Why Chipotle's Share Price Is Still Too High

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Includes: CMG
by: TipRanks

Summary

Looming Guacapocalypse?

Battle to accelerate sales.

Lingering virus memories.

Chipotle Mexican Grill's (NYSE:CMG) share price is currently at $395.59, and we believe that it has further room to fall. (Bear in mind that back in 2015 the shares were trading at $749, you have some idea how far shares have already dropped.) For Q4, Chipotle reported EPS of $0.55 above consensus estimates of $0.54 on sales of $1.03 billion which missed estimates of $1.04 billion. Total sales for 2016 were a shocking 13% below 2015 at $3 billion. We can see here how share prices slumped on the news:

However the market was split in its reaction to the earnings release- on the positive side Wells Fargo analyst Jeff Farmer was encouraged by better-than-expected January same-store-sales while Wedbush analyst Nick Setyan noted "an improving top-line trajectory, as well as a realistic trajectory for margin improvement."

We think there are three key reasons why Chipotle's share price is still too high, and why it's best to keep a bearish outlook on the stock at this point in time:

1. Higher expenses: Could Chipotle be facing a "Guacapocalypse"? The big fear now is that if Trump imposes a 20% tariff on Mexican imports this would seriously hurt Chipotle's supply of Mexican avocados- estimated to be about 70-90% of Chipotle's total avocado requirements for its popular guacamole condiment (as well as potentially impacting Chipotle's tomatoes and jalapeños supply).

The chain has already been hit by the rising cost of food- and even without a Trump tariff this is a challenge that is unlikely to go away any time soon. In particular, pre-diced tomatoes and avocado prices became more expensive (although beef prices did fall) and as a result food costs were up 150 basis points, representing 35.3% of revenue. Higher marketing and promotional spending also reduced restaurant operating margins to 13.5% (down 19.6% y-o-y).

2. Uphill battle to accelerate sales: Sales need to improve if the company has any chance of achieving management's high-single-digit comp guidance for 2017. However this is not necessarily an easy task: Deutsche Bank analyst Brett Levy reiterated his sell rating for the food chain as "management's description of its roadmap has not changed our view that the company still faces an uphill battle to regain its prior sales, profits, valuation levels." Chipotle is trying to improve sales via initiatives such as new menu items and digital ordering and payment.

CEO Steve Ells says the company plans "to continue to simplify and improve our restaurant operations, utilize creative marketing to rebuild our brand, and further the roll-out of our digital sales efforts."

3. Lingering memories: It appears that customers have not forgotten the E-coli, salmonella and novovirus outbreaks at Chipotle stores despite the fact that these outbreaks were all the way back in fall 2015 and the FDA subsequently gave Chipotle the all-clear. The company has fought hard to shake off the outbreak, even introducing its second protein chorizo to the menu, but it is beginning to feel like the chain will never be able to return to its former glory, especially as competitors such as Panera, McDonald's, and even pizza restaurants such as Domino's and Papa John's are all busy upping their game.

According to financial accountability engine TipRanks, the analyst consensus rating for the burrito chain is hold while the average price target of $409.50 represents a 3.52% upside from the current share price. In fact the mixed message from the market is clear in the spread of analyst price targets from a 42% upside to a -45% downside potential.

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. I have no business relationship with any company whose stock is mentioned in this article.

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Tagged: , Restaurants, Earnings
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