After months of negative publicity, Chipotle (NYSE:CMG) is setting the tone for the future with its fourth-quarter earnings report this week and a company-wide meeting next week. Chipotle has been in the headlines a lot lately, mostly for the wrong reasons -- until the Centers for Disease Control's announcement on Monday that the E.coli outbreaks connected to the company's restaurants were likely over. Chipotle has been doing a lot to work its way back into consumers' good graces, but will those efforts be sufficient?
In this clip, Sean O'Reilly and Vincent Shen talk about how Chipotle has responded, and is continuing to respond, to the crisis, how hard the stock was hit, what we were expecting from the earnings call, and how well the company is positioned to make a recovery.
A transcript follows the video.
This podcast was recorded on Feb. 3, 2016.
Sean O'Reilly: First up is Chipotle. Obviously, they have been beaten up a little bit, but are they finally moving past this whole cilantro poisoning thing?
Vincent Shen: Cilantro poisoning. The reason why we talk about it is few reasons. First of all, CDC officially has said that they believe -- they announced this on Monday -- that they believe the E. coli outbreaks at Chipotle appear to be over.
O'Reilly: I can breathe a sigh of relief.
Shen: The stock bounced up a little bit. I think it was up a little over 4% yesterday as a result of that announcement. Pretty fitting, because they're actually reporting their earnings after the close today. They also have another big event coming, which is next Monday. They have that company-wide meeting, which you have mentioned previously on another episode.
O'Reilly: Yeah, for listeners that don't know what he's talking about, they're actually closing all the stores and having this meeting about safety and food prep and just talking about this thing, right?
Shen: Yeah, exactly. They are closing all the stores for the lunch service. They are reopening at 3 p.m. During that intermission, call it, they're going to be broadcasting the meeting out of Denver to hundreds of locations.
O'Reilly: The symbolism of this alone is awesome.
O'Reilly: I like it a lot.
Shen: Let's take this one at a time. First of all, the CDC announcement, they basically said that their investigation, excuse me, indicated that some Chipotle ingredient or meal was probably the source of the contamination but they couldn't actually identify the specific ingredient or whatever that caused it. The stock bounced up 4%. It closed at $473 on the positive development. Keep in mind, they've been dealing with these food safety issues since last August. They had salmonella cases in Minnesota in August 2015 with about 60 people affected. Then they had all those E. coli cases, which I think were the brunt of the PR hit where that was in the Pacific Northwest, spread to other states, again about 60 people. And then I think it was in December where they had the Norovirus cases in California and Boston that affected hundreds of people.
O'Reilly: This has been a cascade of bad news.
Shen: Exactly. It's really interesting when you look at some of the 8-Ks they filed as updates on these situations; how the news of the Norovirus cases, for example, in December really hit their comps week by week. You can see how it's swaying. Things look like they're setting and then they completely just plummet as a result of the headlines.
O'Reilly: The CDC announcement couldn't come at a better time because they're about to report earnings that are probably going to be bad.
Shen: Yeah, exactly.
O'Reilly: They can just point and be like, "Listen, it's over."
Shen: I think everyone will acknowledge the fact that they've had these challenges, that they're dealing with the best they can. Going forward, they're obviously looking to a brighter future. That's for sure.
O'Reilly: What kind of results can we probably expect with these likely abysmal same-store sales results for the fourth quarter and last year?
Shen: Sure, sure. Just for a quick recap. The company initially expected to be hit for their comp restaurant sales down 8% to 11% for the fourth quarter.
O'Reilly: That's how they used to grow every quarter.
Shen: Exactly. They thought that restaurant-level operating margins would be about 22% to 24%. Earnings per share between about $245 and $285. Then, the company issued an update early last month that kind of basically said, "Things are worse then we thought." Fourth-quarter comp restaurant sales, those are actually down 15%, operating margins were down to 20 to 21%, earnings per share of just $170 to $190. On all three of those metrics, they pretty much downgraded significantly.
Shen: Just to give you a little bit of context, for the year-ago quarter, restaurant-level operating margin was 26.6%, earnings per share was $384, and comp restaurant sales were up 16% year-over-year. That's like a 30% swing.
Now, for the month of December, specifically, I think with some of the additional news, how everything cascaded together, they saw their comp restaurant sales down 30%.
Shen: Specifically for that month. That's what people are expecting for the fourth quarter/full year obviously ...
O'Reilly: Makes for shorter lines doesn't it?
Shen: Yes. Exactly. That is obviously is going to have a really negative impact on their full year as well. We've talked about next Monday, that meeting. To be specific, the company mentioned in a press release that the point of the meeting is, one, to thank everyone who is part of the organization who has worked really hard in the past couple of months to institute new stricter safety standards, make sure things are operating well, that there's no more of these cases breaking out. Second, to announce some of their new initiatives which they hope will guarantee that there won't be another outbreak like this in the future.
O'Reilly: Right. Did they mention anything along the lines of the ... Is it going to make them less profitable to have all these new safety standards? That is my question. Have you caught anything like that?
Shen: The thing is, the meeting is next week. I'd be curious to hear about details with that in the earnings call today and also in the meeting. I'm sure, I know for a fact that they've reported increased costs as a result of these incidents. It was like $16 million, $18 million, I think.
O'Reilly: We just don't know what they are.
Shen: Specifically, where they're going to, how it's going to impact some of the margins, we've yet to see that.
O'Reilly: Cool. OK. Very cool.
Shen: Another thing you mentioned that you brought up is their 2016 forecast. Basically, they've acknowledged that any previous forecasts provided for this year ...
O'Reilly: Throw them out the window.
Shen: Throw them out the window entirely, because there's no way we can know, based on this climate. From Wall Street at least, analysts are expecting revenue earnings to decline 15% to 20%. I think for this company, long term, they are really going to need to execute well on these food safety plans, because even the slightest hiccup is going to crush them. It's going to crush them.
O'Reilly: It's going to be bad.
Shen: Otherwise, you know, in my personal view, I'm pretty confident that they'll recover this as time passes, assuming there aren't any headline-worthy incidents. The thing is, other restaurants have run into issues like this, even worse ones, and they've managed to recover, let alone Chipotle being arguably the leader in the whole fast casual movement. I think they're in a strong position.
O'Reilly: It definitely seems like Chipotle's got the heart and soul of what you want in an organization doing this sort of thing.
Shen: Yeah, their leadership has embraced everything. They've been very, very forthcoming with information. Working as much as they can with the various regulatory agencies that have been involved looking into this. I think that they're in a good place and people should be looking to the future a bit now.