The good news for Chipotle is that its food doesn’t appear to be making customers sick anymore. The bad news is that investors should be sick over the embattled company’s unrealistic growth expectations and financial mismanagement.
Many investors are still buying expensive Chipotle shares in hopes that the company returns to its prosperous days in 2014. That’s not going to happen.
Before 2015, Chipotle was the envy of restaurant operators across the country. Many industry participants were convinced Chipotle had cracked the code on an industry operating model that led to outsized margins. But the outbreak of foodborne illnesses that broke out coast to coast for five months in 2015 has permanently impaired the profitability of its business model. Simply put, the company’s lack of investment in basic food safety procedures violated the first rule of running a restaurant: Don’t get the customer sick.
As a result, Chipotle now has significant operating costs that will make it nearly impossible for the company to return to its status prior to the outbreak. Moreover, the company previously relied on word of mouth to attract new customers. Those days are over. From this point forward, just like every other restaurant company, Chipotle will need to spend major marketing dollars to drive customer visits. Incidentally, the company recently revealed that its payment processing network was hacked. This is yet another reminder that Chipotle’s management team is unprepared to manage a business of this size.
Those optimistic about Chipotle’s future cling to the fact that it’s building new stores across the country. Although Chipotle is now focused on better-performing territories, it doesn’t stop the fact that customers still think of Chipotle as the place that has E. coli.
This isn’t a good way to start a potential relationship, especially when there are so many fast casual alternatives with similar business models. Companies like Freshii, Sweetgreen, and Dig Inn are already stealing market share from Chipotle, and Panera is likely to cut in with its recently improved offerings and delivery services. McDonald’s also can’t be underestimated, with its campaign to add new technology to its restaurants and decision to serve fresh beef in Quarter Pounder burgers starting in 2018.
It’s easy to forget that Chipotle’s massive expansion was done under the majority ownership of McDonald’s from 1998 to 2006, which culminated in Chipotle’s IPO when McDonald’s wanted to cash out. Over the succeeding decade, CEO Steve Ells grew the company from 500 to approximately 2,000 locations, but forgot to build the infrastructure to support such a system alongside it. That story didn’t end well.
It’s clear that Chipotle’s current management is not fit to guide the company’s ship going forward. The best, but unlikely, scenario would be for Ells to step away from the business and hire a reputable operations person from a proven company. But since that’s likely off the table, Chipotle is stuck with the guy that destroyed the second-best brand McDonald’s ever cultivated—other than its own.
Howard Penney and Shayne Laidlaw are restaurants analysts for Hedgeye. Neither analyst nor Hedgeye are investors of any of the companies mentioned in this article.