Why Chipotle Stock Needs More Than an Earnings Beat

Here at Cabot, we regularly preach “buying bad news”—that is, investing in good companies beaten down by a series of bad headlines. Often, the bad headlines only last a few days, and investors eventually buy back in after a brief period of typical Wall Street overreaction. Chipotle stock may fall into a different category.

Chipotle Mexican Grill (CMG) built its once-spotless reputation on being the rare fast-food joint that actually cared about the quality and freshness of its food. Sourced from farms instead of factories and served without preservatives, Chipotle’s fast-casual Mexican restaurants spread like wildfire around the country. The food tasted good, it was fast and it was (allegedly) fresh.

Then it poisoned hundreds of customers in 10 states in 2015.

The fast-food giant was forced to close 43 restaurants in nine states after diners contracted a bacteria-based illness from eating their food. To make matters worse, a few weeks later, 141 Boston College students (including more than half the men’s basketball team) got sick from eating at a Boston Chipotle after contracting a different virus, something called norovirus.

Chipotle Stock Rally Halted

Needless to say, that wasn’t good for Chipotle stock; CMG tumbled 44% in three months. Sales suffered too, declining for four straight quarters after years of consistent double-digit growth. Chipotle didn’t return to top-line growth until the fourth quarter of last year.

When growth returned, so did investors: after bottoming below 360 last November, CMG stock was knocking on the door of 500 this May—a 38% jump in just over six months! Perhaps more importantly, there were no further cases of Chipotle’s food making its customers violently ill.

Until two weeks ago. The company had to close a restaurant in Sterling, Virginia, for two days after 133 diners fell ill due to what health officials classified as norovirus. Then last week, video was captured at a Dallas Chipotle of mice falling from the ceiling and running around the restaurant. Yikes!

Okay, so the latter incident is more of a freak occurrence (and a comical one) that could probably happen anywhere. But the timing was horrible. Investors again bailed on Chipotle stock in droves, resulting in a 15% drop in CMG in the last 10 days. At 342 as of this writing, the stock has broken below its 2016 lows, and appears to be in freefall.

Amid all this drama, Chipotle will report earnings after the bell today (Tuesday) afternoon. Analysts are expecting a very strong quarter, with estimates of 19% sales growth and 151% EPS growth. But I’m not so sure a strong quarter from Chipotle can stop the bleeding in CMG stock.

While the first set of food-poisoning outbreaks could be easily deemed an aberration, even if it took some time for Chipotle customers to return, a second occurrence looks more like a trend. Mice aside, we’re talking about one rogue restaurant where customers contracted norovirus. It seems unfair to completely write Chipotle off based on an outbreak in one of its 2,250 locations. But at this point, Chipotle has lost the benefit of the doubt in the minds of the American public—and certainly on Wall Street. Thus, I think the selloff in Chipotle stock will continue for some time.

CMG Is Sick Again

No, I don’t think CMG stock is dead, just like Chipotle itself, it will bounce back. But with trust eroding, it could be a while. Last time, it was a full year before Chipotle stock found bottom, which coincided with four straight quarters of negative sales growth. If the company’s top-line resurgence continues in the current quarter, then perhaps this downturn in CMG will be much shorter lived. But last quarter’s earnings are virtually irrelevant, so don’t expect a turnaround to commence this week even if it beats optimistic estimates.

Bottom line: though beaten down stocks can often become attractive bargain opportunities for value investors, Chipotle stock is simply too toxic (or should I say poisonous?) right now. Like the food in its Sterling chain, I wouldn’t touch it.

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