The last year has been a tough one for Chipotle Mexican Grill (NYSE:CMG) after an E. coli epidemic swept through the American fast casual restaurant chain, forcing store closures and a reevaluation of food safety measures. Share prices have been beaten up by the ongoing decline in same store sales and expected penalties and fines that could arise from both civil and criminal proceedings. While it might appear to be a useful distraction from the ongoing bad press related to the ongoing civil and criminal investigations being conducted, store sales show a downward trend that is unlikely to be reversed by the introduction of a new chain called "Better Burger". Unlikely to improve results and overshadow negative media, the burger is merely a sideshow to the bigger factors at play that could ultimately cost Chipotle what remains of its reputation.
Epidemic Impact Still Unknown
Even though executives have been eager to move past this unfortunate incident, the food poisoning story is nowhere near over, and will follow the company around for years to come. As the saying goes, it takes years to build a reputation, and mere seconds to destroy. The opening of another criminal subpoena early in March adds to the one made public in January, litigation that is unlikely to move swiftly as the process lumbers forward. To put it in perspective, take BP (NYSE:BP), which is still working to settle all the claims against the company for its actions with the Deep Water Horizon accident, has only recently seen a historic $20 billion judgment await approval of a Federal Court after the fallout in 2010. Chipotle is likely to see this drag on for years thanks to complexity and different regions involved. The company has not put forth any estimates as to the legal costs, but it will likely prove a protracted, money draining affair.
On the Offensive
Chipotle is aggressively fighting back for public opinion as evidenced by its free food giveaway estimated to cost over $60 million in an effort to woo back nervous customers. These sort of enticements however fail to offset the facts in play. The same store sales collapse is a strong indication of just how dire conditions are. According to comments made by CFO Jack Hartung, as much as 7% of its customer base is permanently lost. While shocking, the real number could be substantially larger, and enticements to bring back traffic might have to last, adding costs at a time when the company is spending hand over fist to restore its tarnished image. The sales trend is the best indication that things are headed south after same store sales collapsed 26% in February.
The public relations offensive has been charming, but it does not negate the facts few eaters will be quick to forget. As such, the unveiling of a hamburger comes at a questionable time for the company. Despite actively seeding other casual dining businesses, none have matched Chipotle's sheer scale. The decision to unleash another hamburger on the American public seems poorly timed and just a distraction to the reality facing the company. Even with its roots with McDonald's (NYSE:MCD) as a major investor, Chipotle is a far cry from dominating the fiercely competitive hamburger market. Additionally, increased capital expenditures could not come at a worse time for a company that still is unable to accurately assess the costs of potential civil and criminal penalties. The hamburger is not going to make these reputation problems disappear unless it was a coy move to quickly rebrand the entire chain and reshape the image.
Chipotle shares have been battered since the foodborne illnesses hit the newswires, falling 28% over the last year and creating a massive headache for shareholders. Although nearly matching the drop in same-store sales, the shares have managed to bounce off of multi-year lows of $339.14, representing a jaw dropping 55% below 52-week highs. The market is already preparing for dismal results in the upcoming April earnings report, with the company forecasting its first quarterly loss ever. Consensus estimates are anticipating earnings per share of -$0.86 for first quarter. With revenue growth plunging 6.75% in the fourth quarter alone and net income fall by a stunning 44.01% over the same time, consumers are voting with their feet and Chipotle's results show it.
While the company has room to maneuver thanks to its largely pristine balance sheet with no debt, cash levels have been falling, dropping to $663.20 million by the end of the fourth quarter and likely taking a major hit. Costly marketing initiatives and promotions such as the free burritos along with a campaign to get the word out about its new measures have seen marketing expenses balloon the highest level ever. Additionally, not all investors are sold on comeback potential yet as evidenced by the burgeoning short interest remaining the shares. As of the middle of March, short interest as a percentage of the outstanding float stood at 9.85%. While it represented a drop from the previous measure by nearly -10%, it coincided with the CDC declaring the crisis was over, adding to the bounce's upward momentum, and indicating a potential opening for Chipotle shorts to reestablish positions.
Although initially displaying a positive response with the "Better Burger" disclosure, optimism quickly fizzled with shares reversing lower, continuing to retreat from what would appear to a be correction to the longer-term downtrend shares have experienced. With an earnings disaster waiting in the wings and the PE ratio at a bloated 30.89, this is still not a great value even for value investors looking at companies that have overshot to the downside. Price momentum remains largely lower and a retest of 52-week lows at $399.14 is especially likely after the first quarter earnings report. Once a new same-store sales trend is mapped, the carnage and extent of Chipotle's reputational problems will become clearer. Recovery expectations are coming too soon and likely discounting the amount of time it will take to climb out of this whole. In the meantime, cheap ploys like "Better Burger" do more to damage expectations than manage them for remaining shareholders.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.