We wanted to highlight an opportunity to short Chipotle Mexican Grill (CMG). Typically, we do not consider shorting companies unless they are fundamentally flawed, fraudulent or in a fundamentally declining industry, nevertheless, we believe that there are multiple factors that will hold down the price of CMG in the short-term.
First, Chipotle has experienced declining comparable sales year over year.
As you can see, the sales were already declining even before the E-coli debacle came into play.
Secondly, Chipotle has had other health-related incidents that are not as well- known as the recent E-Coli.
For example, in August, 2015 in Simi Valley, CA there were 234 people suffering from norovirus. The same month, there were 64 Salmonella cases. Even before the Boston E-coli outbreak, there were 52 cases of E-coli across the states. These outbreaks were not effectively discussed by Chipotle. As you can see, the E-Coli outbreak is not a one-time event, but rather part of a larger issue that Chipotle has not appropriately addressed in our belief.
Third, there will be negative public perception that will drag down the price for the foreseeable future. Consumers demand high quality, safe food and will harshly penalize companies that do not hold up to those standards. It is difficult to place a quantitative value on the effect of negative PR, however, we believe that it is not trivial.
Fourth, Chipotle is overvalued relative to industry peers. Considering recent events, we do not see a strong case for Chipotle to be trading at a premium. Chipotle has to undertake strategic actions that will lower its profitability, erode its perception as a “premium” brand and place it in line with other peers. Undergoing additional steps to make its food safer, Chipotle will incur higher expenses that will impact its margins, slow store expansions and cause multiple contraction.
Fifth, Chipotle’s price will be affected by the downturn in the market. Recent market events were an unforeseen event, and certainly unpredictable by Chipotle’s management, but current market pullback will magnify the gravity of the E-Coli outbreak.
Sixth, a potential outbreak can occur in the future. The current market price, in our belief, has not appropriately incorporated the likelihood of such an event taking place. If it does occur, it will materially lower the stock’s price.
Conclusion: We anticipate Chipotle to trade in the lower $400’s range for the year.
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