Short sell: Tainted grub

February 16, 2016 09:00 AM

Selecting shorts is a difficult art, however particular companies stand out as potential shorts when critical technical patterns emerge. One has to make sure that the issue will not be called by the lender and that the stock will not split all while analyzing stocks where the growth rate has slowed.

One stock that has been in the news is Chipotle, most notably after the media coverage surrounding its food tainted by E.coli. While this has sent the stock moving lower, ripe for shorting, there were signs that made this a long-term short for us since April of 2015. 

Chipotle Mexican Grill Inc. (CMG) is a fast, casual Mexican restaurant chain with approximately 1,900 locations. We first shorted CMG on Feb. 4, 2015 after it violated its 50-day moving average at $670. We increased our short position in May at $630 despite the temptation to take profits and after it reversed to $750 in August.  

We felt this reversal was an exaggeration; not an example of a true recovery but a response to the April 22 plunge. The chart pattern showed that it boosted the price excessively above its 50-day MA and a reverse death cross appeared where the 200-day MA crosses the 50-day MA, signalling the potential of further declines. This continued before the E.coli outbreak scandal was fully reported in October and the subsequent report from the Centers for Disease Control on Nov. 12.

It was easy to recognize CMG as a short after the E.coli news, but CMG signaled further short possibilities as  no visible “V” shaped rebound materialized. Also, any rebound was unlikely while not penetrating its 200-day MA. Its third plunge, from $614 to $539, indicated a “death cross,” where the 50-day MA fell below its 200-day, was forming (see “Taking a dive”). This convergence gives one the belief that the short trend will continue and has not hit its final low.

An actual death cross appeared on Nov. 27, leading us to conclude that the subsequent rebounds since CMG’s third plunge were not strong enough to become a true reversal. Continued losses on low volume led to a fourth plunge around Dec 7. Another short rebound at $577 gave a false indication of accumulation, but had particularly shallow volume. The fifth plunge showed negative accumulation below the “flat line” with continued selling taking CMG to its sixth plunge. This has continued to manifest into a seventh plunge on Jan. 4 and an eight plunge on Jan 7.

Many think Chipotle has reached its bottom, however we continue to maintain our short because its trading below its 50- and 200-day MA, below its death cross suggestive of continued losses. A rebound will be very difficult and typically requires it to meet a primary resistance at $459 and a secondary resistance at $489. Normally as this is happening a company’s market value will fall and they subsequently slash their growth rate. In the case of CMG, this is decelerating significantly and these falling prices are suggestive of further short potential. 

Aside from the chart pattern, CMG lowered its guidance for Q4 to $2.45-$2.85 per share, substantially below its previous year of $3.84 for Q4. December sales were down 30% and same-store sales fell to 14.6% during Q4 while CMG previously predicted an 11% decline. In addition, there has been another investigation instituted in California from August regarding Chipotle in Simi Valley, Calif. The declining double-digit growth maturity rate of 30%-40%, the rising completion and lofty P/E ratio in contrast to its competitors, cutting its Q4 guidance, and slashing its sales and earnings forecast is all evidence of a cloudy outlook. Markets don’t favor uncertainty, which discourages reversal.

CMG announced that it would close all stores on Feb. 8 to discuss food safety.

About the Author