Chipotle's Move Into Burgers Is A Bad Idea

| About: Chipotle Mexican (CMG)

Summary

Chipotle will open its first gourmet burger restaurant this fall.

The industry has strong growth potential.

But CMG will have trouble competing, and the move could distract management from the issues plaguing the core business.

Chipotle (NYSE:CMG) announced that it will open its first hamburger restaurant, Tasty Made, this fall. The restaurant will focus on a narrow menu of burgers, fries, and milkshakes made with high-quality, natural ingredients. The move into gourmet burgers represents the latest step in CMG's efforts to diversify away from burritos into new categories, and follows in the footsteps of ShopHouse Southeast Asia Kitchen and Pizzeria Locale. Chipotle will follow the same "food with responsibility" concept that made its restaurants so popular to begin with, and will use beef from animals raised without the use of antibiotics and added hormones. We can understand why Chipotle wants to expand into the premium burger category, but CMG will struggle and we think the firm would be better served cleaning up issues at its core business.

The gourmet burger sector is the fastest-growing segment in the restaurant industry. More and more consumers, especially those in younger demographics, are demanding foods made with all natural ingredients, and burgers are a timeless classic that will never wear out even as customers become more conscious of their health. The demand for quality, "responsible" foods is what made Chipotle such a disruptive force in the first place, and the likes of McDonald's (NYSE:MCD) and other fast food chains that focus on value over quality have lost share in recent years. One in 10 fast food burger customers switched to gourmet burgers in the last year alone, and by expanding into this segment CMG could start replacing some of the customers it lost as a result of the e.coli outbreak. Management has offered discounts and promotions to win back customers, which has had a big impact on margins. In the latest quarter CMG's profits fell 82%. Premium burgers would give CMG the opportunity to get some of these margins back, as customers have showed a willingness to pay up for quality.

But the expansion into gourmet burgers presents a number of challenges, and we think CMG should avoid the category altogether. Our biggest concern is that it would distract Chipotle from the food safety issues in its core business that have crushed the stock over the past year. Management needs to focus on getting back customers and restoring CMG's reputation instead of branching into a new area in which it lacks experience. And, despite the strong market growth, competition in the premium burger category has gotten much more intense in recent years, with a proliferation of new chains coming on line. Shake Shack (NYSE:SHAK), Five Guys, Smash Burger, and Habit Burger, are just a few examples, and SHAK in particular has established competitive advantages that will make it difficult for less-proven rivals to unseat, especially a company like Chipotle. This is because competition in the premium burger category is based on food quality, which shapes brand perceptions. This is a big problem for Chipotle, whose reputation has been tarnished by beef quality issues. Premium burger customers, many of whom are likely former Chipotle patrons, will not have not forgotten the issues at Chipotle, and we think CMG will have trouble generating excitement for its burgers.

Conclusion:

Chipotle is getting desperate, but premium burgers aren't the answer. It does not make sense for a company, whose reputation has been tarnished by food quality issues, to enter an industry where purchase decisions are based on perceptions of food quality and reputation. The incumbents are much stronger in these areas, and CMG needs to focus on turning things around in its core business. Only after it does this should CMG even consider going after gourmet burgers.

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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.