Chipotle Mexican Grill (CMG 6.33%) stock is down almost 15% since management updated its guidance last month for the second quarter of 2017. It was close to the same guidance management gave in late April during the first quarter conference call (with a small upward revision for marketing expenses), making the sell off an aggravating head-scratcher for Foolish investors.
Despite the overreaction from a short-sighted market, there are plenty of positive developments underway that indicate Chipotle is picking up speed on the road to recovery.
Image source: Chipotle Mexican Grill.
Customers are responding to new marketing
Shortly after founder and chairman Steve Ells returned to the role of CEO in Dec. 2016, Chipotle hired a new advertising agency to reenergize its marketing strategy. Part of that new strategy includes the launch of the company's largest ever advertising campaign -- "As real as it gets" -- to help distinguish the Chipotle brand as one that stands for fresh, clean, high-quality ingredients.
So far in 2017, the marketing seems to be working. In the first quarter, comparable restaurant sales grew 17.8%, a major improvement over the double digit declines in 2016. Chipotle also reported a steady flow of new customers, and 18% of those customers are becoming regulars after their first visit -- a solid conversion rate.
Restaurants getting more efficient
Granted, Chipotle is dealing with some very easy comparable sales numbers from last year, but this improvement in comparable restaurant sales, coupled with other restaurant level improvements is an encouraging sign that Chipotle is getting back to growth mode.
Management has eliminated unnecessary tasks for restaurant crew and managers and installed new incentives based around five key, easy to understand metrics. The result so far is improved customer service and reduced employee turnover. All in all, Chipotle has seen six straight months of improving customer-related scores.
Not good enough for Wall Street
However, it's all about the expectations game with Wall Street. Management previously guided for high single-digit comparable restaurant sales growth, and that hasn't changed. The company is also holding steady on its expectations for food costs to be 34.2% of revenue, while marketing expense increased to 3.6% to 3.7% of revenue in the second quarter. That increase of 20 to 30 basis points sent the stock tumbling.
This is a silly game that Foolish investors should avoid at all costs. The recovery is about improving comparable restaurant sales growth and focusing customers on what the Chipotle brand represents. The company has fixed costs in its operating cost structure, and as the company grows, those fixed costs will generally hold steady, allowing incremental revenue gains to drop to the bottom line. That, in turn, expands margins and boosts earnings.
So with that perspective, Chipotle needs the flexibility to spend more in the short term on marketing to win over customers and position itself for long-term growth. What matters is how Chipotle looks in five or 10 years, not the next quarter.
Is it time to buy?
The stock looks expensive with a forward P/E of 48. Management is still aiming for their original "stretch" goal of $10 in earnings per share for 2017, which puts the forward P/E closer to 40 times earnings. Chipotle definitely appears to be regaining its footing, given stronger first quarter financial results compared to last year's numbers and management's guidance for high single-digit growth in comparable restaurant sales. Investors can start a position now, while the stock is down, instead of waiting until momentum picks up for the company. By then, it could be well on its way to resetting highs for 2017.
