Why Chipotle Stock Could Fall Another 20% from Here

I would think twice before buying Chipotle (CMG) at these levels…

Chipotle is one of the biggest growth companies in the restaurant space. Over the past three years, the stock has easily outperformed just about every one of its competitors. This includes Panera Bread (PNRA) and McDonald’s (MCD).

However, Chipotle watched its shares fall by 30% over the past two months.

The huge downturn was caused by an outbreak of E. coli found in several of its restaurants. E. coli are bacteria found in humans and animals. Some strains can cause severe food poisoning, kidney failure and even death.

I received several e-mails from subscribers asking if Chipotle is a buy following the huge pullback. It’s a good question. …

After all, it’s not often you get the chance to buy one of the fastest-growing stocks in any industry at a 30% discount.

But I suggest staying clear of Chipotle. In fact, the stock could fall another 20% as sales and earnings will likely plunge over the next few quarters.

On Nov. 1, Chipotle announced it would close dozens of restaurants in Washington state and Oregon due to an E. coli outbreak. This was after 19 people became sick after eating at the Mexican food chain.

Since the announcement, the Centers for Disease Control and Prevention linked 47 E. coli cases in nine states to Chipotle. To make matters worse, Chipotle just announced 120 students in Boston felt ill after eating at one of their restaurants.

The students have been diagnosed with norovirus — which is similar to the common flu. In other words, these students did not contract E. coli. However, norovirus is transmitted by touching contaminated surfaces or people who are sick.

Chipotle is trying to contain the situation.

The company temporarily closed 43 stores in the Pacific Northwest — and its one store in Boston where the norovirus outbreak was reported.  These stores have been sterilized and all the ingredients have been replaced. Most of these stores have reopened.

However, it’s still too early to buy the stock.

More times than not, I would recommend buying a solid industry-leading company after a temporary setback. After all, I am a huge fan of Chipotle. And this breakout will eventually be contained.

But Chipotle is trading at a very expensive 30 times forward earnings. This valuation is from today — after the 30% decline in the stock since mid-October.

This valuation is warranted if a company is growing sales and earnings much faster than the market. Yet, Chipotle announced that sales plunged 16% in November. This compares to a low-single-digit growth in sales from earlier in the year.

I wouldn’t be surprised if sales fall more than 20% in December following the Boston scare. And I expect this weakness to continue at least over the next few months as customers are likely to rethink their willingness to take their families to Chipotle.

My advice is to avoid Chipotle stock.

The company is likely to post huge sales declines in the coming quarters. This is significant since Chipotle — along with other high-growth companies like Netflix (NFLX) and Facebook (FB) — trade mostly on sales trends.

Plus, the company has still not figured out the cause of the E. coli breakout. This could result in another setback for the stock, and more negative headlines.

Also, most institutional analysts have not adjusted their estimates enough to account for the latest sales declines. For example, there are 31 analysts who provide research on Chipotle according to Thomson/First Call. Yet, not one of these analysts has a sell rating on the stock.

This is surprising since Chipotle has fallen 30% over the past two months. And the stock is still trading at a super-high valuation — while sales are expected to plunge at least over the next few months.

In other words … expectations from the "Street" are still optimistic. This suggests Chipotle is likely to report weaker-than-expected sales and earnings in the coming quarters which could push the stock even lower in the short-term.

Good investing,

Frank Curzio