Why Key Analyst Sees More Challenges Ahead for Chipotle

It has been over a year since Chipotle Mexican Grill Inc. (NYSE: CMG) crashed after its E. coli scare ,but this burrito giant still has yet to recover, at all. New directives and sanitary practices are in place to prevent these troubles from happening again, but investors still don’t seem to be hungry yet. One analyst took a somewhat negative perspective in its most recent call, which may explain why Chipotle may continue to be fundamentally overvalued.

Wedbush issued an Underperform rating and a $370 price target Chipotle. Although this is not a call for a significant drop in the price, Wedbush is still positing that Chipotle has room to fall.

According to the firm, Chipotle’s early position under the McDonald’s Corp. (NYSE: MCD) umbrella and its company-owned model allowed it access to real estate that was the envy of the category, precipitating a virtuous cycle of increasing brand equity, higher volumes and an increasing volume gap relative to competition. Also the company’s real estate footprint is not replicable today by others in the category, providing a large moat. But this comes with a downside.

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Chipotle itself now occupies most of the best real estate in its target markets, and an increasing mix of incremental units are being built, and will be built going forward, in relatively inferior locations in dense/urban markets and in less dense, less urban markets.

Also the firm sees the recent communications regarding Chipotle’s operational changes as an indication that management may have pivoted from a strategy of regaining lost sales in the near-term to a focus on profitability at current sales run-rates. The largest margin opportunity lies in labor costs as Chipotle has historically overinvested in labor. However, such overinvestment drove employee loyalty and commitment, and was a key enabler of the company’s growth strategy, but this could hurt the company going forward. Chipotle’s largest challenge in executing its margin strategy successfully may be the reconciliation of cutting labor costs while investing in the training of new managers and line employees to recapture its unique culture.

The firm noted that a price increase at Chipotle is not expected within the next 12 months, specifically until 2018.

Shares of Chipotle closed Friday at $392.07, with a consensus analyst price target of $392.32 and a 52-week trading range of $352.96 to $544.88.

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