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Chipotle (CMG) Q4 Earnings: Will E. coli Scandal Hit Results?

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Chipotle Mexican Grill, Inc. (CMG - Free Report) is set to report fourth-quarter and full-year 2015 results on Feb 2, after the market closes. Last quarter, the Colorado-based fast casual restaurant operator posted a negative earnings surprise of 0.91%.

However, the company has surpassed earnings estimates in three out of the four trailing quarters with an average positive earnings surprise of 2.16%.

Let’s see how things are shaping up for this announcement.

Factors at Play

Chipotle’s fourth quarter has been marred by negative publicity related to the E. coli outbreak – which affected more than 50 customers – in Oregon and Washington at the end of October. It later spread to seven other states, namely, Illinois, Maryland, Pennsylvania, California, Minnesota, New York and Ohio. Along with this, a norovirus outbreak linked to one of its outlet in Boston's Cleveland Circle added to the company’s woes.

Later, in December, the U.S. Centers for Disease Control and Prevention (CDC) announced that it was probing the restaurateur’s links with another E. coli outbreak (with a rare DNA fingerprint) in three states – Kansas, North Dakota and Oklahoma.

As a safety measure, the fast casual chain was forced to close several outlets. Although these were reopened later with fresh ingredients and deep cleaning and sanitizing, these incidents dealt a severe blow to Chipotle’s sales.

Chipotle confirmed that sales have been ‘extremely volatile’ during the last quarter of the year due to the health scares. While the company reported low single-digit comps growth in October, it declined 16% in November. In fact, negative publicity is likely to remain a top-line headwind and fourth-quarter comps are expected to decline 8–11%. The comps decline would dent the bottom line to a large extent and the company expects earnings per share between $2.45 and $2.85, substantially lower than $3.84 reported last year.

Meanwhile, higher food costs, especially beef, along with increased labor costs would hurt profits in the to-be-reported quarter. Also, the company incurred non-recurring expenses for replacing food items in certain restaurants and other costs due to food sample tests due to the E.coli incidents. As a result of higher expenses and considerably lower revenues, the company projects operating margins in the 22–24% range for the fourth quarter, much lower than the year-ago quarter level of 26.6%.

Earnings Whispers

Our proven model does not conclusively show that Chipotle is likely to beat earnings this quarter. That is because a stock needs to have both a positive Earnings ESP and a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) for this to happen. That is not the case here as you will see below.

Zacks ESP: The company’s Earnings ESP stands at 0.00%. This is because both the Most Accurate estimate and the Zacks Consensus Estimate are pegged at $1.84 per share.   

Zacks Rank: Chipotle carries a Zacks Rank #5 (Strong Sell).

We caution against stocks with a Zacks Rank #4 or 5 (Sell-rated stocks) going into the earnings announcement, especially when the company is seeing negative estimate revisions.

Stocks to Consider

Here are a few companies in the restaurant industry which have a favorable Zacks Rank and a positive Earnings ESP and are therefore likely to beat earnings:

Chuy's Holdings, Inc. (CHUY - Free Report) , with an Earnings ESP of +15.39% and a Zacks Rank #2.

Panera Bread Company , with an Earnings ESP of +1.69% and a Zacks Rank #2.

Dave & Buster's Entertainment, Inc. (PLAY - Free Report) , with an Earnings ESP of +4.76% and a Zacks Rank #1.

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