Why Chipotle is Still a Greasy Sell

I am getting slammed with emails today asking whether after my negative pre-earnings stance on Chipotle (link to that call here: www.decodingwallst.com), would I buy the weakness. So, I felt very compelled to break out precisely why one should continue to avoid the stock like a bad, non-organic burrito from Taco Bell. The analysis is simple to grasp when keeping in mind that even post sell-off, Chipotle shares will continue to be valued at mucho premiums to comparable companies and the broader market. That extreme valuation was justifiable as Chipotle's comparable restaurant sales were accelerating quarter over quarter. But, don't follow the herd mentality on this cult favorite stock and be mindful that the fundamental story of Chipotle is changing.

Every Reason to Avoid Chipotle

This is something I call the “pyramid of analytical disaster”…

The top: Chipotle logged its first single-digit percentage comparable restaurant sales increase dating back to the second quarter of 2010, and the worst since the first quarter of that year (+4.3%). The key drivers of Chipotle's comparable restaurant sales, customer traffic and price increases, have now begun to evolve. First, customer traffic, which was a strong driver in the first quarter of the year, is poised to moderate heading into the third and fourth quarters. There is downside risk to traffic given cautious consumer spending trends and possible brush back to Chipotle's late 2011 menu price increases. As that traffic risk elevates (and likely occurs), pricing gains may have to be reversed ever so slightly. Ultimately, the collection of these “what ifs” leads to concerns on the bottom of the analytical pyramid.

The bottom: With slowing comparable restaurant sales comes less “leverage” on costs and operating expenses. I am most concerned with costs. The company is ramping up efforts to use more naturally grown meat, which is a great social message, but does raise costs structurally (and this is structural because Chipotle will not suddenly go away from its natural message, its key to the brand) as sales are moderating. Additionally, severe drought conditions are likely to translate to higher supply chain costs for restaurant operators and as we know, Chipotle is not likely to reignite price increases this year (has stated it won't, plus I am not sure how much more open the consumer would be to further Chipotle price increases…might opt to pack lunch for work).

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