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Here's Why You Should Steer Clear of Chipotle (CMG) Stock

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Shares of quick-casual and fresh Mexican food restaurant chains operator, Chipotle Mexican Grill, Inc. (CMG - Free Report) , have declined 32.8% over the past six months compared with 8% growth of the industry it belongs to.

Moreover, this Zacks Rank #5 (Strong Sell) company has been witnessing downward estimate revisions of late, reflecting analysts’ pessimism on its growth prospects.

Over the last 60 days, the Zacks Consensus Estimate for Chipotle’s current-quarter earnings has slumped 8.7%, reflecting 12 downward revisions versus none upward. Also, its current-year earnings estimates have moved down 5%, due to nine downward revisions versus three upward revisions.

This apart, Chipotle has a number of other aspects that make it an unattractive investment option at this point.

Food-Safety Issues

Throughout 2016 Chipotle’s results continued to be affected by the negative publicity related to the food-borne illnesses, which surfaced toward 2015-end.

Moreover, the recent closure of a Washington-area outlet due to an apparent norovirus alert has started a fresh round of food-safety scare. Evidence of rodents was also found at a Dallas outlet that further added to the woes.

Industry Headwinds

The U.S. restaurant space has not been too enticing for the last few quarters. Notably, same-store sales growth has been dull in a difficult sales environment. Traffic too has been weak. In fact, the second quarter of 2017 marked the sixth consecutive quarter of negative comp sales for the restaurant industry as a whole, thus continuing the somber mood. Chipotle is no exception to the trend, and resultantly the company’s sales have also come under pressure.

Rising Costs Putting Pressure on Margins

Chipotle intends to continue using a mix of marketing programs designed to drive traffic and build loyalty with its customers. In fact, the company expects marketing and promo costs to account for nearly 3.1% of sales in the second half of 2017.

Also, implementation of food safety practices has increased the amount of labor required to prepare and serve food, resulting in higher labor costs that may continue to keep profits under pressure. Alongside, rising avocado prices pose a threat to the restaurant chain's profitability as well.

In fact, Chipotle has recorded trailing 12-month net margin of just 3.2% compared with the industry average of 15.1%. Given the continual rise in expenses, the trend is not expected to reverse for the company any time soon.

Valuation Looks Irrational

Chipotle seems overvalued when compared with the broader industry. Its current price-earnings (F1) and price-sales (P/S) ratios are higher than the respective industry averages

Bottom Line

Despite a solid start in 2017, a fresh round of food-safety fright has once again gripped the company in dilemma. Consequently, alarming questions have been raised over Chipotle’s turnaround in the near term.

Notwithstanding various sales-building and strategic initiatives undertaken by the company, we particularly believe that a stretched valuation, negative estimates revision and renewed food-safety concerns limit the upside potential for the stock.

Stocks to Consider

Better-ranked stocks from the same sector include McDonald's Corporation (MCD - Free Report) , Restaurant Brands International Inc. (QSR - Free Report) and Domino's Pizza, Inc. (DPZ - Free Report) holding a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

In the trailing four quarters, McDonald's, Restaurant Brands and Domino's pulled off an average positive earnings surprise of 7.44%, 6.46% and 6.75%, respectively.

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