Does the Recent Drop in Chipotle Provides a Window to Invest?
Gayatri is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The Stock price of Chipotle Mexican Grill Inc, (NYSE: CMG) has corrected significantly since the company announced its 2Q earnings. Although, the company's 2Q EPS of $2.56 exceeded the consensus estimate of $2.30, same store sales of 8% (3.4% traffic, 4.6% pricing) missed the consensus estimate of 10.1%. I believe the company’s stock price is likely to continue its downward trend going forward. Following are the key reasons for my bearish thesis.
Direct competition with Cantina Bell menu
YUM brands (NYSE: YUM)owned Taco Bell's 2Q SSS growth of 13% was higher than Chipotle's 2Q SSS growth by 5%. This exemplifies that chipotle is losing traffic to Taco Bell. In our view, amalgamation of Taco Bell with former parent Frito-Lay (PEP) to release the Doritos Locos Tacos has driven customers to their previously favorite Taco Bell. Another reason for this diversion is that Taco Bell has started to offer Chipotle-esque items to complement its relatively vast and inexpensive menu. Moreover, Taco Bell has recently introduced the Cantina Bell menu (closely resembles that of CMG) to gain a wider consumer base; attracting customers interested in gourmet Mexican offerings.
At the ICR conference, on January’12, CMG’s management indicated that it might increase prices in 2H12, likely to accommodate food cost inflation. But management's unwillingness to increase prices have depressed margins and 2Q SSS to some extent. The management is concerned that an increase in menu prices could further move away the already decelerating traffic. The company will likely to face higher costs going forward due to the terrible growing conditions for farmers throughout the Midwest and the resulting increase in feed costs that makes chicken more expensive. Given such macro headwinds, it seems quite difficult for CMG to balance out the effect of food cost inflation.
No Longer a Secular Growth Story in Investor’s Eye
The market seems to overreact at both good and bad earnings news. For a company like CMG, which has been growing very fast, these overreactions have more powerful consequences. The company reported best-in-class traffic trends for 7 consecutive quarters (3Q10-1Q12). However with a 2.1% miss in SSS in the last quarter, the company has lost investor's trust. As a result, its stock price has taken a fall of 25%. The investors betting on CMG's secular growth story have been disappointed and it will be very hard for CMG to gain the trust of investors and attain the valuation above 35x forward earnings it once enjoyed.
Chipotle is facing competition from a variety of mid-priced casual-dining chains, fast-casual restaurants, and traditional fast-food concepts and must provide a differentiated customer experience to continue building market share. Despite the fact that CMG has strong drivers to support top-line growth, we believe commodity inflation, pricing pressures, and increasing competition from Taco Bell, will continue to create hurdles ahead. Thus, I remain bearish on the stock.
GayatriSharma has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill. Motley Fool newsletter services recommend Chipotle Mexican Grill and Yum! Brands. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.