A big shake-up just hit Chipotle Mexican Grill (NYSE: CMG). Longtime chief executive officer (CEO) Brian Niccol just announced a surprising departure to Starbucks. Niccol has been instrumental in delivering a turnaround for Chipotle after its foodborne illness outbreaks, leading the stock to 800% returns since joining in 2018, making it one of the best-performing stocks in the world over that time.
Leaving a company -- especially for a competitor -- will always upset investors. It is no surprise, then, to see Chipotle stock falling on this news. In fact, the stock has taken a 25% dive since its recent stock split in June. This is not the worst drawdown ever for Chipotle, but one of the most significant in the last 10 years. Here's my prediction for what comes next with the Brian Niccol era over.
A surprising CEO exit
On Aug. 13, Starbucks announced it had hired Brian Niccol away from Chipotle as its CEO, effective immediately. This was a shocker for two reasons. First, Starbucks had not previously told investors it was looking for a new CEO. Second, Chipotle's valuation was similar to that of Starbucks at the time of the announcement, with a market cap range of $75 billion to $100 billion. It also has a clearer path to store expansion and has put up much better performance over the last few years compared to the coffee giant.
So why did Niccol leave for Starbucks? We may never know the real details, but it seems like Niccol may have thought Chipotle was in a great place and was now looking for his next big project. After Niccol arrived at Chipotle in 2018, he righted the ship after the terrible foodborne illness outbreaks at its restaurants.
The stock has returned over 800% for investors since he had taken over the reins, crushing Starbucks' returns over that same time period. Niccol may see more ways to improve the Starbucks business and feels comfortable with the culture he has built. Or, it might just be the money.
Either way, this shouldn't be taken as a knock on Chipotle's business. In fact, it says the opposite. Chipotle's business has thrived over the past few years, posting positive same-store sales growth every year since Niccol took over, even during the COVID-19 pandemic. This is why the stock trades at a price-to-earnings ratio (P/E) above 50. Investors are optimistic about the future for Chipotle.
The new CEO hire is a vital decision
The new CEO hire will be a big moment for Chipotle investors. Management changes always come with uncertainty, especially with delicate operations such as restaurants. The new leader won't be in as difficult as a spot as Niccol in 2018, with Chipotle's business firing on all cylinders at the moment while Niccol had to rebuild the brand after the food poisonings. In fact, the biggest risk is that the new CEO changes up Chipotle's strategy and makes things worse. You might say it is impossible to mess up its burrito and Mexican bowl formula, but you'd be surprised how often management can impair a once-loved business.
We've seen it happen many times before. Starbucks has struggled multiple times in the past when longtime CEO Howard Schultz left the company. Even outside the restaurant industry, Disney has gone through bouts of inconsistent managers that have hampered operations. There's no guarantee the new CEO will break Chipotle's momentum. But there's no guarantee they will succeed, either. There is uncertainty today as opposed to with Niccol, who investors had high certainty was a strong leader.
CMG Revenue (TTM) data by YCharts.
What comes next for the stock?
There are three possible outcomes for Chipotle and its new CEO. Either they improve, maintain, or impair Chipotle's restaurant operations. Given that Brian Niccol might be the best leader in the entire restaurant industry, I have doubts a new CEO can meaningfully improve Chipotle's business can from here. It can keep growing the number of restaurants in operation (3,530 at the end of last quarter) for a long while, but there is only so much you can do to optimize the restaurant business, especially if the company has exhausted its possibilities of opening new restaurants in prime locations. It is a simple model at the end of the day.
So, Chipotle will either maintain its stellar performance or get worse under the new CEO. However, even if Chipotle maintains its excellence, I think investors should be cautious about the stock. It trades at a P/E of 53, which is around double the S&P 500 index average.
Assuming sales and net profit grow by 100% over the next five years (the former grew at the same pace over the last five years), it's hard to argue the stock is worth owning. Assuming consistent profit margins, that would only bring down Chipotle's P/E to 26.5, which is not cheap on a five-year forward basis.
Add it altogether, and it looks like Chipotle stock is pricing in a ton of growth and high expectations for the next few years, no matter who the CEO would be. Despite its strong historical performance, this indicates investors should stay away from buying Chipotle stock. Keep this one on the watch list for now.
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Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chipotle Mexican Grill and Starbucks. The Motley Fool recommends the following options: short September 2024 $52 puts on Chipotle Mexican Grill. The Motley Fool has a disclosure policy.