The 'Time Has Expired' For A Chipotle Turnaround, Mizuho Says In Downgrade

Shares of Chipotle Mexican Grill, Inc. CMG lost more than 10 percent after the company's fourth-quarter earnings report Tuesday failed to impress Wall Street analysts who lowered their ratings on the fast casual restaurant chain.

The Analysts

• Mizuho Securities' Jeremy Scott downgraded Chipotle Mexican Grill's stock from Buy to Neutral with a price target slashed from $370 to $300.
• Stifel's Chris O'Cull downgraded Chipotle Mexican Grill's stock rating from Hold to Sell with a price target lowered from $310 to $250.

Scott: 'Time Has Expired'

Scott initiated coverage of Chipotle back in 2017 under the assumption that management could successfully recover from major incidents, including multiple food illness scares over a 24-to-30 month period, Scott said in the downgrade note.

But the earnings report on Tuesday makes it clear that the time for a Chipotle turnaround has run out and a bullish stance can no longer be justified, he said. 

"While the brand has experienced numerous unforseen setbacks along the way, the bottom line is that time has expired and we can no lnoger hold up previous incidents as a guide." 

Chipotle's earnings report consisted of multiple good, bad and ugly data points, Scott said. 

The Good

• The launch of Chiptopia "reinvigorated" the loyal base and resulted in meaningful improvement in guest scores.
• New store productivity is moving higher and should be supported by new stores opening in proven and established markets.
• Queso mix was around 10 percent of transactions, which implies "good traction."

The Bad

• Chipotle is taking "considerable price" amid a value war in the quick service restaurant space.
• The company plans on spending $300 million on planned capital expenditures in 2018 — an $80-million increase from 2017 — and the expenditures are unlikely to be a meaningful driver of comps.
• The company will continue to focus on TV marketing campaigns, which is seen as an "ineffective messaging platform."

The Ugly

• SG&A for 2018 is projected to grow at 2.5x the rate of sales. Traffic fell 3 percent in the quarter and weakness carried over into January.

Related Link: Earnings Preview: General Motors And Chipotle Earnings On Tuesday Docket

Stifel: Three Reasons To Turn Bearish

The rationale for a downgrade toward a bearish stance on the restaurant chain is threefold, Stifel's O'Cull said in a research report.

• Management's 2018 guidance is calling for negative traffic through the first half of the year, and a call for incremental investments in R&M and employee programs was not anticipated. G&A expense is also expected to be notably higher due to incremental stock compensation, employee bonuses, retention bonuses, stock grants and the biennial manager conference.
• Chipotle is spending roughly $20,000 per store to give the appearance a refresh. But based on remodel programs overseen at other restaurant chains, the $20,000 figure is unlikely to be large enough to "have much impact to the look and feel."
• Chipotle co-founder and outgoing CEO Steve Ells' comments during the conference call that he will transition to the role of executive chairman, rather than chairman, is "interesting." Specifically, the executive chairman role comes with substantial influence and a notable role in day-to-day management of the company, and Ells could even lead board meetings. The analyst said that he also struggles to "see how any experienced CEO candidate would find this arrangement ideal for implementing change.

Related Link:

Chipotle Naming A New CEO Would Remove A Big Overhang, Says William Blair

Photo courtesy of Chipotle Mexican Grill.