CMG - Chipotle

[awindenberger]

Ackman needs to leave Chipotle alone. Their model is already excellent, they simply need time to make customers forget the problem last year and return to their previous habits. If it can happen with Jack in the Box, then I'm confident that CMG will see their traffic figures back around previous highs within 2-3 years. This will get their operational metrics back in line, and once that happens its simply a matter of continuing to open more stores.

 

Given their spectacular long term returns on new store construction, I would argue that the company could easily continue its long term growth path by being less picky with their locations and going into smaller towns. I know CMG would kill it in my town of 10k, but of course wouldn't manage to do $2.4mil revs. But $1.2-1.5m would likely be doable, and the store buildout itself would likely be less expensive.

 

CMG is certainly not cheap now, but in the long run (10 years+), I don't see how one doesn't get a market beating return investing in the company at current prices.

 

Of course, I'm still waiting for the next recession to hopefully take the stock down into the low $300s (or better!), but thats more hope based thinking.

[KCLarkin]

What is it exactly do you see Ackman as being able to do here? It's not apparent to me that there is some low hanging fruit to be snatched by shaking up the board or dislodging the founder.

 

3G/QSR?

 

3G's restaurant investments had quite different characteristics as this.  Massive re-franchising, etc.  I can't imagine 3G would be willing to pay anything like this multiple for CMG when there is not an obvious way to cut costs/expenses in a massive way for a business like this.  I guess one possible theory, that seems exceedingly unlikely to me, could be that 3G would buy it and sell of the Chipotle's to turn it into a franchisor.  I believe there under a 1% chance, probably well under, of 3G getting involved in this.

 

 

- Chipotle has no debt (and substantial cash+investments): 3G could lever this up to > 5x EBITDA

- CMG is company-operated. 3G re-franchised almost all company-operated BK stores

- 3G paid a big premium (16x EBITDA) to buy a fantastic business (Tim Horton's). Given CMG's growth opportunities and ROE, a 3G takeout is realistic at current price

- 3G brought in master franchisors to speed up growth at Tim's and improve efficiency at BK

- Zero-based budgeting

 

 

 

[Astrea]

Could someone who likes this explain why it is attractive quantitatively? I couldn't make the numbers work playing with them and using Ruane's rationale for their purchase. Clearly, some other guy who knows a little about fast food disagrees.

 

Double the revenue $9B, 16% op margin, a few other assumptions gets one $30/share in EPS. What am I missing?

 

My simplified, but hopefully not simplistic, version of the CMG story:

 

Let’s assume you want to start a fast-casual restaurant business.

 

What you’d like is for all your food to be fresh, locally sourced and responsibly farmed. So you’ll build your business model in a way that allows you to invest in higher quality ingredients but without charging higher prices than your competitors. That’ll be your edge.

 

To achieve this you opt for a simple menu. That way you’ll save time and effort when you buy your ingredients. You’ll also save time and effort when you prepare and serve your food. That works well because all that time and effort you save means you can afford to spend more on the higher quality ingredients.

 

You decide that your simple menu will comprise burritos, tacos and salads. You figure that’s a great way of doing more with less. Whilst you may be serving only three things, your customers will get to customize their orders with a variety of meat and veggie fillings and toppings. That way they’ll get to choose precisely what they want, and all the resulting combinations, not only for taste but also for diet, will keep them coming back.

 

Of course, a big part of the customer experience will be the quality of your service. It will have to be fast, consistent and friendly. So you’ll make sure you only recruit top performers. That’s people who are high energy, conscientious and driven. If your people have those traits, and then if you incentivise them to achieve high standards, you figure you’ll have the right culture in place to deliver an outstanding service.

 

You’re now comfortable with the concept. And so you invest $800 to open your first restaurant. The restaurant gets off to a great start. You make around $2,400 in sales. With 10.5% after-tax margins, you’re making $250 annually. Your return on capital is 30% + and you like the feeling.

 

It’s worth taking a minute to highlight your high returns on invested capital which are a particularly pleasant aspect of the economics of your business. There are two factors which help minimise the funds you require for operations. First, your food is sold for cash and that eliminates accounts receivable. Then, your production and distribution cycle is short and that minimizes inventories.

 

You keep going and by year 4 you’ve got $1,000 saved in the bank. That’s enough to open a second restaurant. And with an expected after-tax return above 30%, it’s an easy decision to make.

 

In fact, it’s such a no-brainer that it attracts the attention of your rich Uncle Ronald. He’s an old hand at the restaurant business who’s been running his fast-food burger chain for over half a century. Uncle Ronald reckons there’s room for 4,000 of your restaurants in America alone. And if there’s one thing he likes more than his tasty burgers, it’s a high return business with plenty of reinvestment opportunities.

 

So you make a deal with Uncle Ronald. You’ll take his investment and his know-how to accelerate your growth. But you both agree that you won’t run the business the way traditional fast-food works (that’s a model which relies on cheap ingredients and lots of automation in order to deliver low prices). Instead, your kitchens will continue to have cutting boards and knives, pots and pans and your employees will continue to dice and cook fresh, high quality foods. Uncle Ronald is fine with that; he’s well aware that food which takes into account health and nutrition in addition to just flavour is growing in relevance.

 

The years go by and you continue to have great success. You’ve opened 2,000 restaurants - in twenty years - serving burritos, tacos and salads all across America. You’ve had the people and the capital to grow which means you haven’t had to franchise. You’ve actually run such a successful operation that you’ve grown without incurring any debt and have plenty of excess cash on your balance sheet. You’ve started to test the waters in Canada and Europe and you’re also experimenting with a Southeast Asian and a pizza concept to see if your model works with other kinds of cuisine.

 

Sure, your success has attracted more competition. But if your competitors are going to say, okay, let’s start sourcing higher quality, more expensive and healthier ingredients, then something will have to give. Either they’ll have to charge higher prices or they’ll have to accept lower margins. Then, you’ve got that special people culture which won’t be easy to replicate. If you think about it, you’ve spent years recruiting great people and promoting overwhelmingly from within. Your employees know they’ll be the future leaders of the business and for that reason they have a huge sense of ownership in what they do. And that’s a powerful incentive to continuously improve every aspect of the business and drive for better, faster service, cleaner restaurants, higher sales and better tasting food. You’ve also developed a loyal customer base and you dominate the Mexican fast-casual market both in mind share and scale. However way you look at it, your competition is facing an uphill battle and whilst a few might eventually succeed, it will take time and in the meanwhile they are likely to take customers away from others before they take them away from you.

 

Okay, so you’re pleased with your business and take a step back to work out what it’s actually worth.

 

This year you’ll make $2,400 in sales in each of your 2,000 restaurants. That’s $4.8 million in sales. Your after-tax margins remain at 10.5% and so you’ll earn $500,000 after-tax. Over the years you’ve accumulated $650,000 in cash which sits on your balance sheet and is not required for your operations.

 

Let’s say you continue to open restaurants at the current pace (200+ each year) at a cost of $800 per restaurant. That means you’ll have 4,000 restaurants in just under ten years’ time. You’ll then be earning $1 million after-tax and you’ll have accumulated excess cash totalling $7.7 million. You reckon you’ll still be growing organically mid-single digits because favourable demographic and lifestyle trends are likely to support your volumes and pricing power. So if you capitalize your earnings in year 10 at 5%, that’s going to be $20 million and plus the cash, your business will be worth $27.7 million. If you then have a hypothetical buyer who is willing to purchase your business at 24 times today’s earnings [Footnote: It so happens that Chipotle Mexican Grill, Inc., a real-life publicly-traded corporation, which bears an uncanny resemblance to this fictional fast-casual restaurant business of yours, also trades around 24 times its estimated normalised earnings], he’ll pay $12 million today for $27.7 million in ten years’ time, netting him an 8.7% compounded annual return on his money. 

 

Now let’s assume all is not plain sailing and something materially adverse happens to your business. Let’s say you get an e-coli, salmonella and norovirus outbreak all at once in multiple locations throughout the country. Hundreds of your customers get sick. The headlines are bad and their effect is compounded by social media frenzy. Naturally, you lose a substantial part of your business as customers stay away from your restaurants. The numbers are terrible and, after much math and little thinking, the experts extrapolate the present indefinitely into the future. Soon enough though, lines outside your restaurants start to build again. And just as quickly as the crowd deserted, the crowd returns. The reason you recover is quite simple. You’ve got no close substitute. Your economic model, underpinned by your special food and people culture, makes it so that customers simply won’t get the same quality burrito for the same price and served as fast anywhere else. You might find yourself on the operating table for a while after the outbreak but you can take the pain and the forces at play mean you should come out of this episode with the value of your business largely intact.

 

You’re mindful that there’s also room for pleasant surprises. Your business might reach 4,000 restaurants in America and then meet with some success in Canada and perhaps the rest of the world. Your pizza and Southeast Asian concepts could very well take off too. And with your same focus on food, people and high return economics, it’s not too much of a stretch to imagine a future in which value creation exceeds the 8.7% base case compounded annual return of your hypothetical buyer.

 

[awindenberger]

I love the story Astrea. Very well put.

 

 

[TorontoRaptorsFan]

Alphabet delivering Chipotle burritos by drones to students at Virginia Tech

 

http://www.bloomberg.com/news/articles/2016-09-08/burrito-by-drone-coming-to-campus-in-test-of-alphabet-s-delivery

[rayfinkle]

Fwiw- - few downtown San Francisco locations that were ghost towns a few months ago in the heat of headlines are once again bustling. Lines out the door even at 130-2pm, not core lunch time. Friends in NYC suggest similar behavior. Of course just one soft indicator.

 

Anyone else seeing traffic pick up?

[hooplaer23]

I thought this was a pretty informative (and in-depth) article about Chipotle's food safety issues and response.  I have seen a few investors point to the Jack in the Box issues from the early 90's as a relevant case study, but this article offers some insight into why Chipotle's current situation is a bit more complicated and challenging.

 

https://www.fastcompany.com/3064068/chipotle-eats-itself

[fareastwarriors]

I thought this was a pretty informative (and in-depth) article about Chipotle's food safety issues and response.  I have seen a few investors point to the Jack in the Box issues from the early 90's as a relevant case study, but this article offers some insight into why Chipotle's current situation is a bit more complicated and challenging.

 

https://www.fastcompany.com/3064068/chipotle-eats-itself

 

I spent all morning reading this. Thanks. It's fascinating.

[flesh]

^^^^ same... very good.

[DooDiligence]

Very informative!

 

I've eaten once at a Chipotle in Miami & once in Tallahassee (there's no Chipotle where I live.)

 

I didn't care for the gigantic rice stuffed burrito & on my second visit, asked for the rice to be on the side so I could actually enjoy the meat in the burrito.

 

It was good & the chips & guac were tasty as well.

 

The industrial design of the dining room didn't really appeal to me (Taco Bell actually makes me feel more like hangin around a bit rather than just the "get outa here when your finished" feel I get from the Chipotle design.)

 

Fast forward to a meal at a Moes in my town...

 

The burrito tasted good & I got unlimited self serve access to a wide range of what appeared to be fresh condiments & the line rep said if I want more chips, just ask.

 

The dining room design was no more or less conducive to my feeling of being in a fast/casual/semi fine whatever they're trying to make me feel, establishment.

 

After reading this article; I wonder if a tenuous parallel can be drawn to WalMarts "made in America" dealio which blew up & then got swept away with "Save Money Live Better" now hush up & don't worry where all this cheap stuff comes from.

 

IMHO if you want fresh; visit local Mexican restaurants which don't use Sysco (we have a very good one near the beach where I get chunky fresh pico de gallo & guac at a reasonable price) or invite some friends over & have taco Tuesday...

 

I prefer to support local businesses where the dollars I spend stay in the local economy (admittedly this can't be 100% accomplished; nor is it my mission - just sayin...)

 

All this armchair amateur (what passes for analysis to me) aside; I'm very reluctant to invest in retail or restaurants since I cannot reliably predict whether they'll still be around in 10 years.

 

I'll probably visit a Chipotle again in my life but it's not a burning passion & I'm 99% certain I won't ever buy a stake in the company (I like reading & although I do buy books, I'll never own a book store or a library...)

[DooDiligence]

Forgot to add that Ackman's investment doesn't do a thing to inspire my confidence.

 

I may be an amateur but I passed on Valeant years ago (a rat by any other name is either a rodent or a rat...)

 

Granted; I do believe his call on Herbalife was straight up but I have a hard time seeing how he could beat on them so hard & yet still remain convinced that Valeant is a good biz (he does have nice hair though.)

 

I'm probably just not sophisticated enough to understand...

[DCG]

My local Chipotle has been doing a lot of buy one get one free promotions. Businesses doing well typically don't give away that much free food.

[DooDiligence]

My local Chipotle had been doing a lot of buy one get one free promotions. Businesses doing well typically don't give away that much free food.

 

I think they had an inevitable outcome with the "gut bomb" event due to attempting to locally process ingredients using $9 labor on such a large scale & now they're gradually reacting by going to the very processing & promotional efforts that the CEO has abhorred in the past.

 

The conflict between his epicurean ideals & the realities of doing business at scale may present more problems.

 

If they could pull of another unique startup & create a multi year unit growth scenario like the Chipotle concept did, then maybe...

 

If & maybe combined with no tangible value (a bunch of rooms that someone else could turn into vaping retailers.)

 

I'm just managing my $ & advising family members so I don't have to take chances like this one (gotta say I admire those who do so with integrity!)

[BTShine]

All I want from Chipotle is a jr/mini burrito option so I can eat there for lunch and stay awake in the afternoon.

[glorysk87]

http://www.denverpost.com/2016/09/09/chipotle-foodborne-illness-cases-settled/

[Gregmal]

http://www.denverpost.com/2016/09/09/chipotle-foodborne-illness-cases-settled/

 

Just my 2 cents but CMG does seem to strike me as possessing a lot of the same characteristics held by a certain coffee company during the late 90's. The one that was always grossly overvalued, had a cult like following, and drove short sellers nuts. SBUX

[TwoCitiesCapital]

http://www.cnbc.com/2015/07/21/chipotle-reports-quarterly-earnings.html

 

So Chipotle missed on earnings and same store sales. Really surprised given the massive spike in foot traffic I've witnessed in Manhattan, but I guess that either wasn't reflected country wide or was more than offset by the increased incentives in the 25-30% people were receiving during the Chiptopia rewards program.

 

Probably not going to hold this long-term at these prices. Even the outlook for 2017 wasn't something to get excited over. Was just speculating on the one quarter given the drastic change in foot traffic that I witnessed so I think I'll be moving along.

[awindenberger]

http://www.cnbc.com/2015/07/21/chipotle-reports-quarterly-earnings.html

 

So Chipotle missed on earnings and same store sales. Really surprised given the massive spike in foot traffic I've witnessed in Manhattan, but I guess that either wasn't reflected country wide or was more than offset by the increased incentives in the 25-30% people were receiving during the Chiptopia rewards program.

 

Probably not going to hold this long-term at these prices. Even the outlook for 2017 wasn't something to get excited over. Was just speculating on the one quarter given the drastic change in foot traffic that I witnessed so I think I'll be moving along.

 

I'm really excited about owning CMG long term, but only if the price comes down under $300. I think its possible when we hit the next recession.

[glorysk87]

http://www.cnbc.com/2015/07/21/chipotle-reports-quarterly-earnings.html

 

So Chipotle missed on earnings and same store sales. Really surprised given the massive spike in foot traffic I've witnessed in Manhattan, but I guess that either wasn't reflected country wide or was more than offset by the increased incentives in the 25-30% people were receiving during the Chiptopia rewards program.

 

Probably not going to hold this long-term at these prices. Even the outlook for 2017 wasn't something to get excited over. Was just speculating on the one quarter given the drastic change in foot traffic that I witnessed so I think I'll be moving along.

 

do they call out same store traffic numbers? or only sales? because i don't think sales are indicative of much atm. they've pretty much been giving food away to anyone who will take it.

[muscleman]

http://www.cnbc.com/2015/07/21/chipotle-reports-quarterly-earnings.html

 

So Chipotle missed on earnings and same store sales. Really surprised given the massive spike in foot traffic I've witnessed in Manhattan, but I guess that either wasn't reflected country wide or was more than offset by the increased incentives in the 25-30% people were receiving during the Chiptopia rewards program.

 

Probably not going to hold this long-term at these prices. Even the outlook for 2017 wasn't something to get excited over. Was just speculating on the one quarter given the drastic change in foot traffic that I witnessed so I think I'll be moving along.

 

 

 

 

 

 

 

do they call out same store traffic numbers? or only sales? because i don't think sales are indicative of much atm. they've pretty much been giving food away to anyone who will take it.

 

https://www.sec.gov/Archives/edgar/data/1058090/000105809016000086/cmg-20161025xex99_1.htm

 

There is a chart of sales comp and traffic comp.

Why do you think traffic tracks the real situation better? If they gave away food, traffic will increase too to pick up the food, right?

[muscleman]

http://www.cnbc.com/2015/07/21/chipotle-reports-quarterly-earnings.html

 

So Chipotle missed on earnings and same store sales. Really surprised given the massive spike in foot traffic I've witnessed in Manhattan, but I guess that either wasn't reflected country wide or was more than offset by the increased incentives in the 25-30% people were receiving during the Chiptopia rewards program.

 

Probably not going to hold this long-term at these prices. Even the outlook for 2017 wasn't something to get excited over. Was just speculating on the one quarter given the drastic change in foot traffic that I witnessed so I think I'll be moving along.

 

 

I don't get it. At $400, the EV/EBITDA is still an astronomical 24. $300 won't make much difference.

What kind of EV/EBITDA are you willing to own it? I am willing to pay 8x.

I'm really excited about owning CMG long term, but only if the price comes down under $300. I think its possible when we hit the next recession.

[Gregmal]

http://www.cnbc.com/2015/07/21/chipotle-reports-quarterly-earnings.html

 

So Chipotle missed on earnings and same store sales. Really surprised given the massive spike in foot traffic I've witnessed in Manhattan, but I guess that either wasn't reflected country wide or was more than offset by the increased incentives in the 25-30% people were receiving during the Chiptopia rewards program.

 

Probably not going to hold this long-term at these prices. Even the outlook for 2017 wasn't something to get excited over. Was just speculating on the one quarter given the drastic change in foot traffic that I witnessed so I think I'll be moving along.

 

 

I don't get it. At $400, the EV/EBITDA is still an astronomical 24. $300 won't make much difference.

What kind of EV/EBITDA are you willing to own it? I am willing to pay 8x.

I'm really excited about owning CMG long term, but only if the price comes down under $300. I think its possible when we hit the next recession.

 

Yea this isnt a name Im terribly familiar with however was glancing through some commentary earlier and noticed an optimistic fellow saying they hoped the turn around was beginning and that the company could do $10 EPS next year. Then I'm thinking about it, and was kind of stunned that at $400, and $10 a share seen as the hopeful number, that there are people who think this is cheap.

[JayGatsby]

The long thesis here is that at the current TEV ($11.5B) divided by 2015 EBITDA ($900M), they're trading at a discount to McD while increasing store count by 10% per year. It won't be a quick turnaround, but I thought the revenue numbers seemed to be going in the right direction. Others are right though that it's hard to tell exactly because of the effect of heavy discounting.

 

Edit: Disappointed to see ShopHouse shut down. I liked the concept although it never packed the crowd or had the enthusiasm that Chipotle had.

[Spekulatius]

http://www.cnbc.com/2015/07/21/chipotle-reports-quarterly-earnings.html

 

So Chipotle missed on earnings and same store sales. Really surprised given the massive spike in foot traffic I've witnessed in Manhattan, but I guess that either wasn't reflected country wide or was more than offset by the increased incentives in the 25-30% people were receiving during the Chiptopia rewards program.

 

Probably not going to hold this long-term at these prices. Even the outlook for 2017 wasn't something to get excited over. Was just speculating on the one quarter given the drastic change in foot traffic that I witnessed so I think I'll be moving along.

 

 

 

 

 

 

 

do they call out same store traffic numbers? or only sales? because i don't think sales are indicative of much atm. they've pretty much been giving food away to anyone who will take it.

 

https://www.sec.gov/Archives/edgar/data/1058090/000105809016000086/cmg-20161025xex99_1.htm

 

There is a chart of sales comp and traffic comp.

Why do you think traffic tracks the real situation better? If they gave away food, traffic will increase too to pick up the food, right?

 

The most important metric always has a $ in front of it, imo.

[glorysk87]

http://www.cnbc.com/2015/07/21/chipotle-reports-quarterly-earnings.html

 

So Chipotle missed on earnings and same store sales. Really surprised given the massive spike in foot traffic I've witnessed in Manhattan, but I guess that either wasn't reflected country wide or was more than offset by the increased incentives in the 25-30% people were receiving during the Chiptopia rewards program.

 

Probably not going to hold this long-term at these prices. Even the outlook for 2017 wasn't something to get excited over. Was just speculating on the one quarter given the drastic change in foot traffic that I witnessed so I think I'll be moving along.

 

 

 

 

 

 

 

do they call out same store traffic numbers? or only sales? because i don't think sales are indicative of much atm. they've pretty much been giving food away to anyone who will take it.

 

https://www.sec.gov/Archives/edgar/data/1058090/000105809016000086/cmg-20161025xex99_1.htm

 

There is a chart of sales comp and traffic comp.

Why do you think traffic tracks the real situation better? If they gave away food, traffic will increase too to pick up the food, right?

 

yea, that was pretty much my question, thanks for repeating it though