We are keeping Chipotle (CMG) on the Hedgeye Restaurants Best Idea list as a SHORT.
The 8-K CMG issued on Friday after the close was long on current details but short on what the company is going to do to fix the issues the company faces. We expect the swift decline in same-store sales caught management off guard and they are unprepared to deal with the severity of the problem.
Management’s knee jerk reaction to the bad news is a big buy back to make investors feel better. In CMG’s case the $300 million repurchase announcement is staggeringly small given there is no funded debt and over $1.2 billion in cash and total investments.
The company’s issues are just beginning and it will take time to recover from this debacle. How management handles the process from this point forward will determine the pace of recovery.
HERE IS WHAT WE KNOW SO FAR
- 4Q 2015 Comparable restaurant sales to be in a range of (8%) to (11%) vs FactSet +0.1%
- Non-recurring expenses during Q4 of 2015 in the range of $6.0 to $8.0M
- Restaurant level operating margins of 22% to 24%
- Diluted EPS in the range of $2.45 to $2.85 versus consensus of $4.05
- CMG has withdrawn previously-announced 2016 guidance for same-store sales. The street consensus was +3%.
CURRENT SALES TREND UPDATE
- October same-store sales were positive in the low-single digit range (we are assuming traffic was flat to slightly negative).
- Upon the announcement of the closure of 43 restaurants on November 3rd, company-wide same-store sales dropped “for the ensuing few days” to approximately (20%).
- After the announced re-opening of restaurants in Oregon and Washington on November 10, same-store sales “over the next several days quickly improved” to approximately -9%.
- On November 20th, the U.S. Centers for Disease Control and Prevention (CDC) announced four additional cases linked to the same E. coli incident; “following this announcement and related negative publicity, daily comparable restaurant sales trended down to approximately (22%).”
- Over the past five days, same-store sales “have gradually improved to an average of approximately (16%).”
- For the full month of November, comparable restaurant sales were -16%.
- If these sales trends continue, we believe comparable restaurant sales could be in a range of (8%) to (11%) for the three month period ending 31-Dec-15.
NEW COMPANY GUIDANCE
“Future sales trends may be significantly influenced by further developments, including potential additional announcements from federal and state health authorities.”
WHAT WE DON’T KNOW
- How long will the current issues cause a decline in same-store sales?
- What is management’s plan to fix the company?
- Are there other hidden issues we don’t know about?
- What is the long-term damage to the Chipotle brand? (Chipotle will be forever linked to any story about E. coli with negative implications.)
- Can the company grow its units at the same rate and deliver on consumer and investor expectations?
- How much incremental G&A cost will there be in 2016 to fix the supply chain?
- What will the new margin structure of the company look like?
- Will the company need to adjust its non-GMO claims?
- Will the two class actions lawsuits gain steam because of the company’s problems hurting the brand image even further?
WHAT WE NEED TO SEE TO GET MORE POSITIVE
While we have seen many restaurant companies run into problems over the years, the fall of Chipotle is nothing short of spectacular. The common denominator that most restaurant entrepreneurs have faced, comes down to one thing: hubris. The lack of humility is a killer. It’s almost guaranteed that life takes care of those issues over time!
Howard Schultz, CEO of Starbucks figured it out in 2009, but only after it was too late! How long will it take the management of CMG?
Do the co-CEO’s of CMG see themselves or their lack of knowledge and experience as the problem? The market and the investment community have put them on a pedestal so high they needed oxygen to breathe. As soon as Mr. Moran and Mr. Ells learn that humility is the only thing that can save them we will get more positive on the stock.
The direct impact of a more humble management team will be a company with a lower margin structure and a significantly slower unit growth rate. CMG is just another restaurant company and the management team needs to realize that.
In the meantime, how this unfolds will be fun to watch.
Over the next couple of days the street consensus for 2016 EPS will need to come down to $13.50 (+/- $0.50) and EBITDA will be around $820 million. With the 2016 estimates in mind, fair value for the stock is between $350 and $400.
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