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Long Vs. Short: Is Chipotle a Healthy Investment?

Chipotle. Photo: Patrick T. Fallon/Bloomberg via Getty Images

Normally when a company hits a major milestone, they exploit it incessantly as a promotional opportunity. Yet Chipotle let last year’s 25th anniversary pass with virtually no fanfare as the “fast casual” pioneer replaced its founding CEO, moved its headquarters, shuttered 65 low-performing locations, and turned its gaze decidedly forward.

That’s not such a huge surprise when all anyone could see in the rearview was the wreckage of a devastating, humiliating set of food-safety scandals in 2015 and 2016. Outbreaks of E. coli, salmonella, and norovirus caused dozens of illnesses around the nation, which then launched several federal investigations and crashed the stock from a high around $750 in August 2015 to a bottom of $255 in February 2018.

The rest of its silver anniversary year, though, went a lot better. Investors and the media responded well to the hire of former Taco Bell CEO Brian Niccol, named CEO of the Year for 2018 by CNN for presiding over a giant spike in sales and profits, a modernization of store technology, new menu offerings, and an ad blitz aimed at restoring confidence in the freshness and safety of its ingredients. The stock has more than doubled since last year’s low, now sitting around $530.

Still, it was easier last year for year-over-year comparisons to look impressive, given how badly beaten down the brand was. The big question as Chipotle heads into another earnings release on February 6 is whether growth can be sustained or accelerated, as average sales in 2018 are now expected to top $2 million per restaurant again. The area of digital orders remains ripe for Chipotle to grow, given that just 10 percent of their orders come in digitally compared to about 40 percent for Panera and more than 50 percent for the major pizza chains.

Can Niccol, previously celebrated for turning around Taco Bell, do it again with another Mexican-food icon? How solid is the chain’s recent resurgence? Has Chipotle regained as much of its old glory as it can expect, now that it’s no longer the big enchilada of the now-crowded fast-casual landscape? Or was 2018 a warm-up?

“With a new management team in place, there was a lot of low-hanging fruit to reinvigorate the brand and the growth after several years of digging out after food-safety issues and those challenges. It took a change in leadership and culture to get the organization refocused.

We expect to continue to see an improvement in the same-store sales of about 4 percent in the earnings report for Q4. But the real initiatives will show through in 2019, and we have some of the highest estimates on the Street for 6.5 percent same-store sales in 2019 versus 2018, about half of which can be driven by digital delivery.

There’ll be some onetime costs this quarter, including some restructuring charges from the move of the headquarters from Denver to California and the store closures as they cleaned up the store portfolio in 2018.

But Brian Niccol is really laying out a plan to move the business forward. Clearly, the company had been reactionary. Brian Nichols stepped back and said, ‘Hey, we’ve got to market better, we’ve got to operate better, we’ve gotta drive digital, drive some food news and begin to explore a lot of new areas that the brand hadn’t pursued before.’ It’s not revolutionary stuff, but it’s things that the brand had not particularly focused on under the former leadership.

It’s still relatively early in terms of Chipotle pushing digital orders and engagement, but the easier pickup and the digital ‘second-make lines’ make that whole process more efficient.

It shows you a path to growth. They’re driving engagement with the Chipotle app and they’ve run promotions that have proven to be interesting from the consumer’s perspective, like the free delivery during the College Bowl season.

Because of the history, Chipotle is probably a little bit more at risk of downside if there are any further food-safety problems, but they’ve also put in place procedures and communications to mitigate that risk and be more nimble and quick about discussing problems when they arise. Obviously, the key way to avoid that is to not have those problems.

We set a target of $550 three months ago when the stock was in the mid-$400s. It’s almost there now, so we’ll reassess the next time we publish something. But it’s a leader in fast-casual and obviously has the size and scale and still has opportunities to regain more of what it lost from its peak. I’m not saying they’ll get back to peak, but if they continue to drive same-store sales and average unit volumes, some of the margin flow-through will be pretty powerful.” – Andy Barish, Jefferies Group

“The biggest point of difference between me and the bulls is on the question of labor costs. I’m concerned about labor inflation throughout the industry. I can see opportunities to save money around food and beverage costs, around rent and other operating expenses. But labor costs are rising.

The biggest risk is another food-safety scare. Chipotle is particularly vulnerable because of how they positioned the brand. They’ve actually corrected a lot of their issues and, if anything, it’s probably one of the safest supply chains out there now.

The problem is with how they position the brand. They try to make this a lifestyle brand, and a lot of the marketing and positioning implies that this is food that’s good for you, good for the environment, good for the animals and so on.

But when you eat food that’s supposed to be good for you and you get sick, that directly contradicts that brand equity they’ve developed. Given the positioning, you get a much bigger blowback when that message is undermined.  The new CEO has basically doubled down on that positioning, and so from my perspective, that does not do anything to alleviate that particular issue.

The story originally was, ‘Oh, well we’re going to get all that back in two years.’ And then it shifted to, ‘Oh, you know, it might take four or five years.’ Now it’s all, ‘Forget it, we might never get back to that $2.5 million per-store volume, but if we could do a 5 percent year-over-year growth, then that’s enough for the markets to improve dramatically.’

And we need to see much more significant acceleration in terms of sales growth in order to achieve the year-over-year margin target over the next year to three years that the bulls point to. Over the past couple of quarters, pricing has driven the revenue comparisons up while the number of transactions has stayed negative—so really it’s just Chipotle using price increases to increase revenue. It’s not people coming back and buying more burritos.

The overall average check increase also benefited from people coming in and buying a little bit more stuff. Instead of just buying a burrito, now you buy a burrito and a coke, a burrito and some queso.

The queso was really driving the big positive mix. That was a big initiation, but that happened before Niccol came along.

Going forward, the average check is probably going to be up 2 to 3 percent, not the 5 to 6 percent range that we were seeing in the first three quarters of 2018.

The rest of that has to be made up by acceleration in transactions in the fourth quarter and into 2019. The question is, are we going to see that or not?

I’m on the side of no. And if we see it, it’s going to be less than where expectations are.

The recent uptick in the stock, where it has gone from $400 to $535, is due solely to a big acceleration in revenue seen in weekly credit-card data, a hockey stick acceleration at the end of December into January in terms of sales growth.

According to some clients and investors I speak to, the credit-card data is showing even as high as double-digit comps year-over-year for December and January. But my checks are nowhere near that. I’m getting to a 5-ish comp, maybe 5.5 percent if I really want to be aggressive with my quantification. And even if we see that kind of acceleration, it’s being driven by a free delivery promotion that they advertised very heavily from the end of the quarter into January on national television. But that’s a transient phenomenon.

If they’re doing double-digit comps then I’m wrong and the bearish thesis is wrong. If I’m right and they’re doing mid-single-digit comps, I don’t think that’s enough.

If we’re right about the comp not being as high as the credit-card data is indicating, the stock could go right back down to below $400.” – Nick Setyan, Wedbush Securities

Long Vs. Short: Is Chipotle a Healthy Investment?