You can't keep a good turnaround story down. Shares ofChipotle Mexican Grill opened 2.3% lower yesterday, following an analyst downgrade. However, Chipotle stock turned positive a few hours into the trading day -- even though the rest of the market was still in negative territory. It closed marginally lower on the day, but easily beaten the market.
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A downgrade on a down market day is usually a recipe for disaster, but Chipotle is making up for lost ground. Chipotle stock may be clocking in with a double-digit percentage gain in an otherwise ho-hum 2016, but it has lost nearly a third of its value since peaking last summer.
Deutsche Bank analysts Karen Short and Brett Levy lowered their firm's rating on the stock from hold to sell, sticking with a $400 price target that suggests considerable downside from here. Deutsche Bank notes that Chipotle did the right thing by being proactive in tackling the health scares that have rocked the concept's popularity in recent months, but the actual turnaround could take longer than the current rally in the shares would seem to suggest.
It's no surprise that we're waist deep in what will be Chipotle's worst quarter as a public company. Comps plunged a mind-boggling 36% in January since a year earlier. February may not be as bad, but it's going to be a stinker -- especially with the restaurants closing for lunch one day to update all of its employees on its latest safety procedures.
Then it had folks redeeming vouchers for free burritos that it gave away as a result of the Feb. 8 shutdown. The year-over-year comparable results should improve sequentially in March. Chipotle has widely publicized the measures that it's taking to make the dining experience safer. It's also distancing itself from the last of the gastrointestinal illness outbreaks that took place late last year.
You still don't bounce back from a 36% plunge in store-level sales for the first month of a quarter. Analysts see revenue falling 16%, to $920 million, for the current quarter, its lowest top-line tally since early 2014. However, it also wouldn't be a stretch to predict that this will be Chipotle's last quarter where sales fall short of $1 billion -- ever. Even the lowest of Wall Street's forecasts calls for revenue to top $1 billion for the second quarter; as long as there isn't another health scare, that's what investors should expect.
The bottom line is going to be a disaster. Some analysts think Chipotle will post its first quarterly loss as a public company, and it may very well be lucky to break even in this challenging climate. However, there's little reason to believe that the brand is irreparably damaged. Deutsche Bank warns that there is a possibility that there could be a permanent loss of customers as the competition intensifies and the brand perception suffers; but have you been to a Chipotle lately? The queues are getting back to where they used to be, and it's not just because the spike in mobile orders is slowing down the assembly line.
Deutsche Bank analysts rightfully point out that the trend was already starting to weaken even before the E. coli and norovirus scares. Comps were starting to decelerate sharply after five-straight quarters of double-digit percentage gains in year-over-year comparable-restaurant sales. The analysts blame the organic slowdown before the health scare escalated the exodus on menu fatigue and high prices; but it could also be that Chipotle was just facing difficult comps to build on from its blowout run through 2014.
It may take some time before Chipotle revisits last year's all-time highs. It's no longer an unblemished market darling. However, suggesting that it will shed more than a quarter of its value from here, when so many signs point to the fundamentals actually bottoming out, is a bit of a flour tortilla stretch.
The article Downgrade Chipotle Mexican Grill Inc. at Your Own Risk originally appeared on Fool.com.
Rick Munarriz has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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