Warning: Stay Far Away From This Former Market Darling
A few friends and I were recently looking for a place to eat lunch in Philadelphia’s Rittenhouse Square, which is one of the busiest areas in the city. At noon, workers poured into the already crowded streets for lunch and nearly every cafe and restaurant was jam-packed.
But one restaurant was surprisingly empty despite the lunch rush.
Chipotle Mexican Grill (NYSE: CMG) had just a handful of people waiting in line, even though it occupied one of the busiest corners in town.
I remember a time when customers eagerly lined up around the block to get one of Chipotle’s burritos, but those days seem long gone.
Chipotle operates a unique, Mexican-themed casual dining chain that prides itself on serving “food with integrity,” using non-GMO ingredients and “responsibly-raised” animals. Its goal is to provide high-quality food at affordable prices without feeling like a typical fast-food joint.
Chipotle was once a crowd favorite and stock market darling, achieving rich valuations as it quickly grew its business. But the love affair with its burritos and its stock came to a screeching halt after outbreaks of E. coli and other food-borne illnesses plagued several Chipotle locations.
The first outbreak occurred in Seattle in July 2015, and subsequent outbreaks, the most recent being this summer, sickened hundreds of people across the country.
The company has been working frantically to restore its reputation and sales, but it doesn’t appear to be working.
No Turnaround for This Relapsed Restaurant
Now, you might have heard something about Chipotle’s supposed turnaround, but what I found upon closer inspection is a shrinking customer base comprised mainly of those who are staunchly loyal to the brand and those who can’t resist free food.
In addition to giving away millions of free burritos in an attempt to lure customers back, Chipotle just launched a new animated ad campaign, called “Ingredients Reign,” which ironically focuses on the very thing that got the company into trouble in the first place.
The bottom line is that earnings have taken a huge hit, and I doubt another commercial will change that trend.
In the most recently reported quarter, revenue fell 16.6% year over year, while comparable restaurant sales dropped 23.6%. Increased costs, including those associated with new food safety practices and aggressive marketing strategies, resulted in earnings plummeting more than 80%. And profit margins were slashed to 11.6% in the first six months of the year from 27.7% during the same period in 2015
With such dismal numbers, you’d think it would be best to hunker down and get costs in order and the brand back on its feet, but the company is still trying to expand. It opened 114 new restaurants in the first half of 2016, with plans to open another 100-plus stores by the end of the year. Oh, and did I mention the company is set to lose an additional $20 million in free catering from a promotion it ran this summer?
It appears Chipotle will be fighting an uphill battle for some time. But judging from the stock’s frothy valuations, it seems some investors and analysts are still hanging on to the dream of what Chipotle could have been.
CMG is currently trading at an astronomical 115 times estimated earnings, the highest in its history.
To be clear, I don’t believe Chipotle is going out of business. Most analysts agree that the company will return to growth in the next couple of years.
But I think Chipotle’s high-growth days have gone the way of the dodo bird. Most importantly, I fail to see the turnaround catalyst that some investors and analysts are hoping for. Instead, I see a company desperately trying to spend its way back to “normal growth,” and that does not warrant current valuations.
The company is scheduled to report Q3 earnings on Oct. 25. My models are showing a high likelihood of an earnings miss, which is likely to drive shares lower.
Shorting shares or buying put options on the stock ahead of the report is certainly an option. But given that estimates are setting the bar pretty low, there is always a chance the company will meet them and those investors who want so badly to believe in the stock will push shares higher.
So I plan to increase my odds of success using a Wall Street insider secret that I picked up when I was a, well… a Wall Street insider. It’s perfectly legal and it’s accessible to almost all traders — most people just don’t use it because they aren’t in on the secret.
With this trade, CMG could fall after earnings, stay put or even rise as much as 10% and I’ll still achieve my maximum profit.
Think about that for a minute and consider what a strategy like that could mean for your portfolio. Even if you don’t call stock moves perfectly, you can still come out a winner. That’s why I’m letting traders in this Wall Street insider secret here.