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Why a Contrarian Call on Troubled Chipotle

Chipotle is slowing its new store growth while focusing on operations.

Image via Chris Potter/Flickr CC

Chipotle Mexican Grill (CMG) reported good third-quarter results in late October that did not meet the Wall Street consensus estimates, notes Crista Huff, growth and income expert and editor of Cabot Undervalued Stocks Advisor.

All of the key numbers at the restaurant chain were better than a year ago — operating margin, revenue, net income, same-store sales, food costs and more — but that’s not saying much because 2016 was a horrendous year for Chipotle due to the e coli problems.

Adjusted non-GAAP earnings per share (EPS) were $0.69, net of $0.64 and $0.13 per share charges related to this year’s data security incident and the impact of hurricanes Harvey and Irma.

Added together, the aforementioned EPS and charges totaled $1.46 per share when Wall Street was expecting $1.63 per share. For perspective, Chipotle earned only $0.27 per share in the year-ago quarter, so profits continue to rapidly rebound.

The market reacted poorly to news that the company will open fewer new stores in 2018 and 2019 than previously planned. The company plans to open approximately 190 new stores in 2017, then 130-150 new stores in 2018. Chipotle is slowing its new store growth while focusing on operations. On the plus side, the board of directors authorized another $100 million in share repurchases.

Pershing Square hedge fund manager Bill Ackman, the largest CMG shareholder, remains bullish on Chipotle, stating “This is an eminently fixable company…This is still a great concept.” Ackman foresees great possibilities to enhance Chipotle’s aggressive growth, including the addition of drive-throughs and breakfast food, longer hours and overseas expansion.

The company and its share price suffered greatly after food-borne illness problems dramatically affected 2016 profits. Aggressive attention to the problems caused a turnaround in store traffic and profitability. Adjusted earnings per share (EPS) have since risen from a paltry $0.77 in 2016 to the current consensus estimates of $6.74 and $9.43 in 2017 and 2018.

The stock’s price chart has been somewhat disastrous this year, partly due to news headlines of a sick employee coming to work at a Chipotle restaurant in Virginia and infecting customers, and partly due to the dark cloud that’s still hanging over the stock from the previous and broader food safety issues. The stock has very little chance of a rebound past $320 until tax loss selling season is over in January.

Bottom line: Chipotle is a growing restaurant chain that has many moving parts contributing to current and future profitability, including food and labor costs, new products and services, new stores, increased pricing, and new executives revamping procedures and marketing.

The stock is undervalued, volatile and earnings estimates change weekly. As long as the profit outlook and valuation remain attractive, I will hold CMG for the prospect of future capital gains.

Christa Huff is editor of Cabot Undervalued Stock Advisor.

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