Chipotle: Rise and Fall of a Wall Street Darling

Chipotle's stock price rocketed by more than 23% in trade on April 26, 2018 after it reported better than expected earnings for the first quarter of this year. So far the company's shares have risen 45% YTD on a series of positive news events after a long string of bad press. The struggling fast food chain named Brian Niccol, as its new CEO on February 13, 2018, take turnaround its fortunes. Just four days prior to that announcement Chipotle shares were trading at $249.87, its lowest price in five years. Chipotle's stock fell more than 17% in the three days after it released its 2017 fourth quarter earnings. Health-related issues added to the concerns about the company's performance and added to the woes of its stock.

While the company's shares have seen a wild ride in the past few months in the wake of many issues including health concerns, it was once a hot favorite among investors. Now that there is optimism about its future, it is perhaps also a time to look into the company's past performance to determine if this positive momentum is sustainable.

From the moment shares of Chipotle Mexican Grill Inc. (CMG) hit the market on January 26, 2006, investors couldn't get enough. The stock opened at $45.00, more than double its initial public offering (IPO) price of $22.00 – itself boosted from an initial range of $15.50 to $17.50 – and closed up exactly 100%, at $44.00.

The press gushed. The debut was "spicier than a three-alarm hot sauce," Dow Jones Newswires wrote the following day. Citing another item the chain does not sell, USA Today called the stock "a hot tamale." MarketWatch ticked off an impressive list of bests-since.  

Still owned by McDonald's Corp. (MCD) at the time, the 13-year-old burrito chain was a rising star at the confluence of two major trends: the "fast-casual" approach to dining that has reshaped the restaurant industry and the real-food push that has shunned industrialized farming and over-packaged, over-processed edible plastics. What's better, unlike so many hot IPOs before and after it, Chipotle kept investors hooked using the same approach that kept customers lining up: a simple, quality offering.

To customers it served up a straightforward set of options and the perception that they were eating something honest and reasonably healthy. In the early days, when there was no menu, customers would come in, get confused and turn to walk out. Founder and CEO Steve Ells "would chase them down and say, 'No, no, no, I'll buy you a burrito. Just try it,'" COO Gretchen Selfridge told Bloomberg in 2015. As Ells put it, "Better than a menu board, look at the food." People tried it, and they came back. They brought their friends. (See also, Steve Ells Biography.)

Investors got a refreshing back-to-basics experience with Chipotle, as well. It sold a product within just about everyone's "circle of competence," and from the time Ells opened his first location, it sold vastly higher quantities of it than anyone expected. To break even, the first store needed to sell 107 (or 114, accounts vary) burritos per day. Within a month of opening Ells was pushing over 1,000 out the door every day. Monty Moran, who was co-CEO until December 2016, told Bloomberg, "No one ever looked at the business plan again."

Revenues exploded. Chipotle sold $187.0 million in its first quarter as public company. A year later that figure was up 26%, followed by 29% the next year and 16% the year after that – not bad for the calamity-filled year to March 2009. By the third quarter of 2015 revenues had reached $1.2 billion, an increase of 639% over ten years. 

Profits followed suit: $8.0 million in the first quarter of 2006 rose 55% to $12.4 million a year later, rose 40% to $17.3 million a year after that. Chipotle reported net income of $144.9 million for the quarter ending September 2015, a leap of 2,741% over a decade.

Not that investors wanted any of those profits back. Chipotle has never paid a dividend, focusing instead on relentless expansion. Every 10-K the company put out boasted a list of new states with a smattering of new countries – Canada, Britain, France, Germany – and a reliably triple-digit annual increase in total restaurants. 

Chipotle was doing what its corporate parent (from 1998 to 2005) had done in prior generations, printing cash by selling fast, cheap, tasty food to anyone and everyone. But it was doing it better than McDonald's. Its food was fresher, the line went: healthier, more ethical, better for the environment. It tasted better. Who could resist the burritos or the shares? Chipotle was taking over.

For a while the only problem was the valuation. As shares surged, even rapidly rising sales and profits couldn't keep up. An April 2012 Motley Fool article noted that the company traded for over 60 times its trailing twelve month earnings, but called the "lofty" valuation "rather justified" in light of profit growth that far outstripped that of rivals such as Panera Bread Co. (PNRA) and Qdoba owner Jack in the Box Inc. (JACK). 

Chipotle's shares hit an all-time high of $758.61 on August 5, 2015. The hypothetical oracular investor who had bought at the stock's IPO opening price and sold at that level would have made a 1,586% profit. 

Then five people caught E. coli from a Chipotle in Seattle. No one noticed. Next came a norovirus outbreak in Simi Valley, California, which sickened dozens in mid-August 2015. Early in September, that outbreak was traced back to Chipotle, as was a salmonella outbreak in Minnesota. In late October cases of E. coli began to crop up in Washington and Oregon, prompting the closure of 43 locations in those states as health officials investigated. The CDC reported additional cases of E. coli in California, Minnesota, Ohio and New York later that month, followed by Illinois, Pennsylvania and Maryland in December. A norovirus outbreak at Boston College followed soon after, with over 100 students affected.

The CDC continued to investigate the chain's multiple E. coli outbreaks, with Oklahoma, Kansas and North Dakota joining the ranks of affected states. In January 2016 the company revealed that it had received a grand jury subpoena related to the Simi Valley outbreak. Management began damage control, hosting a Q&A at a conference in Florida that lifted shares for a couple of sessions. The CDC declared an end to the E. coli outbreaks on February 1, 2016 the day before the company reported fourth-quarter results. (See also, This Is Why Every Chipotle Is Closed for One Day.)

For the first time as a public company – and going back at least eight quarters prior to its IPO – Chipotle's same-store sales fell. Nor was it a gentle decline, at 14.6%. Total sales and earnings followed suit: revenues dropped 6.8% year-over-year to $997.5 million, while profits fell 44.0% to $67.9 million. The company also revealed an expanded criminal probe, with the U.S. Attorney's office requesting documents going back to the beginning of 2013.

The company said 2016 would be a "very difficult year." It was. 

All told, hundreds had gotten sick, and many of them had been hospitalized. Shares were down nearly 40%. Expensive promotions and an all-out ad blitz followed, as did Chipotle's first quarterly loss – of $26.4 million – since 2004. Management touted new food safety initiatives, from shredding cheese in central kitchens to offering paid sick leave (a policy that was already in place). (See also, Chipotle Did Not Account for Free Lunches in Q1.)

Investopedia spoke to Dr. Ben Chapman, a food safety expert at North Carolina State University, about Chipotle's response to the outbreaks in early February. He saw more rhetoric than substance in Chipotle's response to the outbreaks, particularly in Ells' assertion that the chain was now "years ahead" of what other restaurants were doing: "I just don't know what that means." 

Shares bottomed out on November 1, 2016 at $352.96, 53% below the all-time high. Fears that people are getting sick again occasionally thwack the stock. In July the author of some of the Bourne novels tweeted that his editor had gotten sick at a Manhattan Chipotle, and shares dropped 3.4% in pre-market trading. The chain shut down a store in Virginia after Business Insider reported on July 18 that at least 13 customers had gotten sick after eating there. (See also, Nearly 10,000 Workers Sue Chipotle for Wage Theft.)

In a shift from its former approach, Chipotle is adding items to its menu. The risk is that the additional options become a distraction, but in a way that's exactly what Chipotle is looking for – a distraction from bacteria-ridden headlines. Lunchtime lines are filling out again, though Ells has attributed the change in part to poorer service; in any case, it would only take one outbreak to drive customers away, perhaps permanently. 

As things quiet down on the disease front, Chipotle is a long way from its halcyon days of unstoppable growth. On the other hand, the chain is showing signs of sustained recovery. The first three months of 2017 saw same-store sales return to growth and marked Chipotle's fourth straight profitable quarter. Of course those twelve months combined fall well short of a single quarter's earnings in the pre-coli days. The company did have a rough third quarter last year, but the growth momentum seems to have returned.

Unfortunately for bottom-fishers, shares – trading at 67 times trailing twelve month earnings – still aren't cheap. And that doesn't include the extra charge for guac.

This post has been updated throughout.