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

 

HEDGEYE OPINION

Today, Chipotle management spoke at the Bernstein Consumer Summit, in large part about their recent E. coli outbreak and how they plan to reach the other side of it. The hubris that management seemed to display was remarkable, in which they showed little remorse for the victims and turned quickly to how they will build traffic once again. Chipotle is quickly beginning to look just like any other restaurant company. They will no longer be cutting cilantro, tomatoes or lettuce fresh in house as they are labeled high risk items to be infected with E. coli. Additionally, if you didn’t know already, their corn mixture is not fresh; due to a short harvest season they freeze the yearly supply at the end of the summer and thaw it as needed. Management is working to implement changes immediately, no matter what the cost is, which we liked to hear. But this will all come with extra costs, and management openly admitted that although not immediately, they are confident that they have the ability to increase price to offset these costs. CMG would have to take a sizeable price increase to offset added infrastructure investment as well as labor pressure. We don’t think it is possible, the days of CMG’s far above industry average margins will be in the past.

In CMG’s recent release on food safety (click HERE to view), CMG made an interesting comment, it reads, “there are about 48 million cases of food-related illness in the U.S. annually, including 265,000 cases of E. coli.” We read this as, “sorry, but we aren’t the only ones causing people to get sick.” This is just a continuation of the hubris from management in which they believe they are not at fault and somehow better than their competitors who use a similar supply chain as them.

We remain firmly SHORT, as we see downside to the $350-$400 range.

 

FOOD SAFETY PLAN

CMG has hired Dr. Mansour Samadpour of IEH Laboratories and Consulting Group to revamp their supply chain and ensure the safety of all the food. He was asked to “design a more robust food safety program to ensure the highest level of safety and the best quality of all meals served at Chipotle.” He has set out to add more washing and testing technology at distribution centers as well as shelf life testing to be used in restaurants. Management has also embarked on enhancing internal training to ensure all employees understand the importance of food safety.

On the supplier front, CMG is in the process of working with them to implement more stringent testing so any bad crops are stopped at the source. Additionally, management does not believe there will be any shortages of naturally raised, sustainably sourced or organic products needed for them to operate.

Improving food safety will be a significant investment, food safety is going to be a greater focus for the organization going forward. They are implementing this at such a fast pace they openly admitted they were doing it inefficiently, but they will refine the process after it is executed.  

Management believes that they have pricing power in order to cover these additional costs. They will begin to look at this dynamic closer to 2017, as it would be disingenuous to raise prices immediately following this outbreak.   

 

WHAT IS THE PLAN FOR TRAFFIC RECOVERY?

Management has spoken with the CDC and the FDA and they said at some point in the future they would declare the restaurants clear of E coli. At that time management plans to market through traditional media, direct mail (BOGO’s), and perform “critically placed interviews,” to say this is over and invite people back in. CMG has conducted research studies specifically regarding this outbreak and they learned that just 57% of CMG customers are aware of this outbreak. They also learned about some lost regular customers due to lack of trust and some new adopters drifting away because they have other options.  No matter how you slice it, the road to recovery for CMG is going to be a long one.

 

TECHNOLOGY AND THE 2ND LINE

CMG is working to make mobile ordering a bigger part of their business, while they improve the efficiency of their second make line. They are going to be standardizing the process and creating tools to control portions. Online and mobile order customers will no longer be able to provide text commentary, although they will still be able to customize to some degree. Part of the enjoyment of eating at Chipotle is being in line and watching your meal being put together, getting to customize everything as you go down the line. That goes away when you order online. Some customers may not care about that, but as lines become shorter because people realize Chipotle is just as healthy as any other fast food, what will happen then?

 

RECENT NOTES

12/6/15 CMG | STARTING TO COME CLEAN

11/23/15 CMG | SHORT THE FUNDAMENTALS

11/17/15 CMG FLASH CALL | SHORT HYPOCRISY THEORY GAINING MOMENTUM

 

Please call or e-mail with any questions.

Howard Penney

Managing Director


Shayne Laidlaw

Analyst