Stifel Sees U.S. Recession; Downgrades Chipotle Mexican Grill To Sell

Stifel has downgraded Chipotle Mexican Grill, Inc. CMG to Sell from Hold as it expects the U.S. economy will likely fall into recession within the next three to nine months.

Comp Outlook, Justification

"More specifically, we adopted a below-consensus two-year (2H16–1H18) industry wide comp outlook of +0.5 percent E (vs. consensus' +1.75 percentE) with a resulting assumed increase in industry discounting (that has historically always accompanied recessionary slowdowns)," analyst Paul Westra wrote in a note.

Westra turned bearish on monolithic restaurants due to the following three reasons:

1. "On Sales: because 2Q16's simultaneous comp deceleration across every industry sector portends to a lasting dining-out slowdown"

2. "On Margins: because historically restaurants have suffered 2+ years of margin-degrading negative Relative Pricing Power (RPP) at the start of dining-out declines as discounting quickly ratchets-up in the face of declining sales"

3. "On Valuation: because in the year preceding the last three U.S. recessions, on average, restaurant stocks have declined -23 percent (vs. S&P 500's -10 percent)"

As such, Stifel now expects a typical recessionary two-year comp slowdown between third quarter 2016 and second quarter 2018.

Q2 Expectations

For the second quarter, the firm expects average industry second half comp guidance to be about 100bps below consensus. In the long term, Stifel expects 3Q16–2Q18 industry-wide comps of +0.50 percent.

"Our final 2Q16 Stifel Sales Survey results suggest that the restaurant industry's 2Q16 industry-wide comp was +0.7 percent A (vs. consensus' +1.0 percent E) and, as such, we believe that the average restaurant company will report a 2Q16 '-30bps comp miss,'" Westra highlighted.

Chipotle Estimates

For Chipotle, Westra has a price target of $215, "which does not account for the prospect of further negative tail risk in the event of any material changes in Chipotle's hourly/manager turnover rates that often accompany the arrival of a concept's peak returns."

Westra said, "Chipotle has reached 60 percent U.S. saturation, a typical arrival point of a concept's 'Peak Returns.'" Further, the company will face competition from "a new breed of quick-casual concepts on the low end (taco joints, along with every other cuisine)."

"Drawing on our 20 years of restaurant-industry experience, our rule-of-thumb is that most chains experience a 'profit-growth spurt' in per-store profitability when a concept moves between 20 percent and 50 percent of its ultimate penetration opportunity within a given market," Westra highlighted.

As such, the analyst questions Chipotle's board approval to purchase about $1.1 billion of stock at an average price of about $480/share since the fourth quarter 2016, reducing the company's cash balance to about $600 million.

"[W]e now hold a near Street-Low 3Q16/4Q16/2017 comp estimates to #18 percent E/-1 percent E/+7 percent E (vs. consensus' #17 percent E/ +2 percentE/+8 percent E) and 3Q16/4Q16/2017 EPS of $1.80E/$2.00E/$10.00E (vs. consensus' $1.75E/$2.13E/$10.55E)," Westra noted.

At the time of writing, shares had fallen 1.89 percent on the day to $433.17. Westra's price target of $215 represents a potential downside of 51 percent versus Monday's close.

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