By Parke Shall
It is difficult for us to think of Chipotle's (NYSE:CMG) interestingly timed move into casual dining and hamburgers as anything more than a desperate attempt to look for new growth strategies.
This morning, another investment bank lowered its price target on CMG as Goldman Sachs came out and lowered their target from $550 to $500, adjusting their recommendation from BUY to NEUTRAL. This is a similar move that several other investment banks, including UBS, have made over the last few weeks.
The concern continues to remain around CMG's ability to rebuild its core business after this most recent E. coli crisis. While many investors wrote off the crisis after it occurred as a one time event that the company will recover from, the company has showed us otherwise, twice lowering it's expected estimates and earnings for the coming year, telling a story to Wall Street of a company that has a serious road to recovery ahead of it.
While the company has its one major flagship brand in crisis, one certainly wouldn't think that this is the best time for the company to look at expansion. Generally, like in the game of Risk, you want to be able to occupy certain territories and safely run your business as it is before you look at expanding. Spreading yourself too thin to quickly can be a recipe for disaster, and we think this may be the road that CMG is going down now.
For those that have missed it, CMG came out two days ago and stated that they were looking into building a burger franchise. USA Today reported,
Chipotle Mexican Grill said Wednesday it has applied for a trademark for "Better Burger" as part of a business diversification move to open a burger restaurant chain.
"We have two non-Chipotle growth seeds open now ― ShopHouse and Pizzeria Locale ― and have noted before that the Chipotle model could be applied to a wide variety of foods," said Chris Arnold, a Chipotle spokesman.
ShopHouse, a Southeast Asian food chain, opened in 2013. Last year, Chipotle began expanding Pizzeria Locale, which specializes in wood-fired pizza, beyond its initial locations in Denver and Boulder, Colo.
There are several obvious issues, not only with the timing but with the strategy of this move. First, an expansion of this type is going to cost a significant sum of cash. CMG is in the process of burning through hundreds of millions of dollars in a stock buyback that they announced while the stock was trading higher. They have been catching their own falling knife with shareholder capital, and when the time comes for them to need resources to expand into their new endeavor, an equity offering or more debt are both going to look like foolish moves after the amount of money the company has spent buying back stock.
It also just doesn't make sense. If CMG knew for a while they were going to go down this road, why start buying back stock now? Certainly the company is aware of what it would cost to make such a grandiose expansion, so one has to assume that the buyback was simply to just stave off the bleeding from the E. coli crisis. That doesn't seem like prudent capital management.
Nevermind the fact that the fast food burger industry is probably the most saturated out of all of the fast food possibilities. CMG was unique in the sense that it had a niche in Mexican food. It's only real competition for casual dining Mexican food is Qdoba (NASDAQ:JACK) and that made it a lot easier for the company to find unsaturated parts of the country to expand to.
The story will certainly not be the same for the burger industry. Aside from the obvious competition like Wendy's (NYSE:WEN) and McDonald's (NYSE:MCD), casual dining burger chains like Shake Shack (NYSE:SHAK) are already several steps ahead of where CMG will be, should they decide to go down the path of running burger joints.
Between the idea and the timing, it just doesn't make sense to us. We have found in the past that when something doesn't make sense, it is probably being done for peculiar means. We do not think that it is out of the realm of common sense to suggest that CMG might be heading down this road because things at their flagship are not going as they planned. Heading into the E. coli crisis, same-store sales were already under pressure. Now that the company has experienced this crisis, it is looking more and more of a possibility that the company may have some real organic growth problems to deal with.
Like an acquisition company that continues to roll up other companies when it needs to grow, perhaps CMG is simply thinking about reinventing itself and its concept so that it can relive it's beginning stage growth pop again between both of its brands. We have been short CMG for several weeks now and we will continue to hold our short, as we believe this news is indicative of a company that may see slowing growth and that is out of ideas.
Disclosure: I am/we are short CMG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.