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Can Chipotle innovate its way to sales growth?

The company’s stock fell on Tuesday after an analyst downgrade that cited its innovation challenges.
Chipotle Mexican Grill

Chipotle Mexican Grill is banking on an improved innovation pipeline with new products and new dayparts that help pull the company out of a long sales slump.

But that innovation could run afoul of another one of the chain’s priorities: improving throughput.

That, at least, is the conclusion of Mizuho analyst Jeremy Scott, who downgraded Chipotle’s stock Tuesday to “Underperform,” meaning he believes investors should sell the chain’s stock.

Chipotle’s share price declined 2% on the downgrade Tuesday. The company’s stock had been up 80% since it announced the hiring of CEO Brian Niccol away from Taco Bell. Chipotle’s shares trade at more than $450. Scott believes the stock should be $300.

“While it is our view that Niccol is the best choice to lead Chipotle from here, in the absence of clear catalysts that can justify significant earnings upside, we’re compelled to recommend investors reduce their risk,” Scott wrote.

Chipotle is arguably the most-watched stock in the restaurant industry at the moment, given its fall from grace following a series of food safety incidents in 2015 that led to a steep decline in sales.

The company overhauled its executive ranks, with founder Steve Ells ultimately moving to the position of executive chairman, and is moving its headquarters to Newport Beach, Calif., from Denver.

That move will result in 399 layoffs in Denver, according to a recent notice filed with regulators in Colorado.

On a conference call with analysts last month, executives said the company’s efforts to revitalize its sales will involve a series of moves to improve marketing, operations and throughput.

But innovation, with new products, is also going to be a featured element. Taco Bell has been famous for its innovative products, with items such as the Naked Chicken Chalupa, a “taco” with a fried chicken shell, or Nacho Fries, which it is bringing back this week.

In a competitive restaurant market, innovative products can drive interest and get customers coming back.

Chipotle’s track record on innovation has generally been weak, however. The company added chorizo in 2016, only to pull it from the menu a year later. It added queso last year, only to reconfigure the recipe for the cheese sauce after early reviews were poor.

Niccol promised a more rigorous testing process, which Scott called “a healthy contrast to the jumpy rollout of queso.”

Yet adding new products could run afoul of the company’s efforts to improve throughput. Scott in his note said that Niccol assured that new menu items would not pass if they hurt that throughput.

That statement “captures some of the challenges we expect new management will face in the R&D process,” Scott wrote, and is “perhaps an indication of a lower risk tolerance with regards to menu development.”

“In a concept where the vast majority of traffic occurs in the lunch daypart and the productivity of its line crew thrives on the simple ordering option tree, innovation can carry unintended consequences,” Scott wrote.

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