The Striking Price

How to Profit as Chipotle Shares Get Grilled

Even Taco Bell is more esteemed. A put option strategy can help you profit from the company's missteps.

By STEVEN SEARS

Saturday, June 18, 2016

Chipotle Mexican Grill trades around 33 times next year’s earnings—a valuation that seems incredible for a stock that has lost the trust of many fanatically loyal customers after a major food-safety crisis.

The restaurant chain's fall from grace is so severe that a recent Harris Poll survey found that even Taco Bell, the exemplar of cheap Mexican food, is now more esteemed.

Chipotle's stock (ticker: CMG) isn't faring much better. Shares are off some 20% this year, and analysts are ratcheting down price targets. This sets up a potential snowball effect on what had once been a great cult stock.

Chipotle electrified the nation, and investors, just as people were tiring of mass-produced food like Taco Bell's. But something happened in Chipotle's ecosystem. The food made some people sick. Some even went to the hospital. Ever since the crisis peaked last November, the stock has struggled. Last week, shares dropped below $400. Their 52-week range: $339.14 to $758.61.

Maxim, a small brokerage firm, told clients the stock could fall to $285. Deutsche Bank sees it fairly valued at $340.

Since the stock was undone by the food safety scandal, we have recommended positioning for it to keep falling. When shares were trading at $472, we advised buying the June $450 put option for $23.50. The put expired around $60. Now it is time to reset the position in anticipation of lower lows.

With the stock trading at $394, investors can buy the December $350 put for $22.70 Should the stock fall to $275, the put would be worth $75 at expiration. If the stock fails to fall below the strike price, the trade fails. The risk is as real as the opportunity.

The $350 strike price anticipates Chipotle keeps failing to persuade people that everything is OK. The expiration, which captures two earnings reports, expresses a view that future financial results will reinforce the first quarter’s lousy results.

In the first quarter, revenue fell 23% to $835 million, and comparative sales fell 30%, while restaurant operating margins collapsed to 7% from 28%. By some measures, each Chipotle restaurant has experienced an annualized loss of $350,000, which is real money.

Chipotle is expected to report second-quarter earnings in mid-to-late July. Currently, Wall Street expects earnings of 98 cents a share on revenue of $1 billion. Ninety days ago, the earnings-per-share estimate was $1.73, and the future does not seem promising.

ASIDE FROM A SLEW of Buy One, Get One Free deals aimed at groups that everyone trusts–nurses and teachers–it’s hard to say what Chipotle is doing to address its food-safety woes. The promotions focus on the freshness of the food while ignoring what is on everyone’s mind: Is it safe to eat? You can ferret about for the information, of course, but having to search reinforces the notion that Chipotle is being defined by the crisis rather than the response to the crisis.

Chipotle's management seems intent on trying to promote its way back to profitability instead of addressing the enormously difficult challenge of making sure everyone knows that the food preparation methods are beyond safe.

This is ironic, and not in an interesting way. The company's founder, chairman, and co-CEO, Steven Ells, built Chipotle under the motto “Food With Integrity,” but its postcrisis steps seem more reminiscent of the corporate strategy known as CYA.

Deutsche Bank is telling clients that Chipotle may have forever lost some customers. This could be the sign of an even larger problem. Moe’s Southwest Grill surpassed Chipotle as America’s most popular Mexican food brand, according to the Harris Poll. Taco Bell is No. 2. Chipotle no longer even ranks in the top four for its category, which it had led since 2013.

 

Reprinted by permission of Barron's Online, © 2016 Dow Jones & Company, Inc. All Rights Reserved Worldwide.

The views expressed in the above papers and articles are solely those of the author of the article, and do not necessarily reflect the views of OIC; the information presented is not intended to constitute investment advice or recommendations to purchase or sell securities of any company; and the information presented is based upon particular events that may or may not recur in the future.

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