Is Chipotle Mexican Grill, Inc. (CMG) Stock a Buy Despite Illness News?
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Just when we thought Chipotle Mexican Grill, Inc. (NYSE:CMG) was embarking on a solid turnaround, we get more bad news. On Tuesday, CMG stock fell over 4% on reports that Chipotle had to close one of its locations due to customers getting sick again.
Source: Shutterstock
With CMG back in the news for the wrong reasons, it seems it had made it out of the woods, just to get thrown back in.
Chipotle has never had the most attractive valuation, always trading above its peers. The thesis (before its food-borne illness issues in 2015) was that strong earnings, revenue and same-store sale growth was worth the premium multiple. Investors were willing to overlook valuation today in lieu of strong growth tomorrow. They were banking on more store openings driving higher sales and allowing the fat margins to trickle down to the bottom line.
But then the illnesses came. Many saw it as a one- to two-year hiccup in the growth story. Perhaps it still is. I saw it that way for a long time too.
Chipotle Stock: Where to From Here?
The hardest thing to work with in stocks is the unknown. We don’t know what Chipotle’s current problem is, how long it will last or if it will happen again. That makes it really hard to pay a premium multiple. Additionally, with all of CMG’s food overhaul programs, margins have been on the decline. Throw in higher SG&A spend and rising input and marketing costs and margins are really feeling the pressure.
Even with a strong recovery in sales, pressure on the bottom line is noteworthy. With that said though, many are willing to overlook margin compression if it results in top-line growth.
We know that Chipotle is not going to out of business. After all, it is profitable. And even though it doesn’t seem like it, people do forgive and forget when it comes to food service. At some point — assuming CMG doesn’t go through the whole food-borne illness thing again — Chipotle will get through its current issues. Its store count will continue to grow and it will have a well-oiled machine for a business.
The issue? We don’t know how long that will take. Currently trading at 31x forward earnings would be fine and dandy had this latest incident not made national headlines. That valuation is high, but justifiable in that CMG stock should have no problem growing earnings and revenue handedly for the next few years.
Now though, we’re in wait-and-see mode to see what kind of impact this will have on Chipotle’s business. We also want to make sure that the incident isn’t as bad as the ones in 2015 (although the store is already reopening). We should find out the answers to those questions in the upcoming earnings conference call.
Trading CMG Stock
Source: Stockcharts.com
Coming into this week, shares were down nearly 20% over the past three months. Believe it or not, those thinking that the company still has a chance can trade CMG stock from the long side.
Looking at the chart, there’s reasonably strong support near $360. This level held CMG up when everyone was seemingly throwing in the towel. The nice thing is that this level is only about $10 from current prices. Meaning investors could use a stop-loss just below Chipotle stock’s lows on the chart. If shares hold up, investors will be in near the lows. If it flounders, investors can escape with minimal losses.
Additionally, the relative strength index (RSI) is the most oversold it has been in the past 18 months. While this doesn’t mean a bounce will happen, it could suggest a low — at least temporarily — is near.
One note though: Breaking news could send CMG reeling, perhaps gaping below investors’ stop-loss. This could cause larger-than-expected losses and is worth taking into account in a situation like this.
The Bottom Line
Three analysts came out with new ratings and price targets for CMG stock. Wells Fargo and BMO downgraded the stock to a market perform rating, assigning price targets of $375 and $350, respectively. Telsey Advisory actually upgraded the stock and assigned a $440 price target.
Downgrades aren’t encouraging, but price targets near current levels suggest maybe the lows aren’t as far away as some are guessing. Chipotle stock has a reasonable risk-reward, allowing investors to take a chance and generate an attractive return. I like Chipotle, but I’m still a bit leery. As a result, I’d rather miss some upside and get in on an “all-clear” sign than buy in now and suffer the consequences.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, he did not hold a position in any of the aforementioned securities.
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