Chipotle Mexican Grill's (NYSE: CMG) third-quarter earnings announcement hit the market with a thud. The company missed analyst expectations on both the top and bottom lines by reporting revenue of $1.13 billion, versus a $1.14 billion estimate, and adjusted EPS of $1.33 versus a $1.63 estimate, according to estimates from Thomson Reuters. Perhaps the most disappointing metric was a paltry 1% comparable-restaurant sales increase, versus meager expectations of 1.2%.
Not surprisingly, shares sold off during the session following the Oct. 24 earnings announcement, to the tune of 14.6%. As of this writing, shares are down 28% year to date, while the broader S&P 500 is up 15%.
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It's important to note that earnings are a backward-looking measurement, while investing should be forward-looking. That's why it's best to ask where the company is headed. And for Chipotle's path forward, it's a simple story: It needs to regain the brand equity it lost over the past two years. The combination of multiple foodborne-illness outbreaks and a data breach have punctured the veil of a company once bold enough to declare "Food With Integrity" as its mission statement.
Product perception is reality, at least in the short term
Chipotle has lost its mojo and entered into a negative feedback loop. The best example has been the company's queso troubles. What was established as a simple add-on to increase per-ticket prices received harsh judgement from customers and the press. In the long run, is bland queso germane to the investing thesis? No, but it does demonstrate that the company's former can't-miss reputation amid a fawning press no longer exists.
That said, it was slightly concerning that CEO Steve Ells said the queso rollout "successfully change[d] the narrative about Chipotle." I don't think a shift from sick customers and stolen data to a poorly received product isn't exactly improving brand equity. There's discussion of possible future menu additions, but Chipotle's management must understand it's no longer given the benefit of the doubt, as with the sofritas rollout. New menu items can help change the narrative, but only if the items are well-received by the public.
Blocking and tackling as a competitive advantage
Another thing investors should continue to monitor is the quality of the stores, as on-the-ground execution will be paramount to changing perceptions. The biggest reason for Chipotle's astronomical rise was a uniform, top-notch experience, something hard for franchised restaurants with diverse ownership to copy. As the company grows, it's harder to consistently monitor every restaurant. A recent video purporting to show rats at a Dallas-area location, for example, brought more negative press to a company struggling to recover from norovirus outbreaks.
Chief Restaurant Officer Scott Boatright noted during the quarterly conference call with investors that the company will be slowing the rollout of new stores to "restore emphasis on a strong training culture." An emphasis on "blocking and tackling," as in improving basic in-store execution, will yield positive results in the future.
On Wall Street, success begets outsize expectations and competition
In many ways, Chipotle is a victim of past success. For years, the stock was a highflier and even now, shares trade for nearly 60 times earnings. Meanwhile, shares of competitor McDonald's trade hands for approximately half of Chipotle's valuation.
It's understandable as growth has slowed that multiples compression would cause a stock drop. However, it's important to note that even in this poorly received quarter, Chipotle increased its top line by 8.8% and its GAAP-compliant diluted EPS by 155% over the prior year. Chipotle is still growing, albeit not at the level analysts and traders desire.
An additional way Chipotle is haunted by its past is copycat competitors. By essentially creating and redefining fast casual, the company has inspired a host of competitors that have essentially reverse-engineered its operations. Nothing Chipotle did was patentable, nor proprietary, and many competitors have copied the burrito-maker down to the line assembly and the industrial-motif eating area. It's an increasingly crowded space, but as the genre creator, Chipotle can succeed in if it can execute.
What's the cure for a diminished reputation amid increased competition and a rich valuation? Simply put: great execution and time. It's not what impatient investors want to hear, but it's most likely Chipotle's path forward. For patient investors, this may be a great opportunity to buy an unloved stock of a company on transient weakness.
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