Chipotle Mexican Grill (CMG 2.41%) is off to a strong start this year; the stock had gained 13.7% through Jan. 23. There's been little news out on the company so far in 2018, but anticipation seems to be building that it could soon announce a new CEO, and the company is also set to benefit from the new tax law.
At the end of November, CEO and founder Steve Ells said he would step down from the helm once the company found a replacement. Investors cheered the news, as Ells was widely seen as having fumbled a chance to recover from the E. coli crisis that has shaved off more than half of the stock's value since 2015.
With Chipotle's fourth-quarter earnings report right around the corner, here are the pros and cons of investing in Chipotle today.
Image source: Chipotle.
The buy case
More than anything else, the potential for a new CEO to take the reins and revamp Chipotle seems like the best reason to buy the stock. We've seen this story play out several times with other restaurant stocks. Domino's Pizza (DPZ 0.87%) went on a tear after CEO Patrick Doyle took over in 2010, acknowledged that the pizza needed improvement, and set about fixing the recipes. Investment in digital channels like its order-facilitating app also helped. Chipotle stock even briefly spiked when Doyle said he was stepping down from Domino's; however, he denied he would be moving on to Chipotle.
Similarly, McDonald's (MCD -0.91%) shares have surged since CEO Steve Easterbook took over in 2015 as he rolled out all-day breakfast, revamped the dollar menu, and refranchised restaurants. Even Olive Garden parent Darden Restaurants (DRI -0.28%) has outperformed thanks to a Starboard Value board takeover and initiatives like making its breadsticks better.
Right now the new Chipotle CEO is a question mark, but investors expect an update on the search when fourth-quarter earnings come in on Feb. 6. If the market likes the new boss, and if that person has a sound plan for boosting sales, potentially leveraging ideas that investors have long suggested like breakfast or drive-thrus, the stock could soar. A new CEO alone may help restore the company's image and confidence in its food safety, and help bring back customers who may still be scared about getting sick. That should lead to a long-term recovery as sales and profits would move higher as customers return and the brand image improves.
The tax cut is another boon for the burrito chain. Doing some quick math shows that the lower corporate tax rate should give Chipotle's earnings about a 23% bump, which should not only lift the company's stock price but also give it more money to invest in stores, staff, and growth.
Finally, with its shares beaten down, Chipotle is arguably a buyout target. There has been considerable consolidation in the fast-casual sector recently, with both Panera Bread and Qdoba getting bought out. While I'd say an acquisition is a long shot at this point, if the company struggles to find a new CEO, the next step could be to seek a buyer. I wouldn't buy simply on that possibility as such acquisitions are hard to predict, but the prospect does offer potential upside.
The sell case
Chipotle is now trading about 25% above its recent lows, a sign that investor confidence is returning, but that also means the valuation is getting stretched. The stock now trades at a trailing P/E ratio of 64, which implies exceptional expected growth, and based on 2018 expected earnings it's still not cheap at forward P/E of 33.6. Investors are betting that the company's profits will eventually return to pre-crisis levels, which were north of $15 in earnings per share.
However, if results continue to drag, that scenario grows more unlikely. Chipotle's most recent earnings report did not inspire confidence: Comparable sales increased just 1%, meaning that two-year comps fell more than 20%. The opportunity for a robust recovery from the E. coli crisis has now passed as comparable sales were expected to bounce back last year, and investors have little reason to expect same-store sales growth of better than low-single digits going forward, especially based on the company's most recent guidance.
Beyond the problems stemming from the food safety issues, Chipotle may struggle to return to its former glory simply because the chain faces steeper competition than it did five or 10 years ago. Its customizable assembly line model has been copied endlessly by promising upstarts like Dos Toros, Sweetgreen, Chop't, and others, and Chipotle has struggled recently to improve its brand, as new menu items like chorizo and queso have failed to wow diners. If comparable sales continue to lag, the stock is likely to slide as hopes for a recovery fade even more.
How this burrito rolls
I've been a Chipotle shareholder since its IPO in 2006. Though I sold part of my stake several years ago, I held onto the stock through the trials and tribulations following the E. coli crisis as I expected the company to eventually bounce back. Over the last two years, however, Chipotle has blown multiple opportunities to bring customers back and recover lost sales, including terrible communication surrounding the initial food safety incidents and a more recent case of norovirus at a Virginia location, a loyalty program that only proved temporary, stores with "C" grades for cleanliness and out-of-stock items, and its disappointing queso rollout.
At this point, I can't call Chipotle stock a buy, though I am willing to hold onto my shares for now and see if a new CEO can restore the brand to its full potential. There's still an opportunity for the company to recover, it just needs better execution and maybe a few sales growth initiatives.
Still, based on its recent results, it wouldn't be surprising if comparable sales growth remains weak. If a new CEO can't revamp the company and growth is still lacking in another year, I will likely sell my stake.
