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Chipotle (CMG) Shares Up 40% in 6 Months: More Room to Run?

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Shares of Chipotle Mexican Grill, Inc. (CMG - Free Report) are riding high on improvement in comps and restaurant openings, various sales-building and strategic initiatives as well as steps to enhance safety and customer experience. These efforts have aided the company’s shares to surge by 39.6% in the past six months, against the industry’s decline of 5.3%. However, higher costs might hurt the company’s performance in the coming quarters. Let’s delve deeper.

Hidden Catalysts

Chipotle, being one of the most recognized fast casual Mexican restaurant chains in the United States, bore the brunt of negative publicity throughout 2016 due to an issue of food-borne illnesses that surfaced toward 2015-end. As a safety measure, the company was forced to close several of its outlets. Ever since then, this fast-casual Mexican chain has been undertaking aggressive efforts to restore its economic model as well as regain customer trust. As part of its revival strategy, Chipotle fulfilled its pledge of using no added colors, flavors or preservatives of any kind in any of its ingredients. In fact, the company now makes use of only 51 real ingredients to prepare all of its food, in stark contrast to most other fast food chains.

The company is also working on strengthening its brand and recovering sales by shifting its focus from giveaways, discounts and rewards to new menu items, operational excellence and enhancement of guest experience by retraining workers, technology-driven convenience along with more aggressive brand marketing.

The company plans to pilot various tests across key innovation-focused areas such as consumer access, digital, menu and restaurant experiences, and realignment of the organization to witness incremental growth. Meanwhile, roll out of queso has substantially spurred sales of the company. The queso added 200 basis points (bps) to the average check in the first quarter of 2018. The Zacks Rank #3 (Hold) company is prioritizing e-commerce program to gain customer confidence as a part of its digital innovation. The company is aggressively trying to make digital ordering more appealing to customers and efficient for its restaurants, in order to drive digital sales and regain customers. In this regard, Chipotle has redesigned and simplified its online ordering site, enabled online payment for catering, online meal customizations and collaborated with several well-known third-party providers for delivery.

Concerns

Chipotle’s continued efforts to connect with its customers in order to regain their trust and loyalty as well as bring them back to its stores on the back of high marketing and promo expenses have been hurting its profitability. Moreover, costs to support the company’s newly designed food safety program is likely to weigh on the company’s margins. Further, the implementation of food safety practices has increased the amount of labor required to prepare and serve food, resulting in higher labor costs that is likely to keep profits under pressure.

Competition among fast-casual, quick-service and casual dining segments of the restaurant industry is expected to remain fierce with respect to price, food quality, service, location and concept, which may adversely impact Chipotle’s operating margins and profits. Particularly, the company is facing price competition from low cost “value meal” menu offerings of fast-casual and quick-service segments of the industry.

Key Picks

Some better-ranked stocks from the restaurant space include Wingstop (WING - Free Report) , Dine Brands (DIN - Free Report) and Domino’s (DPZ - Free Report) . While Wingstop and Dine Brands sport a Zacks Rank #1 (Strong Buy), Domino’s carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Wingstop, Dine Brands and Domino’s earnings for 2018 are expected to grow 13.5%, 23.1% and 55.2%, respectively.

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