CMG thoughts

Investment Analysis Clubs Saul’s Investing Discussions
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This is a very short cross-post I just wrote on Value Hounds, but I had fun writing it so I thought I’d share:

I don’t get what the thesis is [on CMG] other than, “It used to be worth 700 a share, yeehaw!”

This stock is propped up by severe Foolish love + hopes and dreams. I don’t know or care what the long term growth plan is as far as opening new stores, but does anyone really think they’re in for a redux of the phenomenal growth they have had in the past? No, unless they are someday going to have as many stores as McDonald’s or Starbucks, those days are over.

$10 EPS in 2017 seems pretty optimistic, and still doesn’t match the $15 or so they were doing in 2014 and 2015. And that would mean a foward PE of 40.

This is life in a dream world. Time for a red thumb again.

Bear

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Bear wrote: “I don’t get what the thesis is [on CMG] other than, “It used to be worth 700 a share, yeehaw!””

The thesis is based on the unit economics of the stores. They cost about $800,000 to build, quickly ramp up to about $1.5 million in annual sales and - at historical profit margins - the stores pay for themselves in two or three years. I doubt that $15 million revenue amount still holds, and I haven’t re-run the numbers based on more recent sales and margins, but I would guess that each store still covers its construction cost within four-to-five years. They’ve also identified 5% per store construction cost savings that help offset the current traffic decline. Any profits after construction costs are covered are gravy to Chipotle. Although they’ve been buying back a lot of shares - enough to have a noticeable effect on the share count, they still have a lot of “gravy” on the balance sheet. As of the September quarter, the company was still debt-free. I would normally assume that’s still true, but the involvement of Ackman and Pershing Square makes me cautious to claim it definitively.

“I don’t know or care what the long term growth plan is as far as opening new stores, but does anyone really think they’re in for a redux of the phenomenal growth they have had in the past? No, unless they are someday going to have as many stores as McDonald’s or Starbucks, those days are over.”

I think that doubling the Chipotle Mexican Grill restaurant count is a reasonable target. Recent growth has been in the 10% per year range, so a doubling would be about 7-7.5 years out. Growth beyond that would have to come from their other concepts. I’m saddened that they’re shuttering ShopHouse Southeast Asian Kitchen. I tried it once and it was a delightful experience, both from taste and texture perspectives. Their pace of expansion with their pizza and burger concepts falls short of confidence-inspiring, admittedly. The basic restaurant operating model could apply to many cuisines - I’d like to see an Indian version of Chipotle. But it seems as if management currently feels as if they need a mainstream cuisine to bring in sufficient traffic for the beneficial unit economics to occur.

“$10 EPS in 2017 seems pretty optimistic, and still doesn’t match the $15 or so they were doing in 2014 and 2015. And that would mean a foward PE of 40.”

To my mind, focusing on $10 in 2017 is focusing on a very low-confidence number, and drawing conclusions based on it. If restaurant traffic remains low, $10 will be a stretch. If traffic improves, $10 will have been a low hurdle. How confident are you that anyone can predict where Chipotle’s traffic will be in 2017? Calculating a PE off depressed earnings is akin to treating those depressed earnings as a new run rate. Is that what you think?

In 2017, marketing expenses will continue to be elevated. The company has identified some cost savings initiatives that should help to offset that. Getting rid of co-CEO Monty Moran is a huge salary dump, although I haven’t seen details regarding what “parachute” benefits might kick in for him during 2017. It could be a wash for this year, but a benefit in future years.

Good luck with your call, Bear. I’m not trying to argue that Chipotle deserves a “green thumb”, just that a “red thumb” is not the no-brainer it might appear. I’m long Chipotle and I study it pretty carefully. If this board is interested in Chipotle, I can share a lot more analysis - I just haven’t seen sustained interest. Saul? I’ll admit that I’ve considered lightening my position because my conviction no longer quite matches its size. The shares are in a taxable account for me, and I purchased them late in 2008 (I think I’ve shared that here before). I’ve got to consider capital gains tax when I consider a CMG sale, partial or not. If your red thumb turns out to be correct in the short term, I’ll probably continue to hold all my shares. I expect that the unit economics will prevail eventually unless the damage done to traffic patterns proves to be permanent. I’m not ready to concede that yet. I don’t expect a quick return to glory days, but I do expect a resumption of growth. Should the short-term bring a green thumb, then I might consider a sale or partial sale to regain alignment between my holding size and my conviction.

4Q16 earnings are scheduled for February 2, after market close.

Thanks and best wishes,
TMFDatabaseBob (long: CMG)
See my holdings here: http://my.fool.com/profile/TMFDatabasebob/info.aspx
Peace on Earth

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DB Bob wrote: “They cost about $800,000 to build, quickly ramp up to about $1.5 million in annual sales and - at historical profit margins - the stores pay for themselves in two or three years. I doubt that $15 million revenue amount still holds…”

Sorry for the missed decimal point. $1.5 million is the number I meant in both those sentences.

Thanks and best wishes,
TMFDatabaseBob (long: CMG)
See my holdings here: http://my.fool.com/profile/TMFDatabasebob/info.aspx
Peace on Earth

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I’d like to see an Indian version of Chipotle.

Roti Grill

http://www.freshindianfood.com/

The Captain

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If restaurant traffic remains low . . .

This question would be better posed in terms of how long will traffic remain low.

Think back to when Jack In The Box killed some folks with e coli. How long did it take for sales to recover? I don’t recall, but I will tell you that I personally have never eaten at another JITB. Anyone remember Chili’s? I guess they’re still in business, but all the shops in my area are gone.

I drove by my local CMG shop the other day around lunch time. Previous to the contaminated food problems you could not find a place to park and there were long lines waiting to get food. And then you had to wait for a table. Now, the shop is half vacant, easy parking, no lines.

Ouch, it’s just one shop, but that can’t be good for business. The longer it takes for them to recover, the less likely it is that they will ever recover the same momentum they once had, or even survive.

The restaurant business is fraught with danger. Some time ago I violated my better judgment by buying a restaurant stock (I owned CMG). Made some good money with them, but bailed, fortunately, long before the current storm. I owned SBUX as well. Made good money there too, but did not really consider it a restaurant company until they started to sell a lot of food other than pastries. I think the business holds too many risks that can come out of no where with devastating effect.

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Calculating a PE off depressed earnings is akin to treating those depressed earnings as a new run rate. Is that what you think?

Exactly. Brittlerock nailed it:

The longer it takes for them to recover, the less likely it is that they will ever recover the same momentum they once had, or even survive.

Don’t anchor to the past, Bob. CMG is dullsville at best now. Just to throw out a crazy stat, if 2017 EPS were going to be $20, that would still mean a fwd PE of 20. What kind of multiple do you think they deserve?

Bear

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Hi Bear.

I think I’m well aware of the present and I’ve visited Chipotle restaurants in several states within the past year. Some are hopping, even off hours (e.g., State College, PA). Others less so (e.g., Grand Junction CO), but the restaurants aren’t empty.

“What kind of multiple do you think they deserve?”

I think my point, Bear, was that that’s entirely the wrong question to ask. I think the proper question is: “What traffic levels can they regain, and how soon?” Revenues will fall out of traffic. Earnings will fall out of revenues (in a very leveraged way) depending on how expenses are managed. I think they’re taking the right tack that, for now, regaining traffic is more important than managing expenses, but that will become important too.

I don’t disagree with brittlerock’s point that the longer it takes to recover, the less likelihood that the recovery will be significant. I think “survival” is pretty much ensured as long as the company remains debt-free. Obviously, I’m hopeful for the recovery to be “sooner” and “more robust”. But I recognize that’s just a hope.

Many people on the message boards gave CEO Ells a bunch a grief when he said that many stores aren’t up to par in terms of appearances. In my travels, I think that observation is spot-on, and probably an important reason traffic isn’t rebounding faster. It is possible that the new food safety initiatives have things to the point where the food is immaculate. But if the restaurant doesn’t look spotless, it is tough to engender trust that the food is safe. That should be an easy problem to fix. Light traffic should presumably give the staff more time to spruce up the restaurant and keep it looking great. But the staff have to see it as an important goal. I think that Moran’s scheme of compensating the general managers based on certain performance goals had them overly focused on certain goals while missing others. CEO Ells, who is certainly well-trained in what it takes to run a restaurant, needs to get out in front of what is truly important to regaining trust and get his employees - from the top down - focused on that. It should be fixable, but that’s just my opinion.

You say, “CMG is dullsville at best now.” I hear, “Sell low.” As I said earlier, I’m not ready to concede that the problems can’t be fixed.

I’m not sure I did the right thing responding to your post, Bear. This is a battleground stock and it engenders strong feelings. I think it is at a tipping point where things can go wrong or right, and anyone who claims to be sure which way it will tip is overconfident. Both bulls and bears lack proof, in my opinion, because the jury is still out. All that’s left is argumentation. Will that serve the board well?

Thanks and best wishes,
TMFDatabaseBob (long: CMG)
See my holdings here: http://my.fool.com/profile/TMFDatabasebob/info.aspx
Peace on Earth

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I’d like to see an Indian version of Chipotle

http://tavakitchen.com/menu-palo/

I think this is more closer to Chipotle. I have been to Palo Alto store many times. Love it.

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“What kind of multiple do you think they deserve?”

I think my point, Bear, was that that’s entirely the wrong question to ask. I think the proper question is: “What traffic levels can they regain, and how soon?”

FWIW, my thinking is fully aligned with Bear’s on this. CMG was a high-flier like Amazon, where its stock price was based on high future growth expectations. Traffic may recover, heck, some of the growth may even recover, but the momo is gone and with it the high P/E ratios that were supporting the stock price. I’ll argue that the price is easily $100 higher than it would be if there weren’t so many people anchoring on what CMG used to be, and able to hold on since their basis price is so low.

If you look it it objectively today, you’ll have a hard time arguing that CMG is the place to put new money.

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Bob,

I think you’re a nice guy, truly one of the good ones. I’m really not trying to upset you. I have strong opinions about things I believe, but no dog in this fight. I don’t short stocks, and I’m clearly not going long here, so I’m just trying to argue/debate for the sake of mutual edification. If it’s too emotional since you do have a dog in the fight, feel free not to respond; I promise I won’t take offense.

I think my point, Bear, was that that’s entirely the wrong question to ask.

All I asked was what the valuation should be? How can that be irrelevant? If the market cap was 500B don’t you think you’d sell?

You say, “CMG is dullsville at best now.” I hear, “Sell low.” As I said earlier, I’m not ready to concede that the problems can’t be fixed.

I wasn’t talking about the sentiment on the stock, but the likely performance of the company going forward. On the contrary, I believe the stock is OVERvalued and you’d be selling high. I think it’s priced high even if you assume a healthy company with reasonable growth going forward. As Smorg said, people are anchoring to the past, and those days are gone. CMG is simply too big to ever grow like they once did. It’s a lot harder to even double when you already have 2,000+ stores.

As I said, Bob, you’re a great guy and I wish you the best.

Bear

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Hi Bear.

Thank you for your very kind words. Your point regarding market cap is extremely well-taken. I’m not sure what the market cap should be right now. Maybe I’ll have a better opinion once I see the full earnings report (I assume most of you interested in this thread realize that certain aspects of 4Q16 earnings were pre-released before Chipotle presented at a conference; Dec. '16 sales showed a nice uptick over Dec. '15 sales, but we’re talking a very low hurdle there).

Another very well-taken point is Smorg’s “… you’ll have a hard time arguing that CMG is the place to put new money.”

I wouldn’t make such an argument, and I don’t think I said that.

In sum, I’m increasingly thinking that I shouldn’t have responded to Bear’s post. Obviously, he touched a raw nerve for me (inadvertently, I’m sure), and it set me off (hopefully not in an offensive way, but it sounds as if I may have gotten a bit combative, battlefield analogies and all…) I should know better how to recognize when a raw nerve has been touched, and take a few deep breaths.

I’ll stop now. Hopefully some of my points were valid and useful. I know there were certainly good points made on the B/bear side. But I think any additional points I try to make would mostly just be repeating my beliefs, with little in the way of facts to back them up. That should be another subtle cue for me to stop…

Thanks and best wishes,
TMFDatabaseBob (long: CMG; closer to selling than buying (I think I said that), but not in a rush at current prices)
See my holdings here: http://my.fool.com/profile/TMFDatabasebob/info.aspx
Peace on Earth

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Hi Paul,
I’ll take a shot at this as well. Not sure that I can answer any better than Bob, but maybe a bit simpler. You are correct, on a PE basis, this stock is crazily valued, but the stock market is usually not that simple. In fact, the earnings this year are only a dollar and change, a full 300-400 PE. Surely it must be overvalued, right?..

Well, if you look a little deeper, you will see this is a company that has zero debt. They continue to open new stores with just the cash flow from operations. They also are buying back stock in significant quantities. Each store that they open, is fully paid off in a few years, (used to be 18 months when times were better) which means the earnings from those stores can then be used to open more stores, again without borrowing any money. Furthermore, there is very little risk in opening up a new store. They don’t need to invent a new product or create new demand. They just need to fill out the country with stores so that people who know Chipotle and want Chipotle, can find a close store to get their fill…

Now, I know I haven’t talked valuation yet, and I haven’t talked about whether the company’s problems will continue to follow them, but clearly there is potential value here. The question is how do you value a company like this? To do it on a straight PE ratio is clearly faulty. To ignore the problems is clearly faulty as well… hence the volatile nature of the stock.

But lets, just make a couple assumptions that over the next 3 years:
1- They fix the issues.
2- Their public perception of a quality food at a reasonable price returns and so does their margins (or close to their previous margins).
3- They continue to expand their store count and buy back stock until and if it starts to rise again.

These don’t seem like crazy assumptions, in fact, other than the margins question, I would say they are very likely. If so, you will have a company that will be making probably $17-$20 a share…Now assuming that’s true, what do you think the share price will be. You could say it will have a 20x multiple and that would put it at $400, the same price it is today. But that is not really thinking too closely about it.

If, and I say if, they make say $17 a share in 3 years. That means they will have a earnings path of something like $9, $13, and $17… now you tell me, what would you pay for that?..

I would guess it would be back to close to new highs… and it would be a market darling again…

So do I think it is a slam dunk? Heck no. But I am hanging on. I think that the quarterly comparisons are going to start to look good and it wont be hard to start showing 20+ % growth again. They have a long way to go, but I am not sure we haven’t seen the lows now.

Just my opinion, and I recognize that this is not a Saul type opinion… I am okay with that

Randy
Long CMG, but not one of my largest holdings…

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So do I think it is a slam dunk? Heck no. But I am hanging on.

That’s really the fundamental problem, as I see it. Everyone is hanging on because they don’t want to sell when it’s half of what it was two years ago. But there are other things you could be holding that are going up.

If, and I say if, they make say $17 a share in 3 years. That means they will have a earnings path of something like $9, $13, and $17… now you tell me, what would you pay for that?..

I would guess it would be back to close to new highs… and it would be a market darling again…

Again, I just disagree. I don’t think that 9 - 13 - 17 trajectory is sustainable, and I don’t think anybody would be fooled that just because they’re coming off a recovery that they’re somehow going to grow earnings like that forever. And realize that you’re saying it could be 3 years or more before they even get to a PE near 20! This is a restaurant, not a SaaS company.

I think people would be well served to try their best to fall out of love with Chipotle, and then look at it with fresh eyes.

Bear

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I will add this from my experience. As long as the company was not in a true bubble, as long as the company has a real and great business that has not fundamentally changed but is impacted by temporary factors that will clear. Then what I have seen time and time and time and time and time again is that the company will far more likely than not rebound to where it was and to even greater heights long term. The key is, you need a 2 to 3 year window. And often that window will happen within a year.

With biotech I have seen this happen with remarkable consistency. I have seen Starbucks, QCOM, McDonalds, ARM, and whole bunch of non-biotech do the same.

Yes, in retrospect selling quicker would have been wiser. But in prospective analysis, if things have basically bottomed anyways, then I think with a company like CMG the probability is on your side. If you are wrong the downside is not that great from here absent catastrophic business performance.

I really am not a great fan of CMG. I’ve eaten there a few times, not really sure what all the hype is, although I can see it is different from other fast food places without question. Perhaps it is more of an acquired taste for me. One of the few fast food places that I go to where I actually see attractive women eating. More incentive I suppose.

But that is my experience. When real business fundamentals change, yeah that is a big issue. But when issues are temporary and resolvable a great company, with great product, with great management, makes it happen.

Tinker

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I have seen Starbucks, QCOM, McDonalds, ARM, and whole bunch of non-biotech do the same.

OK, I’m going to pick on QCOM: no “greater heights” there. A stock that peaked in the dot com boom over a decade and a half ago. A stock that’s up only 18% in the last 5 years. And QCOM doesn’t have the level of problems that CMG has.

CMG’s issues are not temporary. This is a food quality issue on a company that was all about food quality. Management is not fully intact - one of the co-CEOs is gone and the chief marketing officer just admitted to a cocaine habit. eaters have moved on: CMG is now at best just another high calorie fast food place. It’s about time the bag holders of the stock moved on as well.

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Depends when you bought QCOM. I got an 8 nagger pre 2000 and a triple when the share price collapsed after 2000. Arm had nearly the identical same triple despite also crashing from its previous 2000 high.

I did mention “bubble” in my previous post.

If CMG’s fundamentals are not fixable, say like Krispy Kreme, then it will never recover. The issue w CMG is trust. The consumer is fickle. My post simply stated that probability favors CMG at this point because no one still does as CMG does, same management, same product, same economy. Such products usually rebound.

ThIS said, CMG is no McDonald’s or Starbucks in brand identity, but I do believe it is superior to Krispy Kreme in fundamentals.

Myself, I think it is worth holding as the risk reward merits holding it. But if inonky had to choose a fe stocks to hold CMG would not be in that small grouping. But in a diversified port of say 10 to 30 stocks, why not. It has real rebound capacity at relatively reduced risk.

Tinker

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I don’t have a position in Chipotle but I like to follow discussions about stocks to test how they compare to my own metrics.

The issue with Chipotle is the drop in revenue which leads to the drop in earnings. Analyzing earnings or projecting the future based on current earnings does not make much sense. The falloff is a known entity and it either gets fixed or not – I don’t know. In such a case a better valuation metric than P/E ratio, previous earnings, or previous high stock price is required. I like Price to Sales specially compared to industry similars:


**Ticker   P/S** 
CMG     3.07
SBUX    3.95
MCD     4.05

Based on Price to Sales Chipotle is not terribly expensive, it’s cheaper than Starbux and McDonald’s.

Denny Schlesinger

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OK, I’m going to pick on QCOM: no “greater heights” there. A stock that peaked in the dot com boom over a decade and a half ago. A stock that’s up only 18% in the last 5 years. And QCOM doesn’t have the level of problems that CMG has.

You seem to have missed Tinker’s caveat: As long as the company was not in a true bubble… Qualcomm sure was in a bubble, in a sooper dooper pooper scooper bubble! LOL

Denny Schlesinger

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I’ll stop now. Hopefully some of my points were valid and useful. I know there were certainly good points made on the B/bear side. But I think any additional points I try to make would mostly just be repeating my beliefs, with little in the way of facts to back them up. That should be another subtle cue for me to stop…

TMFDatabaseBob

By all means don’t stop. Noone is taking any personal offense.

I am long in CMG but must admit I have been struggling with that position. Morningstar had a recent analysis but hearing the Bull/Bear on this thread is exactly what I needed. Now I will weigh what I have learned and live with my decision more comfortably.

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By all means don’t stop.

I second what Eyelise said. Great discussion. Thanks to everyone for contributing.

Matt
No position
MasterCard (MA), Nestle (NSRGY), PayPal (PYPL), and Verizon (VZ) Ticker Guide
See all my holdings at http://my.fool.com/profile/CMFCochrane/info.aspx

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