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Chipotle Mexican Grill, Inc. (NYSE:CMG), with its stock price now languishing at well under $400 a share, is resorting to desperate measures in an effort to try and recover its former glory. Free beer is the company's latest incentive and although it will definitely increase foot traffic, margins will continue to suffer. The problem with over generous loyalty programs, burrito coupons and happy hours is that over time the premium brand which Chipotle once was, will get impaired.

The market had really priced this stock high in recent years due to its strong operating income and margin growth, but both of these metrics have fallen off a cliff since the company's e-coli scandal broke out last year. The problem the company faces at present is that if it doesn't convince the market soon that a recovery is on the cards, then from a valuation standpoint, the stock has plenty more downside risk. Even with the stock price down 45%+ from its all-time highs, Chipotle still trades with an earnings multiple of 58 and a sales multiple of 3, both of which are still well above the average numbers in this sector. It is still not cheap enough to risk investing at these levels. Here are my reasons why.

Chipotle Earnings Multiple Is Still Way Too High

Firstly, the drop in earnings has been much bigger than the drop in the share price over the past 9 months which means that Chipotle Mexican Grill, Inc. is still trading at a high earnings multiple of 58.8. This number is still very high despite the stock trading at under $400 a share. Big investment initiatives in areas such as food safety, marketing and labor costs have meaningfully impacted margins to the extent that the company's trailing twelve months (TTM) operating margins have been essentially cut in half to the current 8.2%. This is the risk Chipotle is running at present. Can it return to its peer-leading margins or will its premium brand be eroded in the long run? I believe it will be the latter because other peer leading premium brands never sell their products at heavily discounted prices to get back market share. This is a short term view and an exercise that may help Chipotle in the short term but will hurt its long-term growth ambitions in my opinion

Cash Shrinking Fast On The Balance Sheet

Furthermore, Chipotle may pride itself on its balance sheet and absence of debt, but its cash balance continues to decrease. In fact, if the company feels it needs to continue the current level of spending, it will only be a matter of time before Chipotle has to borrow funds. Last quarter, the company's cash reserves dropped by over $600 million on a rolling quarter basis whereas revenue dropped by over $200 million. These are worrying figures and illustrate how much margins have deteriorated over the past 12 months.

Technical Chart Illustrates A lot Of Downside Risk

On the technical front, Chipotle is in danger of making lower lows and lower highs unless it recovers to the $400+ levels quickly. Remember that the stock rallied by 157% between October 2012 and August 2015. This rally was unprecedented in this sector and explained how its sales multiple spiked past 3.3 last year, which again is a huge number in this sector. Chipotle needs to recover to the $400 level quickly, as there is very little support under this price. The stock is also well under its 50-day moving average. Longs should be worried here.

Thirdly, the last thing Chipotle needs now is for its competition to come out with cheap alternatives to its Mexican food. Well, that is exactly what Burger King has done as it tries to gain market share in this fiercely competitive market. Chipotle did incredibly well over the past few years because consumers wanted fresher healthier ingredients and were willing to pay extra for it (Tex-Mex fast casual segment). Burger King with its far cheaper option will try to get new clientele through its doors. It will never have a better time as Chipotle traffic is still well below its former levels.

Takeaway

To sum up, Chipotle has a serious fight on its hand if it is to regain its former operating margins. Massive spending sprees are shrinking cash levels and its premium brand prices are at risk now of never coming back. Furthermore, if Burger King's Mexican offering proves a hit, it will become a regular on the menu which again will eat into Chipotle's profitability over time.