Chipotle Mexican Grill (NYSE:CMG) is a remarkably interesting investing case. Sales are declining because of customer distrust after the food-safety scare that affected the company in 2015, and the stock is selling at a big discount to price levels before the outbreak. The crucial question for investors in Chipotle is whether the company can start growing again. Or is the restaurant chain on an inevitable path to decline?
The big question
Chipotle stock hit historical highs in the area of $758 per share in August 2015. The stock is now trading at nearly $426, down by approximately 44% from those levels. The main reason for the big decline is that revenue is moving in the wrong direction: Total sales during the second quarter of 2016 declined 17%, to $998 million. Comparable-store sales did even worse, tumbling 19.3% during the period.
When something like this happens, investors typically wonder whether the company's problems are temporary or irreversible. If Chipotle can jump-start sales growth again, then the recent decline in the stock could be an attractive buying opportunity for long-term investors. On the other hand, no price is cheap enough to invest in a company that's suffering from shrinking revenue over the long term.
A lesson from history
It's important to look at the situation with a historical perspective. E. coli has affected multiple restaurant chains in the fast-food sector over the years, and different companies have completely recovered from these kinds of problems over time. Some notable examples to consider:
- Industry giant McDonald's (NYSE:MCD) was hurt by an E. coli outbreak that affected nearly 50 customers in Oregon and Michigan in 1982.
- The 1993 E. coli outbreak linked to Jack in the Box (NASDAQ:JACK) was particularly tragic. It affected 732 people, and four children died.
- Burger King had to recall more than 25 million pounds of meat because of E. coli in 1997.
- An E. coli outbreak affected 71 customers at Yum! Brands' (NYSE:YUM) Taco Bell chain in 2006.
Examples from McDonald's, Jack in the Box, Burger King, and Taco Bell show that food-safety problems related to E. coli aren't a necessarily death sentence for companies in the fast-food industry. As long as management is willing to put in the necessary effort, avoiding shortcuts, and working intensely to regain customer confidence, a full recovery is quite possible.
What Chipotle is doing to reverse the situation
Chipotle is taking full responsibility for the problem and going out of its way to reassure customers that it won't happen again. In a letter to customers on the company's website, Chipotle founder and co-CEO Steve Ells wrote: "The fact that anyone has become ill eating at Chipotle is completely unacceptable to me, and I am deeply sorry. As a result, we are committed to becoming known as the leader in food safety, just as we are known for using the very best ingredients in a fast food setting."
The company has hired food-safety experts to design and implement a revamped food-safety program. This starts at the supplier level, as Chipotle has launched its $10 million Chipotle Local Grower Support Initiative, which is focused on ensuring that suppliers meet the company's enhanced safety standards by providing education, training, and financial assistance to local farmers.
Some ingredients such as tomatoes are now prepared in central kitchens as opposed to restaurants, to reduce the chance that they could pick up germs while being prepared. Chipotle is also implementing high-resolution sampling and testing of ingredients at the farms and central kitchens that prepare many of the company's ingredients
At the restaurant level, Chipotle has developed a set of procedures on aspects such as ingredient handling, storage, and preparation. The company also has new procedures regarding restaurant cleaning and employee training.
According to a report from Reuters, Chipotle has already reached financial settlements with over 100 customers who fell ill after eating at its stores. By resolving these claims out of court, the company is doing right by its customers and also avoiding long legal conflicts that could attract lots of press coverage and further damage the company's reputation.
In terms of marketing, Chipotle is actively offering free foods and drinks with coupons and happy-hour specials. Customers with a student ID can get a free drink when they purchase a food item at Chipotle in September, and the company is also offering free kids' meals with the purchase of an adult meal. In addition, Chipotle has been implementing its Chiptopia Summer Rewards program, which offers free products based on customer loyalty.
Management is doing the smart thing by attracting customers back to the stores with big discounts and free products, since doing so can provide a valuable opportunity to regain customer trust over time. The company just needs to be careful of customers get too accustomed to discounts, which could be a problem in terms of pricing power.
Food safety is a crucial issue for a restaurant chain, and it will take time, effort, and money for Chipotle to completely recover from its problems. However, history shows that other industry players have in fact fully recovered from similar situations, and Chipotle is handling the problem in the right way. Sooner or later, chances are that investors in Chipotle will be well rewarded for their patience.