Hedgeye - [Best Idea Long] Chipotle: I Can See Clearly Now

Editor's Note: Shares of Chipotle (CMG) are up over 35% since our Restaurants analyst Howard Penney and his analyst team moved CMG to their"Best Ideas Long" list from its "Best Ideas Short" list on 12/4/17. Below is a complimentary research note written last week following the print.

HEDGEYE OPINION

As we stated in our recent Black Book on April 12^th, it’s just a matter of time before Chipotle, the one-time insurgent, became a scale insurgent (as defined by the book The Owner’s Mentality). With a fresh set of eyes in the CEO chair, Brian Niccol did not disappoint in his opening earnings call as the CEO of CMG, and his leadership is just what this troubled company needed.

Laying out a preliminary version of the brand’s new way ahead, we were happy to see that many of the management team’s key points mirrored what we laid out in our Black Book (see screenshot below). Going forward, a focus on the frontline and simple blocking and tackling within the four walls will keep the brand on course in the near term. As time goes on, more productive advertising will help to bring CMG out of the shadows and back to the forefront of the industry. However, one thing that we will continue to harp on is the brand’s need to slow unit growth, as Mr. Niccol stated that slowing growth is not something they view as a near-term issue.

With a strategic pivot underway, we are confident that CMG will ride this wave to become a scale insurgent and create significant value for shareholders.

THOUGHTS ON THE PRINT

Comps came in at an impressive +2.2% vs FactSet +1.3%, as the company saw check increase by 5% and traffic fall by approximately -3.3%. However, despite the lackluster traffic figure, we are very optimistic, as the new-look management team has not had an opportunity to implement any traffic driving initiatives. Restaurant level margin for the quarter was 19.5%, compared to 17.7% in the same period a year ago. According to the management team, the current restaurant level margin guidance of 17.5% - 18.5% is conservative, as beating it is well within the realm of possibility. As the company reevaluates spending habits and redirects capex to more impactful / higher return initiatives, we can expect margins to reach our 2020 target of 21-22%.

NOTABLE COMPANY THOUGHTS

“The opportunity is clearly the recovery story in the U.S and we’ll be focused on taking what I believe is a powerful brand that has really strong economics, strong purpose…the innovation will be across the business as I mentioned in access, digital, menu and frankly we’ll double down on our fundamentals,” (Brian Niccol, CEO)

HEDGEYE – As stated in our Black Book, simplifying and focusing on the food will be included in Mr. Niccol’s plan to “double down on our fundamentals.”

“The good news is the economics of the units that we’re opening continue to look very strong; we see no reason for us to change the pace [of unit openings] that we are experiencing this year and obviously as we get further into our plan we’ll give the appropriate updates,” (Brian Niccol, CEO)

HEDGEYE – As Mr. Niccol takes more time to inspect the brand, he will come to see that the only way to truly turn this story around will be to slow unit growth and improve the integrity of current units.

The 5 key initiatives to restore CMG (summarized from call):

Grow sales, transactions, margins, and restaurants
Elevate brand relevance and further brand purpose
Build the right structure and capabilities to sustain performance
Create a people recognition and innovation culture
Run great restaurants that deliver best-in-class financial performance

HEDGEYE – We might be overly obsessed with the company’s need to slow unit growth, but we still think it is the right call. So far, early indications are that the company will not slow unit growth. If executed properly, the balance of the key initiatives will drive the stock much higher.