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It's Not All Bad News for Chipotle Mexican Grill, Inc.

By Jeremy Bowman - Feb 8, 2016 at 1:01PM

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The burrito chain's long national nightmare is coming to an end.

As you've probably heard, things have been bad the past few months for Chipotle Mexican Grill (CMG 1.70%).

Since late October, an E. coli outbreak across several states and Norovirus incident at a Boston location bit the company, and it's now on the receiving end of a federal criminal investigation for its questionable food safety practices that may have led to other outbreaks earlier in the year.

Chipotle's day of reckoning came this Tuesday, when it reported fourth-quarter earnings.  The market already knew that same-store sales fell 14.6% in the period, but it's only gotten worse since. Management revealed that comparable sales had fallen from a 30% decline in December to 36% in January, and it now expects breakeven profit for the current quarter, down from an EPS of $2.17 in Q4.  

The stock fell 3% the next day, but the sell-off could have been much worse. Clearly, the market had already priced in low expectations. With that bad news out of the way, Chipotle can now focus on marketing, implementing its food safety program, and rebuilding sales. While the company is still in the midst of the biggest crisis in its history, a number of positive catalysts appeared this week indicating it should be able to return to its former glory.

CDC gives the all-clear
At the ICR Conference in January, Chipotle stock jumped after management said it expected the Centers for Disease Control to soon declare an end to the E. coli outbreak. A few weeks later, the CDC finally called an end to the outbreak on Feb. 1, saying, the outbreaks "appear to be over" and that the most recent reported illness started on Dec. 1.  

No specific food item was identified as the culprit, though management believed it to be produce such as lettuce, tomatoes, or cilantro.

Chipotle haters considered the food safety crisis to be a righteous comeuppance for a brand they say was overly focused on its "Food With Integrity" marketing message, but Chipotle has been around for over 20 years with no major food safety outbreaks before this one. We won't know the cause of the E. coli or the two norovirus outbreaks. Perhaps, a lack of attention to food safety standards is to blame, or the company's rapid expansion led to improperly trained staff. The question will never be satisfactorily answered, but management is implementing several protocols designed to bring the risk of a future outbreak as close to zero as possible.

Now begins the hard work of getting that message out. Just as it took a while for customers to become aware of the outbreak, it will also take time for them to learn that it's ended.

Tweets directed at Chipotle still ask if it's safe to eat there. 

The first step to rebuilding sales is bringing those customers back in the door.

Analyst upgrades
In the wake of Chipotle's worst earnings report in its history, the Wall Street response was surprisingly positive, as the burrito chain won upgrades from Bank of America and Wells Fargo. Wells lifted its rating to outperform, citing a study of the past 25 years that found that "same-store sales declines can be cut in half six months after the incident and same-store sales growth can return 12 to 15 months after the incident."  The study looked at the famous Jack in the Box (JACK 1.40%) outbreak in 1993 and E. coli outbreak and Yum! Brands' (YUM 0.07%) KFC China locations in 2005 and 2012. The Jack in the Box outbreak sickened over 700 people and killed four children, yet the brand eventually recovered and is thriving today. KFC, meanwhile, has overcome multiple food safety issues in China to deliver strong results.

Analysts at B of A said they have already begun to see sales recovery, and released a survey showing that only 10% of Chipotle customers said they would not return to the restaurant.  46% said they stopped eating there during the outbreak, but would return. 

Other analysts also issued positive notes expressing that Chipotle would recover, and a survey by research group NPD found that young adults, Chipotle's largest demographic, remained loyal to the chain during the outbreak, saying the results show either "unabashed loyalty or a lack of awareness." 

With the outbreak investigation now closed and Wall Street buying into Chipotle's recovery, it seems like there's nowhere for the stock to go but up. Risks remain, including the criminal investigation, but the worst is over. If Chipotle can deliver signs of recovering sales by the next time it reports earnings, investors should be in good shape.

Jeremy Bowman owns shares of Chipotle Mexican Grill. The Motley Fool owns shares of and recommends Chipotle Mexican Grill and Wells Fargo. The Motley Fool has the following options: short March 2016 $52 puts on Wells Fargo. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Chipotle Mexican Grill, Inc. Stock Quote
Chipotle Mexican Grill, Inc.
CMG
$1,692.03 (1.70%) $28.33
Yum! Brands, Inc. Stock Quote
Yum! Brands, Inc.
YUM
$118.24 (0.07%) $0.08
Jack in the Box Inc. Stock Quote
Jack in the Box Inc.
JACK
$88.90 (1.40%) $1.23
Bank of America Corporation Stock Quote
Bank of America Corporation
BAC
$36.25 (-0.14%) $0.05
Wells Fargo & Company Stock Quote
Wells Fargo & Company
WFC
$45.75 (-0.41%) $0.19

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