Until a series of foodborne illness outbreaks caused shares of Chipotle Mexican Grill (NYSE:CMG) to plummet earlier this year, it was one of the market's most beloved stocks. The question now is whether or not the burrito chain can ever regain its former glory.
In this episode of Industry Focus: Financials, The Motley Fool's Gaby Lapera and contributor John Maxfield talk about why Chipotle is one of John's favorite stocks right now.
A full transcript follows the video.
This podcast was recorded on Aug. 22, 2016.
John Maxfield: This is not in an industry right now so much that is having problems like the oil industry, or one might say the bank industry is. However, the company itself has had some issues that has caused its shares to fall almost 50% over the past six months, and that company is Chipotle.
Here's the thing about Chipotle. Its shares have literally been cut in half since it had a series of foodborne illness crises at the end of last year. The thing about it is that -- and I've written about this on Fool.com regularly over the past few months -- every other major food company, for the most part, in the United States has been through a similar experience, in terms of food-borne illness crises, seeing their stock fall, and then gone on to produce large gains. Whether that's Jack in the Box, McDonald's, Yum! Brands -- which owns KFC, Pizza Hut and Taco Bell.
Gaby Lapera: Can I ask you a question?
Maxfield: Of course.
Lapera: Have other brands had as a prolonged time period with foodborne illness news?
Maxfield: Really good point. There are some unique characteristics about Chipotle's foodborne illness situation. The first is that, like McDonald's -- its big E. coli scandal was I think in 1993, so that was pre-internet so you didn't have that proliferation of information the same way that it happens now online. You didn't have that. However, while Chipotle seems like it's gone on for a long time, I think that what you really want to look at is the severity of the crisis itself. In that regard, Chipotle's was actually not very severe. Let me give you an example. Jack in the Box dealt with an E. coli situation, I can't remember exactly when that was. It was a couple of decades ago. Something like four people died from it.
Lapera: Wow. That's horrifying!
Maxfield: Yeah, exactly! Is Jack in the Box the busiest fast food chain ever? No, it's nothing like McDonald's or Chipotle or the other ones. But afterward, it went on to produce huge gains after that scandal. The point is that this is an opportunity to get in on a company that just last year was trading at almost twice the price and everybody was talking about what an amazing company it was. It goes through a pretty standard thing. It's not a good thing, of course, but it goes through a relatively standard thing for a company in its industry. Its stock falls 50%; it presumably will recover. This is the opportunity that you want to use to get in on a company like that.
Lapera: I have to say that there was a little bit there where that E. coli scare was great, because I eat at Chipotle all the time, and I would get in line and there would be no one there. I would get my burrito so fast, and apparently that fear is waning, because the lines are very long again, and that's upsetting to me as a consumer.
Maxfield: Let me ask you that. I'm out in Portland, Oregon, which is really where that E. coli scandal was centered. And not only that, but the Chipotle closest to my house is one of the restaurants that it happened at. I have noticed that at that restaurant, which we go to most frequently because it's close, the lines just have not picked back up to the pre-crisis level. Would you say that, from your perspective in the D.C. area, it has recovered, or that it's in the process of recovering? Where would you put that?
Lapera: This is completely anecdotal research based on me going to three area Chipotles. There is King Street Chipotle; Dukepotle, which we like to call the Chipotle on Duke Street; and the one near my house in Columbia Heights. All of those are slammed all the time.
Maxfield: Yeah, that's a great sign.
Lapera: Like I said, a few months ago, it was definitely a lot quieter. I guess this was in the winter. I don't know if it was just too cold for people to go outside. Like Snowpocalypse. The third version of Snowpocalypse, and people are still debating what to call that snow storm. Maybe that deterred them from going outside. Not me. I needed to get my burrito, but I don't know. I think it's doing fine. As far as I can tell, the food quality hasn't changed. I might just have a stomach of steel, or it could be that I'm so hyper-cautious that I ... I don't know if this is too much information, John. I'm going to share it with you anyway.
Maxfield: Share. Share away.
Lapera: I vomit a lot.
Maxfield: OK, that's too much!
Lapera: I am such a nervous vomiter, it's insane. It can be like emotional stress, it can be motion sickness, it can also be like I just psyched myself out of something, and that includes food. I haven't had that problem with Chipotle ever.
Maxfield: That's great. That's quite a recommendation. This doesn't have anything to do with that, but let me take this in a different direction. I think this is a great stock. It's my second-largest holding after Bank of America in my combined portfolio with my wife. Let me tell you the one part of the Chipotle thesis that a lot of people seem to be sold on that I am not sold on.
Lapera: Tell me.
Maxfield: That is this idea that these other concepts it is developing are really going to do well, and let me tell you why I question that.
Lapera: Are you talking about Chiptopia?
Maxfield: I'm talking about ShopHouse, their Asian concept.
Lapera: Oh, OK.
Maxfield: And Pizzeria, I think it's ... I can't remember. Pizzeria Locale or something like that. Their pizza concept that's in Denver. ShopHouse, their first restaurant was out there in D.C., and I think they have a couple of them now. You're just not seeing, at least from everything you hear from the company, the same acceleration in sales that you saw in Chipotle early on. That's one part of the thesis that I'm not as optimistic about as I think a lot of other people [are] that look at Chipotle and like its stock.
Lapera: On the other hand, I also think that since Chipotle does have such an established network, it's not as big of a risk as it could take. If another company were trying to do this earlier on in its life cycle, it would probably be a huge risk, but for Chipotle, it's kind of a middling risk, I feel like.
Maxfield: The other thing is that they are able to finance all of these things through its cash flow. It's not like going out and borrowing a whole bunch of money. In fact, if you look at its balance sheet, it doesn't have any debt. It's not like it's going out and borrowing and doing these things. It's not increasing the frailty of its balance sheet to do that, but still, it just doesn't seem to help out with that in terms of the premium valuation on its stock.
Let me just bring up one more point about Chipotle, and just to kind of put all this into perspective: One of the things that Warren Buffett talks about a lot is the importance of ... Because nobody can foresee the future, what's going to happen in any company. What you want to do to protect you on the downside is, you want to identify stocks where there's a margin of safety. Even if things do go bad, the downside is relatively limited. And when you think about Chipotle, it just looks like one of those asymmetric bets where the probability of it going up at this point seems to be much greater than the probability of it going down, because it's already dropped 50%. There's just a limit to how far it can go unless Chipotle is going to go away, which, again, the historical precedent does not support that. It's one of those stocks where I think you can get in -- this is my thesis on it, anyway -- assuming it's a long-term hold, and feel comfortable that you have a margin of safety built into that holding.
Gaby Lapera has no position in any stocks mentioned. John Maxfield owns shares of Bank of America and Chipotle Mexican Grill. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. The Motley Fool recommends Bank of America. 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.