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CMG | CHASING GHOSTS

Chipotle Mexican Grill, Inc. (CMG) remains on the Hedgeye Restaurants Best Ideas list as a SHORT

 

KEY POINTS FROM THE INVESTOR CONFERENCE:

  • Co-CEO Monty Moran was not present, likely on his way out.
  • CMG is focused on making changes to the board, adding relevant experience and addressing tenure issues.
  • Sales recovery is slower than expected, recovering at 1% per month for the last 10 months.
  • Core customers have almost returned to pre-crisis levels, but management missed out on a crop of potential new consumers during this crisis.
  • No disagreements with Ackman on what needs to happen, Ackman wants a Board seat, and appears like he will get one.
  • ~50% of restaurants have an internal rating on key metrics of ‘C’ or worse.
  • Lines are back, but some of them are just due to slower throughput.
  • Management remains dedicated to store opening trajectory; long-term 5,000 units still feels right for them.
  • Selective price increases could hit in 2017.

 

On October 28th, we outlined what we believed Chipotle needed to do in order to come out on the other side of this debacle in one (badly beaten) piece. Atop that list was “Chipotle desperately needs NEW LEADERSHIP and, more importantly, a NEW DIRECTION.” This sentiment has not changed on our end, and it seems that CMG may be coming around with regard to new leadership, as Co-CEO Monty Moran was not present at today’s presentation and Steve Ells’ insistence that the company is taking very seriously complaints regarding the tenures of some on their Board of Directors. According to Ells, they have been hard at work on a Board “refreshment”, with hopes of addressing complaints regarding the long tenures of various Board members and focusing on individuals with expertise in governance, finance, and crisis management, in addition to hinting at the fact that Bill Ackman could land a seat on the Board.

 

That being said, CMG has a long way to go as the recovery has been hard to come by. Chipotle's stock took a 7%+ plunge in mid-day trading today after Ells admitted that he has concerns about CMG’s ability to adequately recover from last year’s foodborne illness disaster.  According to management, over the past 10 months, the brand has recovered sales at a pace of 1% per month, as they are just beginning to gain more customers than they are losing (according to research conducted by CMG). However, overall customer experience is still unsatisfactory and has contributed to the brand’s slower than anticipated recovery. To combat this, the Company has strengthened field leadership in their Boston and NY markets, and reiterated that guest experience is at the top of their priority list.

 

Moving to sales and comps, Management emphasized that they are hoping to push comps higher through an increased emphasis on the guest experience. Ells expressed uneasiness about hitting sales targets provided in October, as lines are back at Chipotle locations, but some of those lines are a result of poor throughput, not improving traffic (re: customer experience).  According to the Company, their slow recovery is also largely attributable to their sales makeup, as a small number of customers represent a large portion of their sales. In 1H16, their incoming wave of customers was wiped out, and ~78% of their least frequent customers were eliminated. During the second half of the year, the Company saw a sizeable increase in patronage, but ONLY AFTER aggressive marketing and promotions! And when pressed about possible minimum wage increases coming down the pike, Management expressed intentions to raise prices to offset possible wage increases. Increases in labor costs means that margins could come under even more pressure!

 

No matter how much makeup you put on a pig, at the end of the day, it is still a pig! CMG disregarded the most important rule of the restaurant business, and that is DO NOT GET YOUR CUSTOMERS SICK! No matter how much technology you place around your business, or how many bags of free chips you give away, when a brand is broken, you have to rebuild it from the bottom up.

 

CMG | CHASING GHOSTS - Chart 1

 

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst


PNRA | #BOSTONSTRONG

Panera Bread Company (PNRA) is on the Hedgeye Restaurants Best Ideas list as a LONG

 

HEDGEYE OPINION

 

I love Boston! 

 

I have been working out of the Hedgeye Boston office for nearly a year now!  Ron’s Boston marathon references on the earnings call take on new meaning for me now.  What makes PNRA a best idea LONG is the notion that the company has already begun to make investments to offset the negative MACRO environment.    

 

The investments include:

  • Panera 2.0, a comprehensive guest experience platform enabled by digital.
  • Accelerated growth of catering, delivery, and rapid pick up
  • Panera at Home
  • Early in understanding the growing importance of wellness and doubled down on menu transparency and clean food
  • Creation of a loyalty program that is now the industry's largest

The investments the company is making have driven seven straight quarters of incremental entrees served.  While the number of entrées served is a new method for PNRA to calculate traffic, it is a more classic method used by a number of restaurant companies.  While some critics might say this is done just to make the numbers look better, it calculates a more accurate view of the number of people eating at a PNRA.    

 

As we stated in our Sneak Peek note last week, we expected Q3 to be a sloppy quarter for PNRA, and our prediction was not far off, as the company came in strong overall, despite a noticeable industry slowdown.  As expected, spending on Panera 2.0 conversions did not slow down, putting pressure on the P&L while these restaurants get on line.

 

PNRA reported 3Q16 EPS of $1.37 vs FactSet $1.34 and bakery-cafe margins rose 30bps to 15.6% vs FactSet 15.4%. Going forward, their 4Q16 company-owned comps guidance of 3.5-4.0% and EPS guidance of $1.96 - $2.01 (increased from previous guidance of $1.94 – $2.01) are guiding incidence that their initiatives will yield positive growth for the company going forward.

 

Lastly, the evidence that PNRA has turned the corner can be seen in the company’s TTM EPS growth rate.  Prior to this 3Q16, the company TTM EPS growth rate was declining.  Sequentially, the TTM EPS growth has gone from (1.3%) to 3.8% in 3Q16.  By June 2017, the TTM EPS growth rate could approach 20%!  

 

NOTABLE COMPANY THOUGHTS

 

“To build expanded runways for growth we have been focused on delivery, catering and Panera at home as well as new formats for development. We believe that over time we will not only win our fair share of the existing $40 billion delivery category but we also believe we can grow the category as we fulfill a significant unmet need for an elevated, delivery experience with higher quality, healthy food,” (Ron Shaich, Founder, CEO)

 

HEDGEYE Management sees the niche that needs to be filled and are charging full-speed ahead to fill it. It will be interesting to see how their new delivery technology capabilities will help this cause.

 

 

“I should note that the end of Q3 66% of all Panera Company cafés had been converted to Panera 2.0 with over 50% of those cafés having been converted within the last four quarters. With this rapid rate of conversion, driving profitability in the future, investors should take note that startup and transition costs associated with immature Panera 2.0 cafés do weigh on our P&L during approximately the first four quarters post conversion,” (Ron Shaich, Founder, CEO)

 

HEDGEYE We saw this as an issue coming down the pipeline, as peak spending on Panera 2.0 conversions would come into play.

 

 

“To add to our successes in Q3, we have essentially delivered on a commitment to convert approximately 200 Company cafés to Panera 2.0 in 2016. Specifically, we have converted 194 cafés YTD. Moreover, given the positive impact we see with Panera 2.0, we now plan to convert an additional 30 to 40 Company cafés to 2.0 during the fourth quarter.” (Ron Shaich, Founder, CEO)

 

HEDGEYE Reiterating our stance that aggressive spending on Panera 2.0 conversions is an issue we see cropping up in the near term.

 

 

“Because we are seeing significant incremental sales and comps from delivery, we're moving quickly to roll out the program broadly throughout the Panera system. At the end of Q3, 178 Company cafes were offering delivery.   Indeed, that's 20% of Company cafes offering delivery at the end of Q3. In addition, delivery is now available in 76 franchise bakery cafes across nine franchise groups. And we remain on pace to roll out delivery to 15% of our total system, including franchisees, up as you know from our initial target of 10% of the system and to accomplish that by the end of 2016.  In fact, today 13% of our total system is already offering delivery as of the end of Q3. In addition, and based on our initial success with delivery, we are now planning to have in place delivery in 35% to 40% of our total system by year end 2017.”

 

HEDGEYE Delivery will be a big business for PNRA and has the potential to change how the street views the overall company over time. 

 

 

QUICK COMPS

  • System-wide SSS: +1.7% vs FactSet +2.8%
  • Company –owned SSS: +3.4%  (two-year comps +7.2%) vs FactSet +3.7%
  • Franchise SSS: +0.2% vs FactSet +1.2%

 

PNRA | #BOSTONSTRONG  - Chart 1

 

PNRA | #BOSTONSTRONG  - Chart 2

 

PNRA | #BOSTONSTRONG  - Chart 3

 

 

Revenue: $684.2mm vs FactSet $680.1mm

 

 

Sales:

  • Bakery-café: $593.4mm vs FactSet $591.5mm
  • Fresh dough to franchisees: $52.6mm vs FactSet $51.2mm
  • Royalties and fees: $38.2mm vs FactSet $38.6mm

 

 

Bakery-café operating margin: 15.6% vs FactSet 15.4%

 

 

Operating margin: 7.6% vs FactSet 7.6%

 

 

Outlook:

  • EPS $1.96 – 2.01 vs. FactSet $2.00
  • Company –owned comps +3.5-4.0% vs FactSet +3.9%
  • Expect to come in at the low end of 90 to 100 system-wide bakery-café openings in fiscal 2016
  • Average weekly net sales performance for new company-owned bakery-cafes is now expected to be modestly above the high-end of the previously provided target range of $45,000 to $47,000

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 


RESTAURANTS MACRO NOTE | SALES TRENDS | EMPLOYMENT

KNAPP-TRACK

The political process strikes again per Knapp-Track, as the continued fascination with the election process has seen TV viewership up 60-90% in July; restaurant sales continue to struggle as a result.  While Knapp cites people staying home as the reason for this month’s decline, it does not explain the continued softening in sales since the peak in January 2015.  We believe there are a number of reasons for the restaurant malaise currently being played out across the industry.  The most important of which can be gleaned by the excess inflation in the core services inflation (i.e. housing, healthcare, education, transportation).  The Hedgeye Macro team makes a very strong case that the government continues to underreport these measures. 

 

Knapp reported that sales in July were -0.2%.  This suggests that sales improved 210bps sequentially, after being down 210bps sequentially in June. The two-year average improved 50bps in July, which represents the third month of 2016 with improvement in the sequential two-year average change. In 2Q16 it was more than just casual diners that were affected by a slowing in the restaurant industry. We have heard from nearly all the restaurant companies at this point and virtually all of them mentioned a slowing in consumer spending on restaurants. This is now a widespread slowing in the restaurant industry, and coupled with the slowing in restaurant employment as shown below, leads us to believe we will be in for prolonged slowdown in spending. The restaurant industry has always been a game of market share, but now that will become an even greater focus for operators as there are fewer consumer dollars to go around.

RESTAURANTS MACRO NOTE | SALES TRENDS | EMPLOYMENT  - CHART 1

 

For just the second time this year, the two-year average comparable guest count number improved sequentially. In July, Knapp-Track traffic was down -3.4%, which represents a 140bps improvement sequentially, and 60bps improvement on the two-year average sequentially.

RESTAURANTS MACRO NOTE | SALES TRENDS | EMPLOYMENT  - CHART 2

 

RESTAURANT EMPLOYMENT

Two of the top drivers of restaurant industry success in our opinion are income and jobs. The May data we saw in June showed a continued flattening out of growth which started to shift towards a slowdown. Now, coming out of July as we got a look at the June data, we saw an accelerating slowdown in the growth of limited service restaurants. Growth in limited service restaurant employment slowed 36bps sequentially to 2.72%, down from 3.08% in May. Since hitting a peak in summer of 2013, limited service restaurant employment, and broader restaurant industry employment has slowed and is beginning to roll-over.

RESTAURANTS MACRO NOTE | SALES TRENDS | EMPLOYMENT  - CHART 3

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 

 


EVENT | Restaurants Speaker Series: "Wall Street Meets Main Street"

Monday, August 8th at 11:00AM ET

Watch a replay below.

CLICK HERE to access an audio-only replay.

CLICK HERE to access the associated slides.

 

 


CMG | 2Q16 QUARTERLY DASHBOARD

Chipotle (CMG) is on the HEDGEYE Restaurants Best Ideas list as a SHORT.

 

SUMMARY

We still think there is significant downside to CMG.  The challenge to our short call remains timing.  The biggest challenge remains finding the right balance of being aggressive on the SHORT versus the slope of the line in the recovery in sales trends.  Aggressive capital allocation toward new units will be the ultimate downfall of the stock.  Timing matters.    

CMG | 2Q16 QUARTERLY DASHBOARD - CHART 1

 

STOCK PERFORMANCE

CMG continues to underperform the S&P 500 across all but the one-month duration!  

  • 1-Month – +7.1% vs. S&P 500 +4.5%
  • 3-Month – (10.9%) vs. S&P 500 +3.9%
  • YTD – (12.9%) vs. S&P 500 +5.9%
  • 12-Month – (36.8%) vs. S&P 500 +2.7%

 

BEAT/MISS RATIO

  • Revenues – 1 for 6 (missed the last 2 quarters)
  • Same-Store Sales – 2 for 6 (big miss last quarter)
  • EPS – 5 for 6 quarters
  • Price Impact – On average -4.5% for 5 of the last 6 quarters

 

SHORT INTEREST – SI is at a 5 year high.  Began 2016 at 8.2% and is now 15.5%.

 

EARNINGS REVISION – Will 2Q start to see a stabilization in the negative revision trends? No guidance from the company.

  • 2Q16 – Was $1.58 in MAR currently $0.95 down 40%
  • FY16 – Was $15.97 in DEC ‘15 currently $4.41 down 72%
  • FY17 – Was $16.73 in JAN currently $11.38 down 32%

CMG | 2Q16 QUARTERLY DASHBOARD - CHART 2

 

VALUATION – Currently trading at 22.5x NTM EV/EBITDA - YTD the EV/EBITDA multiple has risen 8.0x due to the decline in profitability. 

CMG | 2Q16 QUARTERLY DASHBOARD - CHART 3

 

OPERATIONAL PERFORMANCE

COMMENTARY – Aggressive store growth is the Achilles heel of the company.  CMG’s profitability trends remain a disaster, and there is no visibility on the trajectory of the recovery.   

  • UNIT GROWTH – 12.8% or opening 52 stores (ending stores 2,118)
  • SAME-STORE SALES - CM is looking for -20.3% or -8.0% on a 2-year basis vs -9.7% in 1Q16; Traffic  -17.6% vs -21% in 1Q16.
  • RESTAURANT LEVEL MARGINS – 15.2% vs. 27.98% LY
  • SG&A – 7.2% vs. 5.9% LY (knowing the LT run rate of this number is critical)
  • OPERATING MARGINS – 4.01% vs. 18.9% LY

CMG | 2Q16 QUARTERLY DASHBOARD - CHART 4

 

CIVICSCIENCE CONSUMER SURVEY

Closing out 2Q16 , the CMG consumer brand survey results held steady versus our last publishing (VIEW HERE). Now, two weeks into 3Q, we have received a few hundred responses to our survey, and it shows a minor trend to the positive for CMG, but before releasing we would like to gather more responses to get a reading representative of the broader population. 

CMG | 2Q16 QUARTERLY DASHBOARD - CHART 5

 

GUIDANCE

The only guidance the company gives is store growth of 220-235 new units.

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 


POSITION MONITOR (SBUX, EAT, SONC)

POSITION MONITOR (SBUX, EAT, SONC) - CHART 1 replace

 

BEST IDEAS LIST ADJUSTMENTS / UPDATES

SBUX — Last week we elevated SBUX to our core Best Ideas list as a SHORT. We will be presenting our thesis in a live Black Book presentation tomorrow, April 5th at 11:00AM ET.

 

Our SBUX SHORT thesis is not an indication that Starbucks is a broken company or that they are in need of a major overhaul. The simple fact is that much of the tailwinds (unit growth, mobile order & pay, daypart expansion) supporting the company right now are already built into the current stock price. So we are left asking, what’s next?

 

Going forward the increased complexity of the store due to the amplified focus on food sales will hamper growth, and could potentially tarnish the premium brand equity that Starbucks currently possesses.  Additionally, the competition in the morning day-part is getting stronger.  While beverage sales remain strong, a significant part of future same-store sales is dependent on selling more food.  Food is not a core competency of the company and the company’s product offering is less compelling than others in the space.  Additionally, the more they broaden the menu to less healthier items the challenges the company faces will intensify.    

 

CALL DETAILS

Toll Free:

Toll:

UK: 0

Confirmation Number: 13633080

Materials: CLICK HERE (materials to be provided approximately 1 hour before the call)

 

EAT — Last week we also elevated EAT from our SHORT bench to our Best Ideas list as a SHORT. We see EAT as a company in transition and believe that FY2017 could become a year where management makes some incremental investments in the Chili’s brand.  While EAT is one of the strongest companies in the Casual Dining space, the Chili’s brand needs to return traffic trends to positive territory again.  What is unclear is how the investment will unfold in FY2017, but we will learn more at the upcoming analyst meeting on June 9th in NYC.  

 

As a result of these investments, we see the Street’s estimates for 2017 as aggressive.  Currently, FY2017 Street consensus is for Brinker to post EPS of $3.95.  We see FY2017 estimates coming in closer to $3.40-$3.45, flat with FY2016 or even lower. 

 

In the intermediate term, EPS for 2H FY2016 are also aggressive.  For 3Q16 and 4Q16 estimates are for $1.00 and $1.25, respectively.  Our model has estimates closer to $0.95 and $1.10, respectively.

 

Currently, EAT EV/NTM EBITDA multiple is 7.3x, significantly below its three year average and the Casual Dining group of 8.4x.  If we are right about the current trend in EPS, the discounted multiple might not be enough of a discount.

 

SONC — Lastly, we moved SONC from our SHORT bench to our LONG bench. Please see our brief note HERE. In the coming weeks we will lay out our more detailed LONG thesis.

 

RECENT NOTES

4/3/16 SONC | ADDING TO THE LONG BENCH

3/31/16 SHAK | SUPPLY CHAIN ISSUES IN THE 10-K

3/30/16 PLAY | THE LAST STAND

3/29/16 EAT | AGGRESSIVE ESTIMATES

3/24/16 PLAY | SHORT| EXPECT VOLATILITY

3/15/16 CMG | DELUSIONAL

3/10/16 KNAPP-TRACK FEBRUARY RESULTS/ISPOT AD ANALYSIS

 

SECTOR PERFORMANCE

Casual Dining and Quick Service stocks that we follow outperformed the XLY last week. The XLY was up +2.4%, top performers on a relative basis from casual dining were KONA and TXRH posting performance of +4.8% and +4.5% respectively, while SHAK and SONC led the quick service group this week up +9.6% and +9.3%, respectively.

POSITION MONITOR (SBUX, EAT, SONC) - CHART 2 replace

POSITION MONITOR (SBUX, EAT, SONC) - CHART 3 replace

 

CASUAL DINING RESTAURANTS

POSITION MONITOR (SBUX, EAT, SONC) - CHART 4

POSITION MONITOR (SBUX, EAT, SONC) - CHART 5

 

QUICK SERVICE RESTAURANTS

POSITION MONITOR (SBUX, EAT, SONC) - CHART 6

POSITION MONITOR (SBUX, EAT, SONC) - CHART 7

 

COMMODITIES

POSITION MONITOR (SBUX, EAT, SONC) - CHART 8 replace

POSITION MONITOR (SBUX, EAT, SONC) - CHART 9 replace

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 


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