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Chipotle downgraded on concerns over African swine fever impact

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Chipotle (CMG) has been on a tear this year, but one analyst warned that the good times may be coming to an end.

African swine fever has been ripping through Asia and has destroyed pig populations in key regions across the continent. Thus, the prices for pork have skyrocketed over the past several months. Lean hog futures (LH=F) have soared 46% this year. BMO Capital Markets analyst Andrew Strelzik thinks the pork meat inflation will have a detrimental impact for Chipotle as margins come under pressure.

After soaring more than 54% in 2019, shares of the Chipotle got crushed Thursday, tumbling 6% midday, after Strelzik downgraded the stock to Underperform from Market Perform and slashed his price target to $620 from $675. That would be a 9% move lower from Thursday’s opening price.

Strelzik cited concerns over the spread of African swine fever for the downgrade and price target cut. “We believe the potential magnitude and duration of ASF [African swine fever] impacts to margins is under-appreciated, and CMG is among the restaurants most at risk. [Chipotle] could begin to recognize stronger protein inflation as early as 3Q19,” he said in a note to clients Thursday.

According to the United Nations’ Food and Agriculture Organization’s (FAO) biannual food outlook report, ASF will likely depress China’s pig meat output by at least 10% this year. Furthermore, “spread of the disease is largely behind the foreseen contraction of 4 percent in world pig meat output,” the FOA said.

Strelzik argued that ASF’s impact on food companies in the U.S. cannot be ignored. “ASF impacts to date already imply the loss of 5%+ of global protein supplies that is likely to result in broad-based protein inflation over at least the next 2+ years,” he explained. “CMG is among the restaurants most at risk from sustained, broad-based protein inflation.”

According to Strelzik, Chipotle has the greatest pork exposure of any of the companies that BMO covers, at an estimated 10%, and thus he expects the burrito chain to start feeling the wrath of ASF as early as Q3 of this year.

“Margin pressure from ASF creates downside risk to EPS and incremental flow through likely will be weak. Our 2020 estimates are nearly 10% below consensus, but we have taken a conservative approach to layering margin pressures from ASF into our model,” Strelzick said.

However, Strelzik’s analysis was not accurate, according to Chipotle. “The cost of our pork represents less than 2% of Chipotle’s total food costs. Since we purchase higher quality, more expensive pork than commodity pork, and we have pricing agreements in place, we don’t expect a significant impact on our costs,” a spokesperson said in a statement to Yahoo Finance.

Other big companies are also feeling the negative ripple effects from ASF.

Hormel (HRL) reported quarterly financial results Thursday morning and also cited ASF in its report. “In spite of record sales, second quarter earnings did not meet our expectations,” CEO Jim Snee said in a statement. “African swine fever in China started to impact global hog and pork markets this quarter, which led to rapidly increasing input costs.”

Heidi Chung is a reporter at Yahoo Finance. Follow her on Twitter: @heidi_chung.

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