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Jim Cramer Is Right About Chipotle Mexican Grill

By John Maxfield - Feb 4, 2017 at 7:18AM

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The burrito chain has turned the corner in its recovery from the food-borne illness outbreaks of 2015 and 2016.

When respected companies go through challenging times, causing their stocks to drop, analysts and commentators begin to predict their demise -- oftentimes pretending as if they knew what would happen all along.

They lower their price targets. They tell you to sell the stocks. And at the very least, they argue, you certainly shouldn't be plowing new money into them.

This happened after the internet bubble, when shares of leading technology firms could be picked up for pennies on the dollar. It happened during the financial crisis, when investors were told to avoid bank stocks. And it's happening today with Chipotle Mexican Grill (CMG 0.31%).

A Chipotle location in New York City.

A Chipotle location in New York City. Image source: Chipotle Mexican Grill.

Be greedy when others are fearful

When Warren Buffett says to be fearful when others are greedy and greedy when others are fearful, this is exactly what he's talking about. If you want to buy stocks when they're low and sell them when they're high, you can only do so when others have convinced themselves that they should do the opposite.

In Chipotle's case, we all know the story of why it's stock plummeted almost a year and a half ago, spurred on by a series of food-borne illness incidents at a number of its restaurants.

It started at the very end of October 2015 with an E. coli outbreak, but then cascaded into a number of subsequent incidents over the next few months. By January 2016, sales at Chipotle's locations open for at least a year had dropped by 36%.

Substantial damage was done

The damage to Chipotle's brand can't be denied. Media reports hounded the burrito chain throughout 2016, culminating in the resignation of its co-CEO Monty Moran and prompting the chain to make changes to its board of directors.

In the midst of the fallout, moreover, Chipotle realized that its former success had disguised problems with its operations and customer service. Combined with investments it's had to make to improve its supply chain, it resulted in the first-ever quarterly loss reported by the chain.

As the old saying goes, however, it's always darkest before the dawn. After a year of reporting substantial, though gradually recovering, same-store sales declines, it's finally clear that Chipotle is on the mend.

When it reported fourth-quarter earnings last week, Chipotle said that comparable sales finally crossed back into positive territory in November and then December. And they didn't just barely cross the threshold; in the final month of last year they were up 14.8%.

A chart of Chipotle's same-store sales.

Data source: Chipotle Mexican Grill. Chart by author.

The turning point

The reason Chipotle's sales gained so much in December is because it was the first time that its year-over-year comparison was up against a full month of crisis-plagued results from 2015 (to be clear, the outbreaks were first reported in October of that year, but it wasn't until two months later that their full force was reflected in Chipotle's performance).

This by no means should be interpreted as a sign that Chipotle is out of the woods. After all, as my Foolish colleague Adam Levine-Weinberg noted here, its same-store sales are still down in aggregate from before the crisis.

Yet Chipotle's most recent quarter marks an important turning point for the chain. Going forward, its same-store sales should head higher on a consistent basis, transforming the narrative surrounding its stock into one about recovery as opposed to crisis.

Fourth-quarter earnings

This is why Chipotle's shareholders should ignore the negative reaction to its fourth-quarter earnings. Its stock didn't fall in the wake of its announcement because the chain performed especially poorly. Its stock fell because analysts and commentators wanted more.

"Chipotle is down and I totally get that because I don't think people understand," noted Jim Cramer at the end of last week. "You have to start getting better same-store sales, and they have to spend more. But, this is the beginning of the turn."

"It takes 18 months from the last incident to get the American people to forget," Cramer went on to observe. That threshold is still a few months away, but when the chain finally passes it, those same analysts that have derided Chipotle's stock will change their tune and begin pretending as if they knew, once again, what would happen all along.

In short, Cramer is right. Chipotle has passed the turning point in this scandal. It's only a matter of time now until the rest of the investment community acknowledges this.

John Maxfield owns shares of Chipotle Mexican Grill. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. The Motley Fool has a disclosure policy.

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