Experts can't fathom what Bill Ackman has planned for Chipotle
Nicole Sinclair
Shares of the Chipotle Mexican Grill (CMG) spiked 6% on Wednesday, following the announcement that Bill Ackman’s Pershing Share took a 9.9% stake in the beleaguered company.
But while the stock, off 39% over the last year, has been beaten down by food safety scandals of the last year, analysts came out in droves overnight to warn against following Ackman into this trade.
Stifel Nicolaus & Co’s Paul Westra and Maxim Group’s Stephen Anderson, who have $300 and $215 price targets on the stock, respectively, cited the pop as an outright opportunity to sell shares, which currently stand at $437.
“We emphatically reiterate our sell rating on CMG shares following news that Pershing Square has started a 9.9% activist position,” wrote Westra. “We cannot fathom Pershing’s operational or mathematical investment thesis.”
Chipotle’s monthly comparable store sales have remained in the negative since the end of last year, a trend that will continue, according to the analysts.
Ackman’s unclear bet
Anderson said Ackman’s timing is off.
“He’s wrong about Chipotle at this point,” Anderson said. “The company isn’t what it once was. If he gets anything done, it’s going to be in the realm of operations and border management makeup.”
Oppenheimer’s Brian Bittner said Chipotle’s multiple, at 35x 2018 P/E, remains steep, with unclear upside.
“Unlike other activist situations, we don’t see any viable paths to financially engineer shareholder value from the boardroom,” he said.
While Ackman did not reveal his specific intentions for Chipotle, Anderson said there could be several possibilities, but he questioned the ability to push these through.
Ackman’s Pershing Square has had a history of shareholder activism in the restaurant industry—including investments in Wendy’s (WEN), McDonald’s (MCD), and Burger King (now called Restaurant Brands (QSR) after its tie-up with Tim Hortons). While he successfully timed those investments, analysts are more skeptical about a comeback at Chipotle.
Of course, Ackman’s recent record with companies from Valeant (VRX) to Herbalife (HLF) has been controversial.
Potential proposals, including selling emerging brands (like ShopHouse and Pizzeria Locale), pushing for slowing company-owned unit development and improving operations to lessen dependence on high-cost labor, could be difficult for this high-flying stock. Meanwhile, a push to shift to a franchising model—embraced by the likes of McDonald’s, Starbucks (SBUX) and Domino’s (DPZ)—would mark a major strategic shift from Chipotle’s ownership focus.
Many issues could continue to plague the stock.
Analysts point to major issues for Chipotle upside
1) Reliance on promotions driving traffic
Anderson cited the company’s reliance on promotions to drive traffic, including the free burrito offers and buy-one-get-one promotions from the past year that could become a more permanent part of the company’s marketing strategy
“While there is no question the storm of promotions has provided a temporary boost to beleaguered customer traffic—with generally high promotion opt-in rates—we believe the food safety incidents have dislodged Chipotle customers’ routines and expect demand to remain depressed for the foreseeable future,” Westra said.
2) Increased permanent costs from increased food safety compliance
Anderson added that the company faces higher permanent costs from increased food safety compliance. Earlier this year, management said increased costs for more intensive food safety protocols could deduct as much as $1.92 per share annually, according to Anderson.
“We see this as a permanent ongoing cost that likely will prevent CMG from repeating its cycle-high 17.3% operating margin in this economic cycle,” he said.
3) Higher exposure to $15 per hour minimum wage mandates
The company also has more exposure than peers to $15 per hour minimum wage mandates, Anderson said, explaining that the company will be subject to accelerated wage increase in at least 25% of the company’s US restaurants in the next three to five years.
“We estimate that CMG will need to implement menu price increases of as much as 150bps per year just to cover mandated wage increases,” Anderson said. “As we contend that CMG still is recovering from food safety scares, we are concerned that the company may not be able to pass along these price increases.”
4) Legal risk
In January, Chipotle was served a subpoena by the US Attorney’s Office for the Central District of California requiring the company to produce documents about the company’s practices at all restaurants nationwide.
“Although we believe that management’s more recent and aggressive food safety stance may mitigate any unfavorable verdict, we still caution that a negative verdict may lead to another bout of negative headline risk and, thus, downside for CMG shares,” Anderson said.
5) No longer a growth story
Management recently acknowledged that it would seek to decelerate unit development, marking the end of CMG’s high-growth story from a company-owned perspective, Anderson said. Although CMG reiterated its goal of 220 to 235 net new unit openings in 2016 during its July earnings call, the company added that beginning in 2017, it would target unit development in existing, high-return markets.
Westra added that, separate from the food safety concerns, he believes that Chipotle had already hit peak returns.
“Chipotle has reached 60% US saturation, a typical arrival point of a concept’s Peak Returns,” he said.
He added that there has been an accelerated emergence of new quick-casual concepts that will compete with Chipotle, especially on the low end.
In the end, there’s no doubt Chipotle has underperformed. But whether it can overcome the food safety obstacles and costs, especially amid rising challenges, remains a big question mark for analysts—despite the Ackman stake.
