This restaurant, plagued by E.coli outbreaks last year, is beginning to turnaround, and Wall Street is jumping on the bandwagon. In the past few weeks, Wells Fargo has upgraded it to ‘Outperform’ and Credit Agricole, to ‘Buy’.
Chipotle Mexican Grill (CMG)
From Ian Wyatt’s Million Dollar Portfolio
Chipotle Mexican Grill (CMG) has been one of the top fast-food stocks of the last 10 years. Ever since its IPO and spinoff from McDonald’s (MCD) in 2006, Chipotle stock has been favorite holding for growth investors.
After an IPO at $45, Chipotle shares rose to an all-time high of $758 in June 2015. That marked a 1,585% increase for the stock. Yet the food safety issues late last year sent shares plunging.
Last fall, the company had E. coli outbreaks linked to its restaurants. The initial E. coli outbreak resulted in the temporary closure of 43 stores in Oregon and Washington for one week. This was followed by additional outbreaks in California, Illinois, Maryland, Minnesota, New York and Pennsylvania. In total, 52 customers have gotten sick. If that wasn’t enough, a norovirus outbreak in Boston affected 120 customers. That restaurant has been temporarily closed.
It now appears that these food safety issues have ended. On Monday, the U.S. Centers for Disease Control and Prevention announced that Chipotle’s E. coli outbreaks were over.
The sell-off for Chipotle stock was deserved. After all, food safety is a serious issue. These issues are clearly a public relations nightmare. But they also have a direct impact on sales and the bottom line. Many customers heard about the news and decided to take their business elsewhere.
In the fourth-quarter, same-store sales shrank nearly 15%. In December—at the height of the E. coli outbreak--Chipotle same-store sales sunk 30%. With sales falling, net income plunged 44%.
The company warned investors that it would have a very difficult 2016. It will be making a big investment in a new food safety program and stepping up marketing efforts to win back customers. Chipotle does not expect to earn a profit in the first quarter, and its chief financial officer commented that margins and earnings would be “messy.”
The sentiment toward Chipotle has turned very negative. News headlines have scared customers away. And Wall Street analysts have appropriately turned very bearish on Chipotle.
With most investors taking a negative view of Chipotle, it’s worth considering all the positives.
Chipotle had become a favorite of growth investors, thanks to rapid expansion and strong same-store sales growth.
At the time of the IPO, Chipotle had more than 500 locations. That number grew by 400% by the end of 2016. That growth in locations helped propel sales and earnings for the company in the last decade.
In addition to growing through new stores, Chipotle has done a phenomenal job of sales growth at existing locations, with 2014 same-store sales growth at 16%. To put that in context, in the latest quarter McDonald’s same-store sales increased 0.9% and Starbucks grew 8%.
As a result of the rapid growth, Chipotle stock has earned a rich valuation. Shares were trading at around $750 prior to the outbreak. At the time, the consensus analyst EPS estimate for 2016 was $20. That meant the stock was trading at around 37 times forward earnings, which is a healthy premium to the S&P 500 and other restaurant stocks.
As a result of the food safety concerns, analyst estimates have been dramatically trimmed. The consensus EPS estimate for 2016 is now just $12.80, a drop of 37%. And it’s likely that estimates could decline even more.
2016 will be a challenging year for Chipotle. But these headwinds should be temporary. Within the next year, most people will have forgotten about the E. coli outbreaks at Chipotle. And I expect the business to return to normal.
Chipotle has plans for 220-235 new restaurants for 2016, marking more than 10% location growth. Same-store sales are expected to remain weak in the first and second quarters, but should start rebounding in the second half of the year.
Additionally, Chipotle is testing two new restaurant concepts: ShopHouse Southeast Asian Kitchen and Pizzeria Locale. If either of these concepts gets traction, it could add to the company’s longer-term growth.
In the near term, Chipotle shares may be buoyed by the company’s stock repurchase program—an authorization to buy back $478 million of its shares, or 4% of its outstanding stock.
My view is that the stock is oversold here. The recent and sharp decline presents an attractive opportunity to start accumulating a small position in the stock. Contrarian investors will want to get invested when the future of Chipotle is uncertain.
Chipotle has been a growth stock that I’ve always wanted to own. But I couldn’t justify the valuation on the stock. Now that shares have taken a big haircut, this presents an attractive entry point. I expect the company will resume its growth trajectory in 2017, and want to own a stake before that materializes.
My projection is that Chipotle rebounds to its previous highs with the next 18 to 24 months. That could put shares back above $750 per share, and give investors a potential 60% return from these levels. I’m prepared to “average down” and accumulate more shares if there is further weakness in the stock.
Ian Wyatt, Ian Wyatt’s Million Dollar Portfolio, www.100kportfolio.com, 802-434-6900, February 3, 2016