Chipotle (CMG) is a Hedgeye Restaurants Best Idea Short.
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Chipotle (CMG) Short Thesis:
- THROUGH THE LENS OF INCENTIVE COMP: In September 2018, we did a LONG Black Book where we praised management for the incentive comp structure as the best way to drive shareholder value - growing same-store sales and margins. Since 2018 same-store sales have grown 9.1% annually; restaurant-level margins have improved 530bps, and earnings have increased from $8.00 to $29.00. In 2022, the company raised prices aggressively, reaching 15% in 4Q22 to protect its incentive comp. Is management pushing the envelope too far on food and labor? Labor unrest is starting to build with the pressure to stop unionization and the economic reality of "Quiet Quitting." Concerns about food quality are also on the rise.
- CMG LABOR PROBLEMS: CMG has improved labor costs by 240bps since 2018, despite significant labor inflation; strong SSS growth (and price) over the same period has helped to leverage the fixed costs. While the company has seen significant labor leverage, investing in labor may be needed, as the CFO's most significant economic concern is "Quiet Quitting." Experts believe "Quiet Quitting" is about "bad bosses and not bad employees," therefore, it appears the CMG c-suite is to blame as they have not invested in its labor force. As the CFO said, "The labor market has been a challenge, as we all know, there's historically low unemployment, you've got this thing called quiet quitting. It's harder to keep young folks in a restaurant engaged in the current business." This issue is just one of many signals that CMG's excessive focus on growing margins by cutting and not investing in labor costs is hurting the business. The fix could be hundreds of BPS of labor margin pressure over the next few years.
- THE LTO TREADMILL: CMG's LTO's success can be attributed to the company's thoughtful "stage gate" process. That said, after five years and ten+ new products, that strategy is getting increasingly ineffective. The recent failure of the BOORITO LTO is the second example in a month of how CMG is now on the LTO treadmill. The price of the BOORITO LTO has gone up over the years; from Free in 2016 to $3 in 2017, $4 in 2019, and $5 for the online-only promotion in 2021, and now in 2022, it was $6. In the early days od\f the turnaround, the company led with what consumers were asking for; I don't believe consumers are telling the company they wanted Garlic Guajillo Steak on the menu. Or is it that food costs have declined 240bps since 2018, and the food quality is not as good?
