After Chipotle Mexican Grill reported its first loss in the company’s history, Michael Berger, Associate Editor of MoneyShow.com, expresses doubt about the company’s ability to maintain a premium valuation and highlights a restaurant stock he believes is undervalued.
Chipotle Mexican Grill (CMG) fell more than 5% after the company reported its first quarterly loss in its history.
The fast-food giant is seeing a slow road to recovery after the company was battered by an E. coli outbreak where same-store sales fell approximately 30% during the quarter.
Could Have Been Worse
Although this was by far the worst quarter in Chipotle’s history, it was not as bad as many people expected.
CMG reported a loss of $0.88 per share on $835 million in revenue. According to a consensus estimate from Thomson Reuters, analysts expected a loss of about $0.95 per share on $868 million in revenue.
The company appears confident in its turnaround as it opened 58 new restaurants during the quarter. Management previously stated that they expected to open more than 200 new restaurants by the end of 2016.
Giveaways Seem to be Working
In an attempt to win back customers, the Mexican food chain resorted to giveaways. The market has received mixed data on the effectiveness of these promotions. We think it will take more than a free burrito for Chipotle to gain back the trust of its loyal following.
According to a survey conducted by Cowen and Company during the first week of April, approximately 41% of customers who received a coupon had visited the restaurant 3.8 times in the prior 30 days. This is significantly higher than the 1.4 times for the 59% of guests who did not receive a coupon.
Although this data seems positive, Cowen said that Chipotle's most loyal customers may use a large amount of the coupons. A recent text promotion showed significantly higher redemption rates than with a direct mail promotion.
Most Loyal Customers Are Key
Chipotle will need to bring back its most loyal customers if it wants to receive a premium valuation from Wall Street.
Chipotle defines its most loyal customers as those who dine at least 25 times a year. The company needs to bring back these customers because they account for up to 20% of sales.
Long Road to Recovery
Chipotle still has its hands full with a major PR crisis stemming from a series of food safety incidents linked to consumers who got sick after eating at their restaurants.
Although the company has taken steps to prevent future incidents, we expect to see margins affected by the higher costs associated with its marketing strategy, its promotions, and more costly food safety procedures.
It is going to take more than one free burrito for Chipotle to gain back the trust of its loyal following and we believe there are better investment opportunities available.
Favorite Restaurant Stock
Our top pick in the restaurant sector is Fiesta Restaurant Group, Inc. (FRGI). Through its subsidiaries FRGI owns, operates, and franchises fast-casual restaurants under the Pollo Tropical and Taco Cabana brand names.
As of January 3, 2016, FRGI had 155 company-owned Pollo Tropical restaurants, 162 company-owned Taco Cabana restaurants, and 35 franchised Pollo Tropical restaurants in the US, Puerto Rico, the Bahamas, Guatemala, Honduras, Panama, Trinidad & Tobago, and Venezuela, as well as 6 franchised Taco Cabana restaurants in the US.
FRGI’s shares are down more than 35% during the last twelve months; the result of near-term traffic concerns at Pollo Tropical. We believe this weakness is overdone and FRGI has not yet recovered (up 3.4% YTD).
We are favorable on FRGI for the following reasons: 1) Customer traffic at Pollo Tropical has improved after the recently launched value promotion (attention grabbing $3.99 price point); 2) Increased confidence in Pollo Tropical’ s 2016 outlook; 3) Remain confident in management's development strategy and Pollo Tropical’ s long-term growth potential; and 4) FRGI is trading near its all-time low and valuation is very attractive at current levels.
