Chipotle’s Turnaround Faces Execution, Cost Questions
Investors should wait for a larger margin of safety before buying shares of Chipotle given the risks involved in the firm’s bid to win back customers.
Narrow-moat Chipotle (CMG) used its third-quarter update to provide a more detailed blueprint for driving customers back to its restaurants, most of which sounds reasonable on paper but also raises execution and cost questions.
It's clear that Chipotle is struggling to reconnect with consumers, evidenced by the 21.9% comp decline during the quarter (including a 15.2% decrease in comparable traffic) and roughly 20% declines thus far in October. Management confirmed our suspicion that the implementation of the food safety program and crew turnover had affected throughput speed and diluted the customer experience, something that aligns with our recent conversations across the fast-casual space.
To remedy these issues, management plans to prioritize menu innovation (including the nationwide rollout of chorizo as a protein option in October and plans to introduce a dessert option) and make digital ordering (currently 6% of sales) more efficient for its customers and restaurants. While new menu additions might seem to run counter to the idea of throughput efficiency, we don't believe any of the new menu items announced (or in test markets) will disrupt the workflow process. However, we do have questions about how quickly digital ordering can be implemented and adopted. While digital ordering clearly plays into consumers wanting greater ordering flexibility, Panera's 2.0 initiatives--which are yielding encouraging results--required healthy investments in technology, training, and implementation. While Chipotle came across as confident about its ability to roll out these changes, we expect unseen implementation and consumer adoption costs and plan to adopt a more conservative outlook than its initial 2017 outlook calling for high-single-digit comps, restaurant margins of 20%, and EPS around $10 per share. Taken together, we're not planning material changes to our $425 fair value estimate and would wait for a wider margin of safety.
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R.J. Hottovy does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
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