Chipotle Mexican Grille (CMG) is on the Hedgeye Restaurants Best Ideas list as a SHORT

 

HEDGEYE OPINION

Hubris is killing Chipotle!  Management currently does not have the capacity to make the type of decisions needed to set this company on a new direction.  The evidence to support this claim was seen on last night’s earnings call, where the management team put forth a plan to fix the company that came across as reactive and not well thought out. The management team is still trying to hang on to the past and can’t come to grips with reality – Chipotle is just another restaurant company.  More importantly, there were a number of times in the very brief Q&A section where they contradicted themselves and made little sense.    

Last night, the emphasis was on accountability, operational improvements, technological advances, and reassurance that management was taking the correct steps to ensure that the health scare is completely behind them.  It is going to be a long road to recovery for CMG, and the numbers reiterate this, with same store sales leading the charge, down (21.9%) vs CM (18.7%) and 2-year SSS has been (9.7%) for the past three quarters.

The path to $250 is still very clear!  

KEY THOUGHTS

The management team of CMG needed 49 minutes to articulate the changes they were making to help improve the business.  Knowing that Bill Ackman is lurking in the background, the tone of the call came across as if they were a child who just discovered his/her shadow:

  1. They announced that ShopHouse does not have a strong economic model and wrote down the assets.  Yet the distractions persist, as they will continue to go after the pizza and burger category (two of the most competitive segments in the industry).
  2. There are going to find and cut more than $100 million in capital and operating expenses combined.  They should cut capital spending by $150 million alone!
  3. They are going to introduce more new menu items.  It was not long ago that the company bragged that “we had 10 years of double-digit comps year after year after year without new menu items, without any kind of jazzy advertising”  (FYI - more menu items slows down thru-put.)  However, I’m sure they will execute dessert flawlessly. 
  4. Now they are going to start advertising nationally, too.  Will that not keep margins lower for longer?
  5. Speaking of advertising, the earnings call welcomed back Mark Crumpacker, who provided the audience with an apology very much akin to when a young boy is forced to kiss and make up with his little sister after he pushes her down the stairs. Needless to say, the apology was forced and forgettable.
  6. Now they are moving more aggressively to make digital ordering more appealing. DPZ has emoji and Facebook ordering capabilities, while CMG is still trying to figure out a digital strategy. 
  7. They guided to $10 in EPS in 2017, which is conveniently $0.10 above the current consensus estimate.           

At the end of the day, operational improvements are all well and good; however, it is all for not if you are unable to regain the TRUST of those who you betrayed. This can also apply to shareholders, who are growing impatient with management’s inability to manage this company thru this crisis. 

NOTABLE COMPANY THOUGHTS

“After operating in three distinct markets, and opening in a variety of trade areas, ShopHouse simply hasn't demonstrated the ability to support an attractive unit economic model, as a result...we have decided not to invest further in developing or growing the ShopHouse brand and will pursue strategic alternatives,” (Steve Ells, CEO)

HEDGEYE – Off-loading minority investments in order to focus on the main revenue driver.  Smart move, but why focus on pizza and Burgers?

“To further these efforts and to continuously improve food safety in our restaurants and supply chain, we have also established an independent food safety Advisory Council made up of the country's foremost experts in food safety and food microbiology.  This Food Safety Council is charged with continuously reviewing our food safety        programs and looking for opportunities to strengthen them even more.”

HEDGEYE – As expected, food safety is going to be leading the charge for the foreseeable future.

“Key to restoring our business model is making sure we're being as efficient as we can with our financial resources, but doing so without compromising the strength of our support teams and field leadership. We are using this crisis as an opportunity to take a critical and disciplined look at how we manage our financial resources and we've established a goal of saving $100 million across operational, G&A and CapEx expenditures.”

HEDGEYE – This is a token move.  They will need to cut capital spending more in FY18.

“Chiptopia helped drive the sales improvement in the quarter. Our most loyal customers returned to the frequency patterns, as Mark mentioned. Comp sales in the middle regions of the country were down in the 17% range from September, outperforming the coastal areas (New England & New York), which were down closer to 24% to 25% in September. We will continue to work harder to recover our sales, shifting our strategy from give-away discounts and rewards to new menu items, technology driven convenience, better operations, including faster throughput and more aggressive brand marketing.”

HEDGEYE – As we mentioned in our September Black Book, the Chiptopia initiative was only a band-aid. The real test has begun, now that the Chiptopia program has concluded.

 “As I mentioned previously, we plan to keep comps flat from 2016 to 2017. We chose not to fill 100 staff positions this year that were lost via turnover and not refilled. This will save $10mm annually and help our underlying G&A levels at that level.”

HEDGEYE – Cutting away the fat in order to increasing efficiency and save money sounds good, but will the business be able to fulfill order flow and deliver a good product with a limited workforce?

“I'm glad to be back and share the important work we're doing to bring customers back and restore our brand image, but first, I want to apologize to everyone for recent events in my personal life. I'm sorry I caused a distraction for the company, I put this behind me, learned from it and returned to my role in eye September, excited and with a renewed focus to drive recovery. I want to thank you for your support and forgiveness which has meant a great deal to me,” (Mark Crumpacker, Chief Marketing & Development Officer)

HEDGEYE – This apology was half-hearted and above all, extremely awkward for those listening.

“So there just isn't an advantage. The recovery doesn't get jumpstarted just because we would peel off another 25, 50 or 100 openings. So there wasn't any advantage to doing so.”

HEDGEYE – WOW this one takes the cake and is a perfect example of how management thinks about the business.  Slowing the pace of growth can place more of the enterprise resources on building sales at existing units.  More importantly, in a company that acknowledged a high turnover rate, opening fewer restaurants would allow for them to grow the bench of hourly employees, and keep the veterans in stores and communities much longer, all of which leads to even better execution in the restaurants and build sales within the four walls.

The CMG management team just doesn’t get it!

 

QUICK COMPS

Same Store Sales: (21.9%) vs CM (18.7%)

Food, beverage and packaging: 35.1% vs FactSet 34.5%

Restaurant margin: 14.1% vs FactSet 18.3% (includes negative impact of (0/9%) from Chiptopia)

Operating Margin: 0.9% vs FactSet 7.0%

Revenue: $1.04B vs FactSet $1.09B

EPS: $0.27 vs CM $1.61 (includes $0.29 related to the ShopHouse impairment charge and a $.23 due to the deferral of revenue from Chiptopia

CMG | AFRAID OF THEIR SHADOW  - Chart 1

FY17 Outlook:

  • Projecting 195-210 new restaurant openings
  • Comparable restaurant sales increases in the high single-digits
  • Restaurant level operating margins of 20%
  • An estimated effective tax rate of approximately 39.5%
  • EPS of $10.00 vs Fact Set $9.87

Please call or e-mail with any questions.

Howard Penney

Managing Director

Shayne Laidlaw

Analyst