There has been a lot of talk that "things are getting better" at Chipotle (CMG). I remain deeply skeptical.
At the recent ICR investment conference in Orlando, Florida, Chipotle's management team presented the initiatives they are intensely focused on to fix the company. At the top of their list, get Chipotle's decimated restaurant level margin (RLM) back up. (It's fallen from a high of 27.2% in 2014 down to a projected 12.8% for 2016.)
Wall Street is clearly buying what management is selling. Chipotle shares are already up +8% this year. A full 30 of 37 analysts that follow Chipotle rate the shares "Buy" or "Hold."
Hang on…
Following last year's ICR conference, Chipotle shares went up $75 in the ensuing months, after management said they are going to get back to peak volume and margins.
What a fantastic selling opportunity that was…
Will management be able to execute this time around? Two major financial metrics need to turn in order for their turnaround to be a success: establish same store sales growth, and return RLM's back to previous levels. The second of which cannot happen without the first.
Looking out to 2018, we do believe they can achieve a 20% RLM. The bigger question is, after all the missteps, how will investors value the company? Will it continue to trade at such a lofty valuation?
If Chipotle's multiple stays up in the clouds, and trades at a 35X P/E, we are looking at a $406 stock on our EPS of $11.59. In other words, in this exceedingly optimistic scenario, investors continue to believe Chipotle will return to the glory days in two years' time but shares stay at current levels.
Then again, what if it doesn't?
There's reason to believe shares are headed to $250. Since the E. coli and foodborne illness outbreaks, Chipotle has failed to address the issues that sent the stock down 50% from the all-time highs in the first place.
In a sign that's sadly emblematic of the dysfunction at Chipotle, co-CEO Monty Moran stepped down in early December. Following the announcement, CEO Steve Ells and Chief Marketing & Development Officer Mark Crumpacker laid bare all of the problems the brand continues to face. This laundry list revealed a number of troubling issues we had not heard before.
Here are a few with our key takeaways:
- Chipotle continues to fail at streamlining the order fulfillment process.
- Management lost sight of the primary purpose of business.
- Employees lacked adequate training, but were promoted nonetheless.
- Management admits that turnover has increased and attributed this to a lack of training (employees lacking skills to succeed) and employees feeling overwhelmed by the complexity of the job, post-outbreak.
- A long and drawn-out hiring process.
- Significant complaints filed by customers, with complaints being (in order of significance): Long lines/slow order throughput; restaurants running out of food; messy dining rooms.
- Competition has improved, resulting in increased competition when trying to win back customers.
It all boils down to this: Chipotle has failed to address many of these problems in a meaningful way. Fixing them will take time and money. The longer management waits, the harder the stock will fall.
I continue to believe Chipotle's hubris has killed the brand and only humility will save them. The road to $250 will be long and hard.
