Chipotle is in Big Trouble

Written By Briton Ryle

Posted July 26, 2017

Fast-casual innovator Chipotle (NYSE: CMG) is in big trouble.

You probably know about the E. coli problem from 2015–2016. Stores around the country were plagued by food poisoning cases. Hundreds of people got sick, and the source was never definitively identified. The impact on the company and the stock was devastating. 

Before E. coli, Chipotle was doing around $4.4–$4.5 billion in annual revenue. The stock price had rolled to around $700. Investors were glad to pay a premium for the shares: growth was fantastic, and the non-GMO food was a favorite of millennials, who would be customers for life.

Then the food poisoning cases hit. Revenue fell below $4 billion. The stock price fell to $400.

Chipotle spent the last 18 months trying to repair its image. Burrito giveaways and more stringent controls on the supply chain were the focus. Plus, the company added chorizo to the menu. I was happy to give it another chance after the first round of food sickness, because, well, what’s better than saying, “May I have a little more chorizo on those tacos?” 

And the plan was working. Chipotle reported second-quarter earnings last night, and they were good. Revenue is on pace to return to that $4.4–$4.5 billion level. People were happy to give the chain a second chance. But a third chance? I don’t know about that…

Puking up Shares

A couple weeks ago, about 100 people got sick from a Chipotle in Northern Virginia. It wasn’t E. coli. It was norovirus, spread by a sick employee. Here we go again…

To be fair, it’s probably not Chipotle’s fault. I also think it doesn’t matter in the least. “Chipotle” and “food sickness” are now synonyms. Honestly, I can actually imagine myself putting on a wig and fake nose, donning a trench coat, and sneaking into a Chipotle for some of those chorizo tacos. But my kids?

Just imagine the conversation with my ex-wife…

Me: “Yeah, I took the kids to Chipotle and they got food poisoning…”

Satan: “You took them there after the THIRD time they’ve had food poisoning issues?” 

Me: “Please don’t stab me.”

Yeah, my kids are 15 and 17. Still, there’s just no way I can take them to a Chipotle. Like, ever. And I don’t think I’m alone on this one. It’s anecdotal, but I drove by one suburban Baltimore location, and it was empty. As in, I wondered if the store was even open. There were maybe four cars in the parking lot.

So those solid second-quarter earnings numbers? You can just ignore them. I think it’s going to take a loooong time for Chipotle to win back its customers’ trust. 

84% in 3 Days

So, when the news hit about this latest round of food sickness, I fired off a trade alert to my Real Income Trader subscribers, advising them to buy some put options on Chipotle ASAP. That was Tuesday, July 18. (Amazingly, I completely missed the Taco Tuesday joke).

The stock was already down big, but so what? This is devastating news, and — fun fact — the forward P/E for Chipotle is still over 30. That’s a huge premium to pay for a company with trust issues.

There was at least one analyst who said the dip to around $370 was a buying opportunity. Maybe it was a young kid who doesn’t really understand what happens to a damaged brand. In any event, three days later, on July 21, my Real Income Trader subscribers were cashing in a sweet 84% gain. 

At the time I told them we’d take another position when the stock rallied — it was really oversold, and a bounce looked likely. Well, that bounce came yesterday. We bought more puts, so if the stock falls another 10%, we will rake it in. Did I say if? I meant when — when the stock falls another 10%.

This seems like a lock to me. Even if revenue stabilizes, that forward P/E of 30 is a thing of the past.

Dear Caterpillar: I’m Sorry, I Didn’t Mean It 

I have an apology to make. I must wake up grumpy on Mondays, because I ripped Caterpillar pretty good. I mean, I’ve done it before. Caterpillar has been hurting for years. And the fact that the share price remained close to all-time highs was driving me crazy. 

Yesterday morning, Caterpillar reported really good second-quarter earnings. Here are a couple quotes form the earnings call:

We are starting to see several markets recover, and demand for China construction and North America gas compressions remains strong. Sales were higher in all three primary product segments, led by Construction Industries, followed by Resource Industries, and then Energy & Transportation.

Strength in China continues to be driven by government support for infrastructure and strong residential investment. Sales in China in the second quarter were better than we had expected, and we now expect demand in China to remain strong through the rest of the year.

You see that? China. It seems demand is improving in China. This is potentially really good news (except not for Chipotle). Commodities across the board have been kind of weak, as China’s demand has been treading water. That includes oil. 

If demand from China picks up, however, I think we owe the stock market a resounding, “Nice call.” Because the stock market has been pricing something in the last few months. And it hasn’t been exactly clear about what.

Yes, there’s earnings. Better earnings, as oil has recovered and oil stocks are ready to show a profit again. Better than half of the expected 7% earnings growth for the S&P 500 in the second quarter is coming from energy stocks. 

Even with an oil price recovery, the virtually uninterrupted march higher for stocks this year has left more than a few investors wondering if the market was out of its tree. I’ve had my moments of doubt, too (ahem, Monday). 

But now? I think we may have to wonder if the market was pricing in a return to growth for China. That would be big.

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.

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