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Chipotle's Signs of Slowdown Send Shares Down 23%

By Annie Gasparro As Chipotle Mexican Grill Inc.'s (CMG) customer traffic slows, investors worry about the economic pressure, increased competition and fundamental maturing of the brand. Chipotle--a longtime investor favorite and leader among fast-casual restaurants--saw its shares tumble 23% to $310.80 recently, marking the biggest drop in the stock since January 2009 when the market bottomed. Chipotle, which went public in 2006, has been known for its rapid growth and high stock valuation. Its second-quarter profit, reported late Thursday, rose 61%, but sales fell below analysts' expectations. Chipotle's sales at established restaurants, or same-store sales, were up 8%, representing a decline from the double-digit growth of quarters past. Cowen analyst Paul Westra said the latest results have "signaled the arrival of middle age for Brand Chipotle in America," with 2012 being a transition year for the chain to move toward "a new era of more normalized" same-store sales trends. He expects growth of around 3% in 2013 and beyond. Chipotle executives said the slowdown began in late April and continued through May and June. "We're seeing a slowdown. I mean, there is no other way around it," said Chief Financial Officer Jack Hartung on a conference call late Thursday. "It's not a significant slowdown, but it is a slowdown." Chipotle has long said that its customers will pay a higher price for its fresh, sustainable and higher-quality food, even during a downturn. The possibility that some are trading down to cheaper, typical fast-food chains like McDonald's Corp. (MCD) or Wendy's Co. (WEN) doesn't bode well for the broader fast-casual space. As a result, shares of peers Panera Bread Co. (PNRA) and Starbucks Corp. (SBUX) fell 4.9% and 4.4%, respectively, in recent trading. Chipotle's co-Chief Executive Monty Moran suggested that growing economic uncertainty is finally hitting its typically resilient customers. "We believe the falloff in customer transactions is due to the sluggishness in the overall economy and a slowing in consumer spending," he said on the call. But when questioned by analysts later, Mr. Hartung conceded that it could also be related to competitive pressure and the tough comparisons to its growth from the prior-year quarter. "So we don't really have a great answer at this point," Mr. Hartung added. "It's a very fairly sudden trend, and it's still a trend that we're trying to figure out." Janney Capital Markets analyst Mark Kalinowski suggests the company was hinting at Yum Brands Inc.'s (YUM) Taco Bell, whose U.S. same-store sales rose a 13% in the second quarter, when it spoke of competitive pressure. Taco Bell has recently bolstered its advertising to promote new Doritos shell tacos and launched Cantina Bell, a fresh-focused menu "offering fast-casual-type products at two-thirds the price," as Yum said. Mr. Kalinowski said he's concerned about the commodity-cost outlook for Chipotle, after management said on the call that recent extreme weather will likely put pressure on food costs later this year and into 2013. Chipotle's stock has historically boasted a price-to-earnings ratio much higher than other restaurants. Even with Friday's decline, Chipotle's price-to-earnings ratio is more than twice that of McDonald's--another historically strong stock. "While we think Chipotle remains the best 'company story' and 'concept story' in the industry, we remain cautious on shares given ongoing 'stock story' valuation concerns," Mr. Westra said. Chipotle's executives say they are sticking to their strategy of focusing on food quality and the customer experience. "We're not going to do things that a traditional quick-service restaurant might do," like discounting or gimmicky new menu items, Mr. Hartung said. "We're not about to change our formula because of a slowdown in monthly or quarterly comps." Write to Annie Gasparro at annie.gasparro@dowjones.com Subscribe to WSJ: http://online.wsj.com?mod=djnwires

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