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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

 


EVENT | PLAY Black Book Presentation

Wednesday, September 28th at 11:00AM ET

Watch a replay below.

CLICK HERE to access the associated slides.

CLICK HERE to access the audio-only replay. 

 

 

 


SBUX | THE TRANSITION IS REAL

SBUX is once again now a Best Idea SHORT.

 

SBUX is a company in the midst of a major transition and the operating results are beginning to reflect that transition.

 

HEDGEYE OPINION

The central thesis for our SHORT on SBUX can be seen in the Black Book we did back in April.  The core theses still hold true and we could be one quarter away from the company scaling back on one if its key growth initiatives – FOOD.  Importantly, did Starbuck’s CEO, Howard Schultz, set the company up for an enormous disappointment in 4Q16?  Why did the CEO make bold predictions on the 3Q16 earnings call?  Is Kevin Johnson the right man for the job as COO? We believe the CEO’s bold statement on the 3Q16 earnings call might cost the company a few multiple points following the 4Q16 earnings call.

 

THE 4Q16 SET UP

We have enormous respect for Howard Schultz, but he may have promised more than the company can deliver.  Here is what he said on the 3Q16 earnings call:

“I want to address right out of the gate the two questions you are likely asking yourselves: does a 4% positive same-store sales comp from our US business in Q3 signify or even suggest a turning point in Starbucks' long-term growth trajectory and does this comp figure in any way relate to the success and value of our Starbucks Rewards loyalty program?”

 

Then he went on to say:

“On today's call we will demonstrate with clarity and specificity why our US comps in Q3 were an anomaly and that we have clear line of sight to returning our business to historic levels of comp growth, which has been at or above 5% for the past 25 consecutive quarters.”

 

Currently, the street estimate for the Starbucks Americas same-store sales is 5.1%, confirming the bullish bias management has instilled in the street models.  This represents a 60bps acceleration in sales quarter-to-quarter.  With the sell-side having an 83% buy rating, they have to be bullish.  We see same-store sales for the Americas coming in around 3-4%. 

 

Howard Schultz has promised the sun the moon and the stars and the consensus is falling into line.  Will the company deliver, but more importantly what happens if they miss for the second quarter in a row?

 

SBUX | THE TRANSITION IS REAL - SBUX SSS

 

 

SUMMARY OF THE 3Q16 ISSUES IMPACTING THE AMERICAS

In 3Q16, the company made a strategic shift in their loyalty program from a frequency-based to a spend-based model.  The company has made it clear that they will not see a shift in usage under the new program.  What if the “spend based model” causes a secular shift in consumer behavior and thus permanently impacted guest frequency?  According to management, the new loyalty model was intended to have the immediate benefit of eliminating a major in-store operating issue, order splitting.  By reducing order splitting the impact will result in shorter lines, increased speed of service, and reduced line attrition.  At the same time, the company’s roll out of mobile order and pay was designed to also increase speed of service and reduce line attrition.  Taken together, both initiatives should have a significant impact on improving traffic, especially in 4Q16.   

 

On the earnings call the CEO explained that the company “underestimated the interdependence of Starbucks Rewards and Frappuccino Happy Hour” and how the two programs was competing for customer and partner mind share.  How the programs are interconnected and work together was never fully explained, but it appears the street has just accepted this as the truth.  The core operational issues in 3Q16 caused a 1% decline in blender drinks due to the competing programs. 

 

The CEO also admitted that the 3Q16 performance in the USA was impacted by the macro trends affecting overall consumer spending.  What was not discussed on the call is what part of the Starbucks business is vulnerable to macro pressures.  Is it just a general slowdown or is the company seeing sales soften in the more discretionary and afternoon daypart.  This would better explain the decline in the blender sales, rather than operational issues.  If the latter is having a bigger impact, it is going to make a 4Q16 sales recover harder to achieve.

 

On top of this we have the emerging issues of slowing food sales.  Slowing food sales was part of our original short thesis.  In Q3, food sales only grew 10% (was 16% in 2Q16) and contributed 1% to the comp versus a 2% contribution in 3Q15.  Over the next two quarters (4Q16 and 1Q17) SBUX is up against challenging food comps of 3% for both quarters.  

 

One of the areas that we believe the macro issues are impacting spending in the SBUX business model will be incremental spending on the food offering.  Overall, the Starbucks food offering is very expensive and the quality of the product is not comparable with competition at similar price points. 

 

THOUGHTS ON MANAGEMENT TRANSITION 

Given the operational challenges SBUX encountered in 3Q16, it’s important to revisit the time line of events that lead to Kevin Johnston becoming COO of the company.  The timing of the appointment of the new COO was a complete surprise and the choice of Kevin Johnson was an even bigger surprise to the street. 

 

SBUX RECENT EVENTS

  • 12/4/14 – Analyst meeting in Seattle (Food is one of the key drives of future growth and COO Troy Alstead was the clear #2)
  • 1/8/15 – Troy Alstead takes unexpected unpaid “coffee break” from SBUX
  • 1/22/15 – Kevin Johnson named COO (CEO of Juniper Networks; 5 year SBUX Board member)
  • 3/1/15 – Kevin Johnson officially takes over as COO
  • 3/10/15 – Troy Alstead announces he not returning to SBUX (23 years at SBUX CFO, COO)
  • 2/21/16 – SBUX announces changes to it Loyalty program
  • 7/11/16 – Baristas get a 5% raise or more
  • 7/21/16 – 5 quarters after Kevin Johnson take over as COO SBUX posts the biggest same-store sales miss in five years
  • 7/26/16 – Howard Schultz stepping back from day to day operations
  • 9/13/16 - Starbucks has announced it's going into content production (Howard Schultz –Producer)

It’s clear that Howard Schultz is ready to move on from running Starbucks Corp.  While it’s easy to understand why he may want to move on, it’s also not that unusual.  When Bill Gates, founder of Microsoft, another Seattle company, moved on from his company, that transition did not go well.  With Howard officially stepping back from Starbucks, so far the Starbucks transition is not off to a great start.  Starbucks, COO Kevin Johnson, has no retail experience and his only experience with Starbucks was as a board member for five years.   

 

Now five quarters after taking over the COO role, the company is experiencing its first significant operational challenge in eight years.  We see the change in the loyalty program as the first big operational initiative under the new COO Kevin Johnson, and his boss thnks the 3Q16 issues will be a one quarter blip.  The 4Q16 earniings call will be very interesting if the Americas does not post same-store sales of better than 5.1%.   

 

This is also on the heels of the company announcing a significant increase in labor costs following significant pressure from Starbucks partners.  If the current operational issues persist, and or new ones crop up, many on the street will begin to ask serious questions about the CEO stepping away from the business and the qualifications of Kevin Johnson. 

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 


POSITION MONITOR

POSITION MONITOR - Chart 1

 

RECENT NOTES

9/08/16 GENERATIONAL DINING | A LOOK INTO THE CONSUMER’S MIND

9/7/16 PLAY | THE SLOWDOWN HAS COMMENCED

9/7/16 CMG | THIS IS WHY I PLAY

8/25/16 MCD | THE SLOWDOWN CAN NOT BE IGNORED

8/23/16 ZOES | THE COLLAPSE WAS FAST

8/18/16 BWLD | THE LATEST RESTAURANT WALK OFF

8/15/16 RESTAURANTS MACRO NOTE | SALES TRENDS | EMPLOYMENT

 

SECTOR PERFORMANCE

Casual Dining and Quick Service stocks that we follow outperformed the XLY last week. The XLY was down -2.8%; top performers on a relative basis from casual dining were BBRG and KONA posting performance of +10.8%, +8.6%, respectively, while CMG and WEN led the quick service group this week up +5.7% and +4.3%, respectively.

POSITION MONITOR - Chart 2

POSITION MONITOR - Chart 3

 

CASUAL DINING RESTAURANTS

POSITION MONITOR - Chart 4

POSITION MONITOR - Chart 5

POSITION MONITOR - Chart 10

 

QUICK SERVICE RESTAURANTS

POSITION MONITOR - Chart 6

POSITION MONITOR - Chart 7

POSITION MONITOR - Chart 11

 

COMMODITIES

POSITION MONITOR - Chart 8

POSITION MONITOR - Chart 9

 

ARTICLES OF INTEREST

COSI | COSI HIRED TURNAROUND FIRM AS INTERIM CFO

In an effort to recover from years of financial losses, Cosi Inc. has hired The O’Connor Group to advise on financial and strategic matters.

CMG | CHIPOTLE IS ACKMAN’S NEXT BIG BET

Bill Ackman’s hedge fund has taken a 9.9% in the embattled chain, believing that the company is undervalued and still an attractive investment.

SUBWAY RESTAURANTS | BOLSTERS DIGITAL ASSETS

In an effort to build its digital presence, the Subway has acquired assets from Avanti Commerce, a Canadian e-commerce company. This purchase comes after Subway organized its digital technology under a single group called Subway Digital.

JIMMY JOHN’S | ROARK CAPITAL TAKES MAJORITY STAKE IN JIMMY JOHN’S

Private equity group, Roark Capital Group, has acquired a majority stake in Jimmy John’s Sandwiches, one of the nation’s fastest-growing chains.

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst


EVENT | Chipotle Mexican Grill (CMG) BlackBook

Tuesday, September 6th at 11:00AM ET

 

Watch a replay below.

CLICK HERE for an audio-only replay.

To access the associated slides contact sales@hedgeye.com.


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