Chipotle’s Unending Woes: Is There Light At The End Of The Tunnel?

After posting encouraging results for Q1 2017, Chipotle Mexican Grill (NYSE: CMG) released a guidance stating that its costs will be higher as it spends more on marketing and promotion expenses. (Read Here’s Why Chipotle Mexican Grill’s Revised Guidance Does Not Impact Our Price Estimate). The company has been spending significantly on promotions to regain customers after it faced a serious reputation loss due to the E. coli virus which hit its food in late 2015. However, Chipotle’s woes seem to be far from over. While the E. coli virus has impacted the visits of its most loyal customers adversely, the company reported a data breach recently, leading to a further reputation loss. In early June, four of its employees were arrested in Pennsylvania for selling drugs from the restaurant. In April and May, Chipotle raised prices in several of its restaurants, however this increase has not led to a positive impact. A survey by M Science reveals that the customer resistance to this price increase has been much stronger than expected by the management of the company.

See Our Complete Analysis For Chipotle Mexican Grill

Mounting Expenses, Lackluster Sales Recovery

While Chipotle’s marketing, promotion, and food safety measures led to higher expenses in 2016 – immediately after it was hit by the E. coli virus, it was expected that these expenses would reduce in 2017, as the company recovers from reputation loss. Similarly, while comparable sales were declining significantly in 2016, an increase was expected this year. However, based on the company’s guidance it appears that the recovery might not be as fast as expected. While Q1 2017 results were encouraging, the comparative number for this quarter was softer, given that the first quarter of 2016 was one of the worst quarters for Chipotle, since it was soon after the E. coli virus had impacted the company. We expect Chipotle’s Food, Beverage, and Packaging Expenses as a percentage of revenues to decline gradually over our forecast period as the company recovers from the E. coli virus. We anticipate that Chipotle might not be able to raise prices of its product given the high competition and reputation loss it has faced (the impact of a recent price rise has not been positive), keeping food expenses as a percentage of revenues high.

However, if these expenses remain steady at around 34-34.5% of revenues over our forecast period there can be a nearly 15% downside to our price estimate. For food expenses as a percentage of revenues to come down, the company also has to generate higher revenues by attracting more customers who visit its stores frequently through its marketing efforts. Currently it appears that this equation is skewed and high marketing expenses are not leading to higher sales.

We expect the average number of visits at Chipotle’s stores to increase over our forecast period as customers return to its restaurants.

Chipotle’s reputation loss due to the E. coli virus has put the company in a difficult situation. While it is trying to invest significantly in growing revenues, the competitive landscape has changed in the past two years. With fast food restaurants moving in the “gourmet menu” space and introducing healthy food options, Chipotle can no longer bank on its “food with integrity” tag line. The company has to innovate and adapt a more aggressive recovery strategy to bring customers back to its stores.  Recovery for the restaurant company has been slow, but there is light at the end of the tunnel.

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