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Chipotle: Nearing a bottom ahead of February marketing effort?

Nicole Sinclair
Markets Correspondent
A logo of Chipotle Mexican Grill is seen on a store entrance in Manhattan, New York, in this file photo taken November 23, 2015. Chipotle Mexican Grill Inc said it was served with a grand jury subpoena in relation to a criminal investigation into a norovirus contamination at one of its restaurants in California in August. REUTERS/Andrew Kelly/Files

Chipotle (CMG) shares rose 6% on Wednesday, bucking the market and following a push by management to calm investors at the annual ICR conference in Orlando, Fla.

At the conference, the Chipotle management team—including co-CEOs Monty Moran and Steve Ells, along with CFO Jack Hartung—tried calming investors who have seen shares lose over 40% since mid-summer. The executives said the company can fully recover by 2017.

The Mexican chain—whose reputation was built on a "Food with Integrity" promise of locally-sourced and fresh ingredients—has seen its sales under pressure after an E. coli outbreak first was reported in the Pacific Northwest and then spread to nine states. Last month, the Centers for Disease Control and Prevention (CDC) said it found five E. coli cases linked to the company in three additional states that it is investigating. The company also closed a Boston restaurant in December after a norovirus outbreak, and last week the company disclosed it had been subpoenaed in an investigation of a separate norovirus outbreak.

The company’s presentation was by far the most attended at the Orlando conference, with analysts and investors crowding the room, looking for more clarity on the vision going forward. The management team was pressed on how it has approached the health and public relations crisis, including a question about a "lack of humility" in recent presentations.

“Let me first say that there’s never been any belief that anybody but us has been responsible. We take full responsibility,” said Chief Creative & Development Officer Mark Crumpacker.

After continued uncertainty, investors responded with optimism this week after founder and co-CEO Steve Ells said he was hopeful that the CDC will soon declare the outbreak over.

The stock kicked off 2016 on a sour note following a difficult end to 2015. On Jan. 6,  the company lowered fourth-quarter guidance, reflecting a significant impact on both its traffic and costs after the string of health concerns. It slashed its EPS outlook to $1.70-1.90 from $2.45-2.85 while lowering its  comparable-store sales projection to -14.6% -- significantly below the -8-11% warning set last month. Management also lowered restaurant margin to 20-21% from 22-24%.

A turn ahead?

Chipotle said it plans a marketing push next month to explain what happened and “invite customers back.” To supplement the public relations message that the health concerns are over, the marketing effort will return to emphasizing the health and good taste of the food.

But don’t expect a return to normalcy for results in 2016, according to management. Hartung emphasized that earnings and margins would be “messy” this year.

“The visibility is not going to be great. We’re not going to be the efficient business model that everyone has come to know—Chipotle has become during 2016, because our primary focus is food safety and bringing our customers back in and delighting them," Hartung said.

Management discussed ongoing and future investments in food safety, which include additional ongoing food testing and changes to its supply chain, which would, according to management, bring Chipotle to be a leader in food safety, years ahead of peers in the space.

And while this would impact margins near-term, investors responded positively to confidence by management that the company could return to its industry-high margin levels. Chipotle’s store-level margins stood over 27% in 2014.

The Chipotle executives said they are confident the company can win back the trust of customers and see a recovery in sales by 2017. The team also announced that it has no plans to slow the pace of new restaurant openings, with as many as 235 slated for 2016.

“We don’t feel any different about our unit economics potential,” said Hartung.

According to Stephens analyst Will Slabaugh, historical cases of foodborne illness have a one-year tail of subdued comp trends, followed by a relatively slow recovery as the brand's marginal customers slowly re-adopt the concept—data that supports what could seem like overly ambitious goals from Chipotle's management.

According to Slabaugh, after the Taco Bell E.coli outbreak in 2006, same-store sales took four quarters to recover to positive territory. In the 1993 Jack in the Box food-borne illness case, it took also a year to recover after a steep drop.

Management characterized the food-safety crisis as a temporary setback as the company continues to transform the way people eat.

Chipotle will hold a companywide meeting on Feb. 8, where employees will tune in to prepare to welcome back the customer.  This will kick off a big marketing push from the company, including an “unprecedented effort” to reach out to its most loyal customers with a detailed story on what happened in an effort to show transparency. Ells expressed he feels “extremely confident” in the brand.

Morgan Stanley surveyed 2,000 adult consumers this month and found that while over 70% had awareness of the health issue and 15% said they won't return to Chipotle for a long time, key brand metrics like food quality, taste and value remained at early-2015 levels which bodes well for a longer-term recovery.

Opportunity for the competition

The looming question, though, is if competitors will gain an edge while Chipotle tries to woo back its core customer.

We’ve seen growing demand for Latin American-inspired food, with many of the names in the space whose stocks have fallen from lofty valuations aiming for a resurgence—These include Fiesta Restaurant Group (FRGI) which owns Taco Cabana, El Pollo Loco (LOCO), and Jack in the Box (JACK) which owns Qdoba. Chuy (CHUY) has seen its stock rise 60% in the last year, with strong comparable-store sales figures including a 4% number last quarter. And YUM Brands (YUM) Taco Bell has started to see a significant turnaround after new offerings have revived traffic, with comparable-store sales for the brand up 4% last quarter.