Welcome to Real Vision's Trade Ideas.
Today we're sitting down with Howard Penny of Hedgeye.
Great to have you here.
Thank you.
So let's talk about a stock you're really well-known for, Chipotle.
I want to give a little bit of a recap.
You were bearish on Chipotle in 2015 and 2016.
Then you flipped a switch and went bullish in late 2017.
And you were dead right on both accounts, which was a really awesome call.
Can you walk us through your short thesis and then what happened and what changed in
late 2017?
So back when we went short, they were claiming that they were able to do things that they
actually weren't doing in their stores.
So for example, they said they were the first non-GMO restaurant company in the country,
which wasn't true.
I mean, there were GMOs all over the place.
So they were putting forth this proposition to the consumer that just was inaccurate.
And as it turned out, because they were trying to serve food, they were taking a big risk,
because their supply chain was not properly set up to serve the kind of food that they
were serving.
And they were growing so fast that they ultimately committed the number one mistake in the restaurant
industry.
And that's don't get your customers sick.
And they were in denial of what happened and the impact on the business.
But it also got worse because they didn't acknowledge the problem that they had.
And they weren't properly prepared to take on an event that happened to them, from a
PR standpoint.
And this really leads to the biggest problem the company had, and that was the CEO at the
time.
While he was a visionary to a certain degree in creating Chipotle, the company that we
know today, he was an entrepreneur.
And he probably should have stepped down a year before or two years before because he
didn't have the skill set to be able to manage the company where it is today.
And that's obvious because you see Brian Niccol, who's the current CEO, and how well he's running
the company today.
And I had said all along, as the stock was going down, it's never going to be fixed until
the CEO leaves, Steve Ells leaves.
Steve Ells left.
The next day I said you got to buy the stock because it's a great company.
It's a great brand.
They have a good consumer proposition.
They just need somebody to run it.
And they got Brian Niccol, who is a rock star, if you will, in the restaurant industry.
And he's just done some amazing things.
So you're mostly bullish on the name specifically because of the CEO?
Yes, because there is so much potential at the company in terms of the unit growth, the
margin profile of the company, the recovery and same-store sales.
It's hard to find a company that was as poorly run as Chipotle was and is an opportunity
in the restaurant space.
Now the stock at $600, it's reflecting a lot of good news.
And it's starting to manifest itself.
The good news is starting to manifest itself since the last quarter where traffic growth
was 2%, which in an industry where traffic is declining, that's an extraordinary performance.
So it's gone from the worst run company to now probably one of the best run companies
in the restaurant space.
What are some other factors that make you really bullish on Chipotle?
So if you think about the company round numbers earned-- will earn something like $10 or $11
this year, 2019.
The potential is $25 or something thereabouts.
And then the biggest question that I ask myself is, prior to the outbreak of the foodborne
illness, the company did average unit volumes of $2 and 1/2 million.
They've increased the capacity of the store.
So when you walk in Chipotle, you walk in.
You get the line.
You can get your burritos.
There's another line in the back of the house where they can make digital orders.
So if they can do $2 and 1/2 million with one line-- food preparation line-- what can
they do with two?
Certainly more than $2 and 1/2 million.
So what if they do $3 million?
So as you see the recovery in sales going from $2 million today, to $2 and 1/2 million,
to $3 million, and the leverage of that provides the company, in terms of earnings growth and
margins, then that $10, $11, $12 earnings number is going to be $25 or $30 in the next
couple years.
So still a lot of potential growth left.
Yeah.
Now, the stock is reflecting some of that, but it doesn't reflect the full recovery yet.
And this is one of the names where I say you buy it on red.
With names like this you don't want to chase it.
But when there are down days you want to buy it.
Because of that recovery in earnings and sales, it's going to go on for the next couple years.
And a PE in the 40s or 50s doesn't bother you too much.
It was actually even more expensive I think when it was $300, because they weren't earning
anything.
So valuation's important, but it's certainly not a catalyst to buy or sell the stock.
And in terms of supply chain issues, you see that as pretty much behind them now.
Yeah.
We have a professional management team running the company today.
And they're not taking risks.
So they're not taking risks with the type of food they're serving, with the lettuce,
the tomatoes, the green onions, all those things that may have caused the food borne
illnesses.
They've changed their process and procedures, so that shouldn't happen again.
Now, will somebody probably get sick at Chipotle?
Yeah.
I mean, it happens all the time.
And it may not be because of green onions.
And it may not be because of salmonella or one of the other issues that you've seen.
But are you going to read about someone getting sick after eating Chipotle?
Sure.
But you read about McDonald's, Burger King, Wendy's.
It happens all the time.
Right.
So I guess the headlines, though, related to Chipotle sometimes stick out more because
of what happened, though.
So then what do you see as the potential upside for the stock?
Well, I have this vision of $1,000, frankly.
But it can't quite get there yet.
I think $700 is probably a-- after next quarter, if the trends that we saw in the fourth quarter
continue in the first quarter, and I think they are, then it'll probably get up to $700.
But I think in the next two to three years, I think $1,000 is probably the real potential.
And you see this well outperforming its peers in the restaurant space?
Yeah, especially for the next year.
I mean, they just have-- it was-- get back to this so poorly managed concept.
So they spent 3 and 1/2% of sales on advertising.
And they were getting zero return for that money spent because it was just so poorly
conceived, the advertising and the promotions they were doing.
Now it's a much better concept in terms of how they're pitching the brand and what they're
doing with the brand that they're actually getting a return on the money they're spending.
And that really just started to unfold this past quarter.
So you have at least four more quarters, or three more quarters, of accelerating momentum
based on just literally just the advertising alone.
And then you have the digital piece, which every time an order comes in, if you were
to pick up your phone and order Chipotle and then go pick it up, that's a higher margin
transaction than if you were to go to the store and go through the line.
So as the digital piece grows, and it could be 30%, 40% of the business at some point,
that's a tailwind to the margins.
More broadly, how do you see the restaurant industry overall performing in the next few
years?
Pretty bearish on it, actually.
OK.
So this is completely different.
Yeah I don't have many longs in the space.
My longs are delivery-focused companies, like Grubhub, and Just Eats, and Waitr because
that's where the big growth is coming for the industry.
And that actually penalizes the operators.
So if you think about paying 15% to 20% for a transaction to a aggregator of Grubhub to
get a meal delivered, and you're a restaurant operator within margins, it's not helpful.
And this is not so much for Chipotle and some of the other fast casual guys.
But if you're a sit down restaurant, and your business model is built on people coming in,
and sit down, and having a meal and drink, and having fun, and they're taking everything
to go, that's a problem.
Right.
Now-- Especially because they're not drinking.
But actually even with Chipotle, there is delivery.
They partnered with Postmates.
Do you see that being a positive or negative for the company?
Well, right now it's a positive.
And we're just going to have to wait and see how big that becomes.
But the issue for Chipotle is no different than anybody else with delivery in terms of
the fees.
That's a headwind, but there are more tailwinds than headwinds.
So for right now, it's a positive.
But if it becomes too big part of the business, and it hurt margins, then it'll ultimately
cause problems.
But for right now, it's not an issue.
Great.
So there are more positives than negatives for Chipotle?
Yes.
All right.
Howard, thank you so much.
Thank you.
So Howard is bullish on Chipotle.
Specifically, he suggests buying CMG on any pullback.
He thinks the stock has potential upside of $1,000 over the next two to three years.
Just remember that this is a trade idea and not investment advice.
You should do your own research, consider your risk tolerance, and invest accordingly.
For Real Vision, I'm Justine Underhill.