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Chipotle's 'Burger' is just noise in what's becoming a multi-year comeback

·Markets Correspondent

Chipotle (CMG), which has fallen from darling status after a E. Coli and norovirus food safety crisis last year, has filed a trademark for the name "Better Burger," potentially setting the stage for growth beyond burritos, which has long been the company’s bread and butter.

Wedbush analyst Nick Setyan, who has an "underperform" rating on the stock, doesn't think that a burger roll-out would be impactful near-term. “It would not impact the pace of a recovery in any way.  Based on the pace of development of their other brands like Shophouse, even if the first Burger unit were opened tomorrow, it wouldn’t be a meaningful contributor for another 5+ years.  In the near-term, it’s nothing but noise,” he told Yahoo Finance.

Co-CEOs Steve Ells and Monty Moran have said that Chipotle’s “Food with “Integrity” healthy food concept can be spread beyond its core offerings. “We believe that the fundamental principles on which our restaurants are based—finding the very best sustainably raised ingredients, prepared and cooked using classical methods in front of the customer, and served in an interactive format by special people dedicated to providing a great dining experience—can be adapted to cuisines other than the food we serve at Chipotle,” according to the company’s annual report.

This is not Chipotle’s first foray into non-burrito chains. The company operates 13 ShopHouse Southeast Asian Kitchen restaurants and three Pizzeria Locale restaurants.

However, the news of a potential brand extension comes just a week after the company said that sales continued to suffer over the past two months--with January comparable store sales down 36.4% and Feburary down 26.1%. This would mark an interesting return to the world of burgers--though of the healthier kind--as Chipotle used to be part of McDonalds (MCD).

The focus for investors has been on the U.S.-based burrito locations, which stood at 1,971 as of the end of last year (the company also has 23 international burrito shops in Canada, France, England and Germany). And with lingering questions surrounding the core business growth, the expansion experiment could present risks for the company.

While Chipotle's stock saw some support after the U.S. Centers for Disease Control declared the E.coli outbreaks over in February, it lost its momentum as analysts began to cite meager store-level data. The company has gotten no less than six ratings downgrades this year from Wall Street analysts.

Yum Brands (YUM) Taco Bell's E.coli outbreak in 2006 and Jack in the Box's (JACK) food-borne illness case in 2993 both took one year to recover after a steep drop, as pointed out by Stephens analyst Will Slabaugh.

But analysts have cited a longer road to recovery for Chipotle. Earlier this month, Jefferies analyst Andy Barish downgraded the stock because of a potentially longer-than-expected road to recovery. Barish pointed to social media and Chipotle's "Food with Integrity" appeal as contributing to a longer road to gaining back consumer trust ahead.

Wedbush's Setyan downgraded the stock on Tuesday to Underperform, citing elevated recovery expectations baked into the stock price.

"We believe a sales recovery by 2018 is the best-case scenario, not the base-case scenario," according to Setyan.

For average unit volumes to recover to pre-outbreak levels of over $2.5 million even by 2018, Setyan says the company would need to see a continuously accelerating 3-year transaction growth trajectory. Meanwhile, margins would be pressured to about 20% versus the mid-20% range given increased expenses including labor and commodities.

When it comes to growth restaurants, unit growth that isn’t matched by confidence in same-store sales growth at already-existent locations pressures valuation in the stock. This can be seen in the fall-off in shares of high-growth chains like El Pollo Loco (LOCO), Noodles & Company (NDLS), and Fiesta Restaurant Group (FRGI).

Chipotle has said that 2016 will be an "investment year." The real question for investors is: How long will the recovery take? While the stock has been dealt blows before--including in 2012 that stemmed from concerns around slowing comparable store sales growth--the ability to restore faith in its core health message could be a higher barrier to climb. 

 

Chipotle’s doubling down and expansion of its “Food with Integrity” message could pay dividends long-term, but in the meantime, does this just add to the list of risks for investors?