Chipotle Still Intriguing

We've said before that Chipotle's recovery would be uneven at times and may not share the same trajectory of other quick-service restaurant chains (including Jack in the Box in 1993 and Taco Bell in 2006), given headline risks tied to the ongoing Department of Justice food safety investigation, consumer misconceptions about new food safety protocols (including the closing of a Boston store March 9 due to employee illnesses that may not be tied to food safety), and social media. That said, we're constructive on initiatives the company will deploy to drive traffic in the coming months, including the introduction of chorizo as a protein option and shifting promotional strategies from food giveaways to buy one, get one free.

Chipotle's recovery will take time, but we believe it would be shortsighted for investors to write off this narrow-moat name. We remain comfortable with the longer-term assumptions behind our $525 fair value estimate and encourage investors able to withstand potential near-term volatility to keep this name on their radar screens.

While we agree with management's statements from its April 26 conference call that the company is likely to return to positive earnings per share in the second quarter, current consensus expectations for the year (revenue of $4.3 billion and EPS of $6.12 heading into the quarter) still strike us as aggressive. However, we remain optimistic that the combination of greater consumer awareness of the company's improved food safety procedures, increased direct marketing efforts and promotional activity, an acceleration of mobile ordering, and more effective use of second assembly lines in existing restaurants (for mobile and catering orders) positions Chipotle for a recovery in 2017. Our model currently calls for midteens comp growth and restaurant margins in the low to mid-20s, contingent on no additional food safety issues surfacing this year.

Investors must be able to tolerate potential near-term stock price volatility here, but we continue to believe there is a lot to like about Chipotle longer term, including meaningful unit expansion opportunities in the United States and beyond, new concept optionality, and significant free cash flow generation. Our five-year margin assumptions (restaurant margins in the mid- to high 20s, operating margins in the high teens) still place Chipotle in the upper echelon of nonfranchised restaurant chains and provide investors with a compelling investment story.