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For fast-casual restaurant chain Chipotle Mexican Grill (NYSE: CMG), the bad news keeps coming. What was once thought to be a mild, contained situation has quickly escalated into a full-blown public relations nightmare.
Reports of E. coli have gotten worse, norovirus has also afflicted Chipotle customers, and the company was recently served with a federal grand jury subpoena. Things keep getting worse, and investors who believe that the decline could be a good buying opportunity may want to wait until further news from the company.
Uncertainty: What the Market Hates Most
Chipotle stock has continued to fall, from above $750 at its 52-week high to its current level of just over $400. That is a stunning drop for what used to be one of the market’s darling stocks and a favorite among growth stock investors. Unfortunately, Chipotle is a case study in what can happen when a company’s brand reputation gets damaged, particularly when that company operates in food.
It goes without saying that for a restaurant, food safety is paramount. Even a perception of unsafe food can cause disastrous results. The pain that Chipotle is currently experiencing is exacerbated by the fact that the company took extraordinary steps to reassure customers and investors that the situation was contained, only to see new reports of individuals getting sick.
Several reports of E. coli incidents were linked to Chipotle in October and November. More than 50 people were believed to have gotten E. coli from eating at Chipotle. On Nov. 20, Chipotle issued a press release detailing the deep cleaning and product testing initiatives undertaken at its restaurants to ensure that its food was safe.
But in early December, norovirus was discovered at one of its restaurants in Massachusetts, and sickened 141 Boston College students. Norovirus can be transmitted by eating contaminated food or touching contaminated surfaces and bringing one’s fingers in contact with the mouth. This made Chipotle look bad, even if it was completely unaware of the norovirus situation.
And now, Chipotle can add legal trouble to its list of problems. Following the norovirus outbreak, the company was subpoenaed by a federal grand jury as part of a criminal investigation.
Therefore, the fallout from investors is understandable, and if anything, investors need to wonder whether there’s another shoe to drop. In my opinion, there might be.
Steer Clear Until Earnings
The next shoe could be Chipotle’s upcoming quarterly earnings report, scheduled for release on Feb. 2. Investors need to be aware of the distinct possibility that the results will be downright disastrous.
Chipotle has already notified investors that comparable sales – a key measure of sales at restaurants open at least one year – declined 14% last quarter. And the downward momentum is accelerating: Chipotle said its same-store sales declined a massive 30% in December. This is a truly shocking result for a company that reported 5% comparable sales growth over the previous three quarters.
The company currently expects to post fourth-quarter earnings of $1.70-$1.90 per share. Consider that in the fourth quarter of last year, Chipotle earned $3.84 per share. That was 51% year-over-year growth for the 2014 fourth quarter, helped by 16% growth in comparable sales. Its current 2015 fourth-quarter forecast would represent a 53% year-over-year decline.
Even though its stock price has declined significantly over the past year, Chipotle stock still trades for 24 times earnings. Given the steep earnings decline expected for the fourth quarter, investors may not be willing to reward Chipotle with such a high multiple. That could lead to multiple contraction – after all, growth investors probably won’t pay such a high price for a stock that is suffering significant declines.
The news has kept getting worse for Chipotle, and the risk that earnings could actually be below management’s forecast should compel investors to sit on the sidelines for now.
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