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CMG BOTTOMING PROCESS COULD TAKE TIME

We think there is modest downside to Chipotle’s share price.  That being said, our favorite short idea in the QSR space is BKW.  As far as the long side of CMG goes, we would possibly become more constructive on the stock closer to $250.

 

Below, we run through some fundamental, macro, and sentiment factors that we think are important for CMG going forward.  In particular, we would highlight new unit performance as a key metric to focus on when trying to get comfortable with the intermediate-to-long term outlook for the stock.

 

 

Top-Down View

 

Chipotle’s stock price has cratered since early 2012, declining almost 40% from its peak in April.  Picking the bottom is likely to be difficult, albeit not as difficult as picking the top, but we believe that the bottoming process is going to take several quarters as the fundamentals flush out.

 

CMG BOTTOMING PROCESS COULD TAKE TIME - CMG vs QSR Index

 

 

Macroeconomic growth is an important driver of Chipotle’s business.  The following chart shows that something clearly has gone awry with the Chipotle growth model; average unit volume growth has decelerated in recent quarters.   

 

CMG BOTTOMING PROCESS COULD TAKE TIME - cmg AUV vs IndProd

 

 

Fundamental Outlook

 

Same-restaurant sales growth has come in meaningfully as the company is struggling to re-accelerate top line growth.  Average check has been negatively impacted by lower drink sales and the outlook for FY13 comps is flat-to-low-mid-single-digit growth.   Two further “difficult” top-line compares remain before we can start to expect higher same-restaurant sales growth numbers.  The favorable weather in 1Q11 added, by management’s estimation, contributed 100-200 bps to the quarter’s same-restaurant sales growth number. We believe that there is a stong possibility that CMG posts negative SRS in one or both of the next two quarters.  Consensus expectations are for the company to maintain positive SRS over the next two quarters.

 

CMG BOTTOMING PROCESS COULD TAKE TIME - cmg pod1

 

CMG BOTTOMING PROCESS COULD TAKE TIME - cmg comps detail

 

 

Total sales growth has been decelerating, sequentially, for the past couple of quarters.  As long as Chipotle is growing at a mid-teen percent-rate, we will focus on the growth in new unit volumes as a signal of likely improving sales growth for the company.

 

CMG BOTTOMING PROCESS COULD TAKE TIME - cmg sales vs auv growth

 

 

We believe that new unit average unit volume growth has, and will continue to be a critical metric for this stock. In terms of picking inflection points in growth, the performance of new units has been the one signal worth watching over the past few years.  For the stock to begin the bottoming process we must also see a stabilization in new unit volume performance.  If the new unit continue to underperform the real estate strategy and the accelerated pace of development will be called into question.

 

CMG BOTTOMING PROCESS COULD TAKE TIME - CMG AUV Growth vs New AUV Growth

 

 

Restaurant-level margins remain the wild-card of 2013, in our view.  Chipotle’s restaurant operating margins are vulnerable to swings in commodity prices as the company purchases its ingredients on the spot market.  Inflation is currently running at low-single-digit levels, driven by higher dairy and meat prices.  Ultimately, margins in 2013 are sensitive to more adverse weather conditions that impact protein prices.  Guidance is also baking in avocado prices remaining at current levels next year

 

Labor costs have been a source of margin expansion for CMG for years as the company’s efficient operating model has been complemented by strong traffic gains.  Now that traffic growth has decelerated considerably, we think that there is heightened risk in assuming continuing leverage to be driven through the labor line. 

 

CMG BOTTOMING PROCESS COULD TAKE TIME - CMG pod 2

 

CMG BOTTOMING PROCESS COULD TAKE TIME - cmg labor costs as   sales

 

In aggregate, the outlook for the company’s Return on Incremental Invested Capital is still uncertain and we believe that the company slowing growth, and cutting capex, could serve as a catalyst to take a long position in the stock at a lower price.  Currently, with capex growth far out-stripping sales growth, we would not sleep too well the night before Chipotle’s next earnings call if we were to buy in at this level.  Longer-term, we believe the company’s business model is likely to deliver strong returns for shareholders but our confidence in near-term ROIIC is less firm. 

 

CMG BOTTOMING PROCESS COULD TAKE TIME - CMG ROIIC

 

CMG BOTTOMING PROCESS COULD TAKE TIME - CMG capex growth sales growth

 

 

 

Sentiment & Valuation

 

The investment community’s view of CMG has changed drastically in 2012 but we would point to historical precedent as a suggestion that the Street can likely become more bearish from here.  Short interest has been rising since May.  It’s worth noting that, the last time this company’s growth model was encountering problems of the magnitude that it now seems to be facing, short interest as a percentage of the float was in the 30’s. 

 

We hold a similar view of the valuation outlook for CMG.  We believe that there is further downside risk to FY13 EBITDA and EPS estimates.  While the multiple has come in, it is possible that the bottoming process could take some time if we are right that there are negative revisions to estimates coming over the next few quarters.

 

CMG BOTTOMING PROCESS COULD TAKE TIME - CMG sell side sentiment

 

CMG BOTTOMING PROCESS COULD TAKE TIME - CMG valuation change

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst

 

 

 

 


Bullish: SP500 Levels, Refreshed

Takeaway: I think the Pain Trade has gone from down to up.

POSITION: Long Consumption (XLY, SBUX, ADM), Short Commodities (XME, XLE, CAT)

 

I was more confident buying red on Thursday-Friday (1% correction in the SP500 from the latest Bernanke lower-high) than I ordinarily would be because: A) TRADE support held and B) our Macro Research call was getting confirming data of global #GrowthStabilizing.

 

Across our core durations, here are the lines that matter to me most:

 

  1. Immediate-term TRADE resistance = 1431
  2. Intermediate-term TREND support = 1419
  3. Immediate-term TRADE support = 1408

 

In other words, there’s a load of support developing in the 1 range, and with short interest as high as it’s been since early SEP, I think the Pain Trade has gone from down to up.

 

I even bought AAPL on red ($502.50) today, for a trade. Fun.

 

KM

 

Keith R. McCullough
Chief Executive Officer

 

Bullish: SP500 Levels, Refreshed - SPX


Changing Tides In Europe

Looking at the Eurozone, risk decreased across several nations while Germany and Italy saw a slight uptick in yield. Greece declined -1.54% to 12.92%, Portugal fell -47 basis points to 7.09% and Spain dropped -8 basis points to 5.38%. Geramany and Italy rose +6 basis points and +5 basis points, respectively. Yields have fallen considerably since highs made in April of this year but have yet to reach levels seen in 2009/2010.

 

Changing Tides In Europe - 22. yields


Early Look

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Good News For The OFS

With the price of oil having declined significantly over the last six months, there’s some modestly bullish news for the oilfield services (OFS) sector. Drilling and services pricing declined in November but equipment prices inflected higher. Drilling PPI was +5.4% year-over-year versus +5.9% in October. Machinery and Equipment PPI was +2.5% year-over-year versus +2.3% in October. That’s a positive for the OFS sector as the rate of change in price declines slows down.

 

Good News For The OFS - OFS


MACAU NORMALIZES

Macau generated average daily table revenue of HK$775 million in the past week, down from HK$930 million in the first 10 days.  ADTR actually fell 1% from the similar week of 2011.  As we learned from our Macau trip last week, hold percentage ran high in the first 10 days (with the exception of Wynn) but seems to have been normal in the past week.  Our YoY projection is for GGR (including slots) YoY growth of 10-14%.

 

MACAU NORMALIZES - m1

 

While still above trend, LVS’s share has moderated to where we would project it to be.  Absent hold fluctuations, we believe LVS will be a consistent market share gainer over the next 12 months.  MPEL’s share has also moderated but still above trend.  MPEL remains on track for an estimated beating Q4, in our opinion.  Surprisingly, Wynn picked up very little share in the past week and remains >200bps below trend.  Galaxy is almost back to normal while MGM is definitely having a good month.

 

MACAU NORMALIZES - m2 


MACAU MEETINGS SUMMARY

Major Takeaways from meetings in Macau last week: 

  1. We continue to believe that Macau could be under a bit of pressure relative to expectations in Q1.  While some of our contacts were not concerned about the smoking ban, a few were.  We tend to agree with the latter opinion although there is a chance that the government provides a grace period.  However, we don’t think the risk is necessarily factored into the stocks.  At least one astute market observer feels that ultimately, the restrictions will be forced on a table basis rather than square footage. 
  2. A lot of the discussions related to the recent corruption crackdown.  We think that there may be another shoe to drop for Macau as the investigations continue and there is risk of further Macau connections.
  3. As you know, Macau GGR increased 33% YoY in the first 10 days of December.  However, most of the growth was likely due to high hold.  Wynn is probably the only operator holding below normal.  Indeed, the numbers we received today moderated significantly from the first 10 days and were actually down 1% YoY.
  4. MPEL and LVS look like the stocks that could hold up the best over the near-term:  LVS because of market share gains and MPEL due to a big Q4
  5. Wynn, Galaxy, and MGM could be under pressure although MGM's December share is trending high

 

Please review the following detailed notes from our trip to Macau.

 

Smoking Restrictions

  • Three concessionaires think this will have very limited impact
  • One thinks a -3% GGR impact and another felt that a double-digit impact could be experienced for a few months
  • LVS probably went all out for square footage split – department of health wasn’t happy
  • WYNN probably went the other way and offered up more non-smoking tables
  • Galaxy is somewhere in the middle
  • Following submissions from each operator of their plans for compliance, it doesn't appear that the government has yet made a decision as to the exact specifications - the uncertainty is likely to create problems and could impact margins
  • January 1 looking like the date for required implementation
  • One operator thinks that the Government could give a last minute grace period of up to 6 months
  • Mass hold is likely to be negatively impacted
  • Good luck trying to enforce it in the VIP rooms
  • Government banned the comping of cigarettes and cigars recently
  • Smoking regulations are probably not done – it is an election year and the dealers have a lot of power – they have the most to gain with a full smoking ban
  • Lower end more at risk because higher end players will always get a seat at a smoking table if they want it
  • MGM – 28% of Mass players are smokers, MPEL – 30-40% are smokers

China Corruption Crackdown

  • Given the early December results, it doesn’t look like it's having an impact
  • The corruption crackdown not focused on Macau but rather an investigation into Bo Xilai, who is suspected of funneling money through Macau
  • One astute contact thinks that there will be a delayed impact and there still is risk because investigations are ongoing and there may be more ties between some indicted individuals and Macau
  • Government handover isn’t complete until March so investigations will go on
  • Contacts in Beijing say big players are being monitored and will likely stay away from Macau
  • David Star junket rep at Four Seasons was one of the ones arrested

December MTD

  • GGR for the first 10 days was up 33% YoY but down 1% in the second week
  • Hold played a huge role and volumes may have only been up single digits
  • Wynn seems to be the only operator holding below normal here in December

WYNN and SJM at capacity but SJM still has a year of growth

  • Wynn can’t do anything meaningful since they are running at a higher level of capacity
  • Some operators believe the gap between what Wynn offers the junkets in terms of commissions and credit and the competition is just too high
  • SJM added some VIP rooms which is growing their market share and should lead to YoY growth over the next 3 or 4 quarters 

Mass Marketing

  • Galaxy Mass advertising program doing well - their recent market share struggles have been in the VIP 
  • Mass business very competitive which is impacting margins – could be some relief next year if Galaxy or MPEL pull back

VIP

  • Galaxy may have pulled back a little on junket comps
  • City of Dreams will likely follow suit

MPEL and the Philippines

  • MPEL can bring smaller Southern China and other Macau junkets to Philippines without hurting existing business
  • Worst case scenario:  Belle Casino in Manila will do $150MM in EBITDA
  • Philippines could ultimately be a US$5 billion market
  • Just got 2 helicopters to bring VIPs from HK airport directly to Macau
  • We remain comfortable with our Street high $255 million EBITDA estimate for MPEL

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.32%
  • SHORT SIGNALS 78.48%
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