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Bull vs. Bear: Chipotle Mexican Grill, Inc.

By Jeremy Bowman and Tamara Walsh - Feb 20, 2016 at 11:12AM

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Two analysts debate the future of the burrito chain.

Chipotle Mexican Grill (CMG 1.04%) has been one of the more hotly debated stocks over the last few months. 

Following an E. coli outbreak and a number of other food safety questions, the company is now in hot water, facing a federal investigation into its food safety practices. Sales and profits have also been decimated as sales at established stores were down a whopping 36% in January, following a 15% decline in the fourth quarter of 2015. The stock fell nearly 50% at its bottom last month, but it has begun to recover as the Centers for Disease Control declared the outbreak to be over, and the company has rolled out initial marketing efforts to bring back customers.

Is Chipotle a buy or a sell? Two of our retail analysts debate this question below.  

Jeremy Bowman (Bull): It's hard to exaggerate the food safety crisis. Around 500 customers fell ill, and Chipotle's fan base has punished it by avoiding the burrito chain, sending sales plummeting.

The company has responded to the outbreak with a comprehensive safety plan that revamps its food processing system to introduce redundant kill steps (such as blanching of vegetables), and it brought in outside auditors to ensure the system is working. It closed stores for lunch earlier this month to have an all-company meeting, and it's even allocated money to help local farms comply with the new food safety standards so it can keep its local produce program.

Many major restaurant chains have suffered from an E. coli outbreak at some point in their histories. Among them are McDonald's (MCD -0.54%), Taco Bell, and Jack in the Box, and all recovered over time. Jack in the Box's outbreak was the most famous of the bunch, which resulted in four deaths, though even it managed to bounce back with the help of a savvy marketing campaign.

If you believe Chipotle will recover from the food safety scare, it's hard to ignore the bright future that still awaits the company. Before sales plummeted, the burrito chain's average sales per restaurant were $2.4 million: even with McDonald's and just behind Chick-Fil-A, the leader in average unit volumes for major fast-food chains.

In others words, the brand has proven enormously popular, especially with millennials, a growing demographic group. Prior to the outbreak, growth constraints were mostly a result of the company's struggles to meet demand during peak lunch and dinner times.

With nearly 2,000 restaurants in the U.S., the company has a long expansion path ahead of it since about 20 other fast-food chains have more locations. McDonald's, for comparison, has more than 14,000. Chipotle's seed concepts, ShopHouse and Pizzeria Locale, also provide potentially huge revenue streams, as does international expansion.

Ten years from now, Chipotle's sales and profits could have easily tripled from its recent peak. As performance improves, so will the stock.

Tamara Walsh (Bear): The fast-casual Mexican food chain's reputation for quality food was damaged recently after outbreaks of E. coli, norovirus, and salmonella sickened dozens of Chipotle's customers. The chain's restaurant traffic could remain challenged in 2016 because of these foodborne illnesses. However, Chipotle will undoubtedly regain the trust of hungry Americans, and when it does, the stock should see a nice lift as a result.

Nonetheless, I'm stepping into bear's clothing for this one and arguing against Chipotle Mexican Grill. Shares of Chipotle still look pricey, despite the recent sell-off in the stock. Therefore, I believe there are better options available to investors today with significantly less risk.

Chipotle's stock plummeted more than 23% in the past year. Shares are currently trading around $514 apiece, or near the low end of the stock's 52-week range. However, don't be (small-f) fooled into thinking Chipotle is a bargain at these prices. The stock still looks expensive with a price-to-earnings growth ratio of 2.4 and a P/E ratio of 34 -- both of which are significantly above industry averages.

There is no shortage of competition in the fast-casual space today. Mexican chains are particularly vulnerable as they make up nearly a fourth of the $40 billion and growing fast-casual market in the U.S., according to data from Morningstar. 

With intensifying competition and Chipotle's temporarily damaged reputation given the recent food scares, I believe investors are better served with a stock such as Starbucks. The coffee retailer is less vulnerable to food-borne illnesses because, unlike Chipotle, it doesn't rely on naturally raised meats or fresh produce for the bulk of its business.

Jeremy Bowman owns shares of Chipotle Mexican Grill. The Motley Fool owns shares of and recommends Chipotle Mexican Grill and Starbucks. 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
$1,600.78 (1.04%) $16.45
McDonald's Corporation Stock Quote
McDonald's Corporation
MCD
$259.23 (-0.54%) $-1.41

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