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Chipotle Hasn't Fixed Its Biggest Problem

By Danny Vena - Updated Oct 31, 2017 at 6:05PM

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Revenue and profit are improving, but the company still hasn't addressed the most pressing issue.

When Chipotle Mexican Grill, Inc. (CMG -0.15%) reported its financial results for the third quarter, investors had hoped that the company would finally get past the slump that began nearly two years ago, during an outbreak of food-borne illnesses.

The company has faced numerous challenges in recent months as well, including another outbreak of norovirus, a breach that compromised customer payment data, and videos of mice in the dining area in a Dallas Chipotle location.

And now Chipotle's financial results have failed to excite investors. As a result, the stock crashed to its lowest level in nearly five years.

The Chipotle logo and slogan "As Real As It Gets" surrounded by fresh ingredients like avocados and limes.

Chipotle's results gave investors heartburn. Image source: Chipotle.

The numbers

For the just-completed quarter, Chipotle's revenue increased to $1.13 billion, up 8.8% over the prior-year quarter but lower than the consensus estimate of $1.14 billion. The company reported diluted earnings per share of $0.69. Adjusted earnings per share, which removes the one-time costs related to the data breach and the impact of hurricane-related store closures, came in at $1.46, a 155% increase over the prior-year quarter.

Chipotle said it took an $18.2 million hit related to the "data security incident" it announced in April, and it was forced to close hundreds of stores because of the impact of hurricanes Harvey and Irma.

The company also curtailed its growth forecasts and said it will "temper" its new restaurant openings.

Beyond the numbers

Chipotle has made a number of moves that it believes will restore the chain to its former glory. In addition to the previous changes to its food-preparation techniques, longtime co-CEO Monty Moran resigned, the company made changes to its board of directors, and it has added both a chief restaurant officer and a chief communications officer to its ranks.

In its conference call, Chipotle executives discussed several new initiatives that it says will improve the guest experience, including better training for employees, a digital sales platform, design changes to restaurants, and new menu items such as salad, desserts, and frozen margaritas. 

CEO Steve Ells said in the conference call that the company was making "meaningful progress" in "restoring the operational excellence that made us successful" and added that "we've also made important strides in restoring consumer trust and driving sales." But the evidence doesn't seem to bear that out.

The problem

All the changes the company is making aren't making up for the lack of returning customers.

The key number that's the most troubling is comparable restaurant sales, which grew an anemic 1% year over year. Adjusting for a sales promotion and new restaurant openings, comps wouldn't have increased at all.

The underlying problem is that customers aren't returning to Chipotle in meaningful numbers. The company was eager to point out a multitude of new initiatives, but until it can get customers back in the door, those changes will go unnoticed. 

Stop with the gimmicks

Ells said during the call that the roll-out of queso during the quarter helped "successfully change the narrative about Chipotle." He's referring, of course, to the public focus on additional sick customers, rodents, and data breaches. In my opinion, if the company wants to change the narrative, Chipotle needs to stop providing new reasons for customers to stay away.

It troubles me that the company is taking a hit-and-miss approach and continues to focus on the wrong things. People are avoiding Chipotle because of all the negative stories in the press. Once those stop appearing, the customers will return.

I'm a longtime Chipotle shareholder, and I keep hoping the company will turn things around. The problem is, hope isn't a very firm foundation on which to build an investing thesis. I'm not selling my shares for now, but I will be watching for signs that customers are finally returning to the stores.


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