Image via Chris Potter/Flickr CC
I’ve been a vocal critic of Chipotle (CMG) for more than 2 years now. Over that time period, I’ve followed Chipotle’s fall from Wall Street darling to complete chaos. Shares have lost -63% from August 2015 all-time highs.
While Chipotle’s struggles with E. coli are in the rearview, underlying problems persist. It’s hubris that’s holding Chipotle back now. Steve Ells is not worthy of the CEO seat anymore. We propose moving Ells to an Executive Chairman position and handing over the day-to-day operations. We’re sticking with our call for a $250 stock.
Let’s take a further look at Steve Ells’ qualifications as stated in the latest proxy:
“Mr. Ells’ visionary thinking has led Chipotle to extraordinary accomplishments, such as growing from a single restaurant to over 2,200 and serving more responsibly-raised meat than any other restaurant company. This thinking has also resulted in Mr. Ells remaining a principal driving force behind making our company innovative and striving for constant improvement, and he continues to provide important leadership to our executive officers, management team, and Board. He is also one of the largest individual shareholders of our company.”
Okay.
We can admit that Steve Ells was instrumental in the growth of fast casual (assembly line) concepts. But looking beyond that, he is a below average CEO that is disconnected from the business. Steve doesn’t even live in Denver (where the company is headquartered) for the majority of the year, as he is focused on building his West Village mansion, and hanging out in the Hamptons during the summer.
This is all while he collected his roughly $15 million all-in compensation for 2016, while Chipotle shares plummeted 21%. Let’s also be clear, Steve Ells did not grow Chipotle from one restaurant to 2,200. McDonald’s (MCD) took a stake in 1998 (when Ells had 13 restaurants) and infused $360 million and grew Chipotle to 500 restaurants before spinning it off in an IPO. Implementing a national supply chain system to accommodate the national network of restaurants is one of the most difficult aspects of building a restaurant company and Ells didn’t even do it (he may have destroyed it though).
Lastly, what innovation has Ells implemented recently? We would not call him an innovator anymore. He’s more of a one trick pony in our eyes.
We hosted a conference call with institutional investors last week to reiterate our now 2-year old short call on Chipotle. The crux of our thesis is Chipotle is growing too fast for the problems they have and probably needs a significant reduction in new unit capital spending, by 50-75%, to shift the focus from growth to turning around the existing business.
It was no surprise to us when yesterday shares of the burrito chain were down as much as -15%. With very limited changes to the current growth plan, Chipotle reported lackluster third quarter earnings that failed to meet Wall Street’s buoyant expectations.
The E. coli outbreaks, that began in late 2015 and hammered Chipotle’s stock, are merely a symptom of the company’s overextended growth strategy. The problems wrought by multiple foodborne illness outbreaks tainted public perception about the brand. While Chipotle was repairing, competitors stepped in to pick up the scraps. While the company has recovered some, Chipotle’s restaurant level margins have never recovered, deteriorating from a peak of 28% to around 16% in the third quarter of 2017.
We have thought about Steve Ells’ position within the Chipotle organization a lot over the last two years. And it is pretty obvious Steve will never leave Chipotle unless it is on his own terms. We believe the correct course of action would be for Steve to move to an Executive Chairman position (just like Howard Schultz, although that is a slightly different situation), while letting someone with immense industry expertise run the day-to-day operations.
Is newly-appointed Chief Restaurant Officer Scott Boatwright the man for the job? Maybe, but we bet they could find someone with a more robust background (especially if they are willing to pay a total package of anywhere near $15 million). We like the idea of someone from a best in class operator such as McDonald’s or Yum (YUM) coming in to improve Chipotle’s operations and employee management.
If line level employees don’t enjoy the job, patrons will never enjoy Chipotle. So the company needs to reinvigorate the staff from the ground up and make Chipotle a desired place to work once again. It is tough for current management to do this given how disconnected they are from Chipotle.
It’s not all bad.
The Chipotle brand is not dead. It takes a lot more than this to kill a great brand, but it is struggling on life support. Current management has tried myriad different actions to turn the ship around to no avail. A strong leader with operational expertise in the quick service restaurant or fast casual space would be an ideal candidate to take over the CEO seat.
After 2 years on the short side, I look forward to the day when I can make the long call on Chipotle.
But not yet.
By Howard Penney, Restaurants analyst at Hedgeye Risk Management.
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