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Will Food Safety Issues Hurt Chipotle's (CMG) Q3 Earnings?

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Chipotle Mexican Grill, Inc. (CMG - Free Report) is scheduled to report third-quarter 2017 results on Oct 24, after market close.

The company’s earnings and revenues are likely to improve year over year. In fact, the Zacks Consensus Estimate for the quarter’s earnings stands at $1.69, representing an year-over-year increase of over 100%. Also, revenues are estimated to increase 10.3% to $1.14 billion.

However, it is to be noted that the to-be-reported quarter is expected to witness easy year-over-year comparisons as Chipotle was in the midst of its massive food-safety scandal this time last year.

Throughout 2016 Chipotle’s results continued to be affected by the negative publicity related to the food-borne illnesses, which surfaced toward 2015-end. Also, the closure of a Washington-area outlet during the third quarter owing to an apparent norovirus alert has started a fresh round of food-safety scare. Evidence of rodents was found at a Dallas outlet, further adding to the woes.

Meanwhile Chipotle continues to make efforts to strengthen its brand and recover sales by shifting strategies from giveaways, discounts and rewards to new menu items, simplification of restaurant operations, upgrade of guest experience, better operations including faster throughput and more aggressive brand marketing. This, in turn, might drive the company’s top- and bottom–line performance in the quarter under review.

Nonetheless, renewed food safety concerns may pressurize the company’s top line, suggesting that the company has a long way to go before it can put all these troubles behind and return to its former glory.

In fact, shares of Chipotle have lost 32% over the past six months, as against 6.3% growth recorded by the industry.

That said, let’s wait and see whether the upcoming earnings release would exert more pressure on the stock. Though Chipotle delivered an earnings beat in three of the trailing four quarters, the average earnings surprise comes in at a negative 3.94%.

Also, our proven model does not conclusively predict an earnings beat in the third quarter.

Notably, a stock needs to have the right combination of the two key criteria — a positive Earnings ESP and a Zacks Rank #1 (Strong Buy) or 2 (Buy) or at least 3 (Hold) — for increasing the odds of an earnings beat.

Unfortunately, this is not the case here, as elaborated below.

Zacks ESP: Chipotle has an Earnings ESP of -9.73%. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

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

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

Other Factors Likely to Influence Q3 Results

Chipotle claims to be the only national restaurant brand to use no added colors, flavors or preservatives of any kind in its ingredients. The company’s enhanced focus on making better food accessible to everyone is thus expected to aid in bringing back health-conscious customers and improving sales in the third quarter.

The addition of new restaurants is expected to bolster revenues. Furthermore, the rollout of Smarter Pickup Times technology in all its restaurants that offer digital ordering is anticipated to drive sales as it improves the digital ordering experience. Markedly, earnings are expected to get a boost from revenue growth and share repurchases.

Yet, costs associated with marketing programs designed to drive traffic and build loyalty with its customers are likely to continue thwarting the quarter’s profitability. In fact, Chipotle expects marketing and promo costs to account for nearly 3.1% of sales in the second half of 2017. Higher labor expenses along with elevated food costs, given rise in avocado prices, are likely to further dent the quarter’s profitability.

Meanwhile, a soft consumer spending environment in the U.S. restaurant space is expected to limit revenue growth. Also, the addition of Queso to its menu is not likely to add much to its top line as it was introduced only in mid-September.

Stocks to Consider

Here are a couple of stocks, which, as per our model, have the right combination of elements to post an earnings beat this quarter:

Dave & Buster's Entertainment, Inc. (PLAY - Free Report) has an Earnings ESP of +9.86% and a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.

El Pollo Loco Holdings, Inc. (LOCO - Free Report) has an Earnings ESP of +6.74% and a Zacks Rank #3.

Shake Shack Inc. (SHAK - Free Report) has an Earnings ESP of +1.40% and a Zacks Rank #3.

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