The Greatest Fall From Grace The Restaurant Industry Has Ever Seen

Editor's Note: Below is an institutional research note written by Hedgeye Restaurants analyst Howard Penney.

The Greatest Fall From Grace The Restaurant Industry Has Ever Seen - chipotle sunset

I hope Mark Crumpacker can get his life back in order. 

That being said, Chipotle desperately needs NEW LEADERSHIP and, importantly, a new direction. 

The story of the rise and fall of Chipotle has become a dark one and now borderline pathetic. The company’s foundation for its food was built on the word “integrity,” ironically; the foundation of its leadership team has demonstrated time and again that there is a complete lack of integrity.  We are witnessing the greatest fall from grace the restaurant industry has ever seen, and many people have suffered as a result. 

How much more damage will be done before changes are made at the top?

Here is what we think Chipotle needs ASAP:

  • A CEO with strong core values and integrity who can inspire others to be their best.
  • Hire a new leadership team with strong values, who demonstrate the courage and ability to cultivate a culture of high integrity, and to do what's right for the business.
  • Honor and support the supply chain and its vendor partners, and not disparage them.
  • Reinvent the business; it will be a process to rebuild this iconic brand that once enjoyed great success.
  • Earn customers trust through transparency, honesty, humility, authenticity, active engagement, collaboration and hard work.
  • Develop and move forward confidently with a well thought out, comprehensive three-year plan that has an ongoing cadence, not a desperate and tactical one based on giving away free food. 
  • Embrace speed - "Be quick, but don't hurry."

As the truth rises to the surface, it’s becoming clear that the current Chipotle management team is not capable of managing the company. The company has served up multiple cases of foodborne illnesses causing pain and suffering for people across the country, all due to Chipotle’s negligence and lack of appropriate controls. The Chipotle problem is so devastating; it makes the entire food service industry look bad. 

Management’s response to the disaster has been late, incomplete and woefully inadequate to actually overcome the flood of consumer complaints and customers' mass exodus away from visiting Chipotle restaurants. Now, one of the top executives, with the responsibility of regaining the trust of the American public, is indicted on major drug charges in New York City.

Financially, the profitability of the company has declined by -70% over the past year (represents FY16E versus FY15).  The market value of the company has decreased by $11.9 billion since October 13, 2015, and we believe there is an additional ~$140 per share of downside from current levels to $250 per share.  Lastly, there is a strong possibility the company will report its second straight quarter of operational losses, currently consensus estimates are projecting a gain of $0.95 per share. 

The Greatest Fall From Grace The Restaurant Industry Has Ever Seen - chipotle same store

The Greatest Fall From Grace The Restaurant Industry Has Ever Seen - CHART 2

OTHER CHANGES THE COMPANY NEEDS TO MAKE 

The Board needs to eliminate the co-CEO structure and immediately begin a search for a new CEO, one who can instill integrity and high standards into this company, and dramatically turn around its performance.  

The Board needs to look outside the company and hire a seasoned restaurant executive with the following experience and results:

  • A leader who has led difficult turnarounds of large brands in the restaurant industry with a proven track record.
  • A leader who understands the subtleties and the enormous importance of branding, consistency, and consumer trust.
  • A leader who has demonstrated the credibility of leading hundreds of thousands of employees to efficiently and profitably run operations, starting first and foremost with ensuring the safety of its quality ingredients sourced throughout the supply chain.

A COMPANY’S CULTURE BEGINS WITH ITS VALUES

Values inherent in the best run companies are developed by the leaders of the company with the thorough involvement of and ownership by its vast and diverse team of employees, and vendors. These values ultimately become the fabric of the organization modeled by the daily behavior and actions of its leaders, starting with its CEO.

We are now seeing what the culture of Chipotle is like.  Over the past year, the behavior of this management team has revealed that the culture is rotten at the core.  From the very beginning the culture is based on arrogance; a lack of transparency; a lack of required skill sets to run a big company; a lack of good judgment; a disturbing complacency; a sense of entitlement and now even more apparently, a recklessness that has further endangered the organization.

When the true values are not present, responsibilities are not met, accountabilities not taken seriously, and results with integrity not achieved, then there should be swift and strong consequences.  It’s time for the Board and the management team of Chipotle to take responsibility and be accountable for what has transpired over the past year.

It’s time to clean house! 

SHAREHOLDERS NEED TO BEGIN TO FORCE CHANGES AT THE COMPANY

It is just unacceptable for two co-CEO’s to be paid what they’re being paid collectively in light of all the problems currently being experienced at Chipotle while on their watch. And now, their close colleague and Chief Marketing Officer, claims that a summer loyalty program and the introduction of chorizo are the answers to Chipotle’s current problems, and will be enough to turn around their hemorrhaging business, while he’s 'pre-occupied' with allegedly doing drugs.

How long are shareholders going to allow this to go on? Is the Board in Founder Steve Ells' back pocket?

Shareholders MUST demand a complete and thorough overhaul of its leadership team if Chipotle has any hope of regaining the trust of the American public.

It is evident to me, that this leadership team does not understand the magnitude of the problem. It is so far reaching and so very deep. As a result, they have no idea what to do. This homegrown group of executives is floundering in uncharted waters, and potentially taking a lot of people down with the ship.

TRANSFORMATIVE CHANGE

Transformative change is needed to consistently ensure a quality experience for customers to overcome an egregious and highly damaging breach of public trust.

Transformative change is necessary to provide a proper working environment for all employees that is based on holding people to high standards and treating them with genuine respect.

And ultimately, transformative change is needed to ensure the ability to create significant value for its shareholders after one of the most embarrassing examples of negligence, arrogance and recklessness in the restaurant industry.

The Shareholders and the Board of Chipotle need to take action, and they need to do it now.

The company desperately needs new leadership at the top.

The troubles this company faces is of epic proportions. Chipotle is quickly running out of time.