Shares of Chipotle Mexican Grill (NYSE:CMG) hit four-year lows last week, and it's easy to wonder if the worst is behind the out-of-favor burrito roller. The stock has plunged nearly 60% since peaking two summers ago.
Bulls will argue that there's no way Chipotle is less than half the company it used to be. Comps are starting to turn positive, and the chain itself is much larger now than it was when the stock topped out 24 months ago. Bears will counter that momentum isn't in Chipotle's corner and that any potential turnaround can't possibly end with the chain as the market darling it was two years ago.
Reality rests somewhere in the middle. The road back won't be easy, and there are a few trends working against Chipotle these days. Let's spell them out.
1. Burrito chains aren't hot anymore
A couple of years ago, it was a safe bet that a vacant lot in a strip mall would be taken over by Chipotle, Qdoba, Moe's, or some other aspiring fast-casual Mexican chain. These days, the fast-casual baton is being handled by made-to-order pizza joints where pies are put together on assembly lines before being heated up in minutes in quick-bake ovens.
Blaze, MOD, Pie Five, and Pieology are among the fastest-growing concepts, with more than 100 locations apiece. Blaze, the niche leader, was dreamed up, ironically enough, in a Chipotle.
Two years ago, Chipotle's biggest challenger for the lunchtime crowd was the "better burger" niche. Those chains are still booming, but now there's another hot trend eating away at the popularity of burritos. If you still think that's not the case and that Chipotle's sharp drop in popularity is the result of the food-borne-illness outbreaks of late 2015, keep in mind that Qdoba's comps have been negative through the past 40-week period.
2. Margin remains challenging
Net margin clocked in just above 10% for four consecutive years through 2015. We may never get there again. We can start with gross margin, which also seems unlikely to top 37% the way it did from 2012 through 2015. Food safety doesn't come cheap, and Chipotle doesn't have the same pricing elasticity it used to have when it could just pass on cost increases.
Cost controls didn't seem to matter when massive queues would snake through the fast-moving assembly line. Things are different now. Labor and occupancy costs keep rising, and something as simple as the employee stock-purchase plan doesn't seem like much of a retention tool when folks buying in over the past four years are underwater.
3. Profit targets are going the wrong way
Bulls argue that Chipotle's valuation gets more compelling as the stock slides, but that's not the only thing in a state of retreat. Analysts keep scaling back their profit expectations, an ugly sign when a company is supposedly in a turnaround.
Wall Street pros saw Chipotle earning $8.49 a share for all of 2017 three months ago. That per-share target was down to $7.90 last month, and it's currently reduced to $7.67. It's easy to dismiss this as a near-term hiccup, with Chipotle's turnaround taking a larger toll on its income statement, but it's not just 2017 that's getting marked down. Analysts now see Chipotle earning just $10.96 a share in 2018, less than the $12.27 a share they were forecasting three months earlier.
Until this trend reverses, it's dangerous to value the stock based on forward multiples.