) shares had undergone since last October was over when the stock reached $533 a share in early March, but the stock couldn't hang on to its 2016 gains and is now down more than 3% year to date. It should now seem evident to investors that Chipotle's recent food safety issues will affect the company's earnings for longer than many anticipated which is why this stock (despite currently trading almost $300 off its 2015 highs) is not a buy at the moment. It's ironic that this company built its reputation by insisting on top quality fresh ingredients for its kitchens, but is suffering by not living up to the expectations the brand had built.
Another fresh food scare would be detrimental to any hopes of a recovery and must be avoided at all costs. Furthermore, first quarter guidance has been dialed down by the company, which is worrying. Chipotle is now guiding an EPS loss of $1 or worse and lower margins ( 4 to 6% max I suspect) for the first quarter which really hammers home how the company has increased its costs in recent months. ( labor costs, marketing, promotion and ongoing legal costs). Chipotle is nowhere near the company it was, so don't let the cheaper valuations entice you just yet.
One of the main reasons why I believe Chipotle won't be able to recover lost ground quickly is its operating margins. These margins which had reached 17.3% in 2014, are predicted at 5% this year, a direct result of the elevated spending the company is currently doing - spending that I believe can't be switched off any time soon. $50 million alone was used in the first quarter for marketing and promotional programs which is the largest marketing budget in the company's history. Moreover, more resources will be piled into direct marketing which will take place from February to May of this year. Now here is what investors should really take note of.
Does one really think that Chipotle will pull back on its marketing efforts if it sees same store sales decline meaningfully? Not a chance. Furthermore, does Chipotle really think it will keep all of its customers when it eventually retires the burrito give-aways? What's the takeaway? While many analysts are predicting a strong recovery in 2017, I fail to see it because I believe spending will remain elevated. Same store sales will improve but at a large cost. Remember, Chipotle only brought in $67 million in net income last quarter and even when you include the company's recent share price fall, its earnings multiple (30.82) is still above industry average, illustrating that this stock could have further to fall before it corrects its ship.
I'm also a bit perplexed why Chipotle has decided to enter the hamburger business which contains fierce competition from the likes of Shake Shack (NYSE:SHAK), Habit Restaurants (NASDAQ:HABT) and privately held Five Guys. Isn't it ironic that this move is coming so soon after the company's e-coli crisis? I just believe it's far too soon to even think about undertaking a move into the burger side of things, especially with the stock down so much from its highs. Should valuable resources and time be put into an unproven venture or should every ounce of energy be put back into restoring the company's brand and Mexican food that made it. I think it's the latter as I can't foresee Chipotle being able to generate high operating margins long term from its "Better Burger" initiative.
If we look at the long term technical weekly chart, we can see that Chipotley stock found support at just over the $400 mark in January of this year (trend line drawn) but what is quite obvious is that the stock is now well under its 200 week average. Many investors are stating that Chipotle is a buy at $400 a share but there is no way of telling if support at that level would hold again. What is evident is that analysts EPS estimates for 2016 continue to fall which is affecting the share price. I would wait for these numbers to stabilize before even entertaining the idea of scaling into this stock. In fact, since Chipotle will probably end up being a long drawn out recovery story, a limit order at the 200 weekly average would be the most prudent play in getting long this stock. There are too many risks at present and traders should also note that the 5 day RSI indicator still hasn't reached oversold levels, so the selling may not be finished just yet here.
To sum up, I would recommend staying clear of Chipotle stock for the time being. The stock is trading well below its 200 week average and recent guidance has illustrated that a recovery is still a long way off. Furthermore, I feel the company's burger initiative will only distract from the core issue which is to rebuild the brand. Finally, I feel elevated spending will not taper off anytime soon which will keep operating margins depressed at least until early 2017.