Ackman and Chipotle Are a Recipe for Indigestion

The chain's problems go deep, and the activist hasn't shown he can handle them.

When it comes to Chipotle, Bill Ackman's eyes may be bigger than his stomach.

The activist investor disclosed a 9.9 percent stake in the burrito maker late Tuesday, along with plans to seek talks with Chipotle's board and management over what he called an "undervalued" stock and an "attractive investment." Shares jumped 6 percent in after-hours trading.

Chipping Away

Chipotle's shares have tumbled 42 percent in the past year

Source: Bloomberg

It's a curious play for Ackman, who has notched more misses than hits lately with a menu of souring bets

Mixed Record

While Bill Ackman has had more big wins than losses, it will take time for the famed activist hedge fund manager to restore his reputation after this brutal year. These are his best-known completed campaigns:

Source: Bloomberg Intelligence

*Fortune also spun off the business that makes Jim Beam whiskey, which was then acquired by Suntory Holdings.

As Gadfly recently noted, Ackman is in dire need of a straightforward activist situation that plays to his strengths: identifying companies with a clearish path to cleaning up operations and simplifying business structure, coupled with a management shakeup to carry out the changes. Think Canadian Pacific, the railroad operator whose stock more than tripled from October 2011, when Ackman got involved, through when he exited the investment last month. 

Tough Year

Pershing Square Holdings, Ackman's publicly traded vehicle, is down 26% this year, still being dragged down by drugmaker Valeant. Here's how his biggest bets are faring:

Source: Bloomberg

Ackman tends to miss out on such returns when he lets his ego take over. Just look at his bets against nutritional products maker Herbalife or for beleaguered drugmaker Valeant. Such emotionally charged crusades can keep him locked into bets for too long. 

Chipotle risks being such a case. It's a trendy company that investors like to short, and Ackman appears to be trying to come to its rescue. We've seen Ackman try this role at J.C. Penney and Target, only to find that fixing consumer companies is harder than it looks. 

For one thing, Chipotle's problems go far beyond merely avoiding a repeat of last year's devastating spate of food-borne illnesses. It has failed to reverse the traffic plunge sparked by that crisis, suffering double-digit year-over-year sales declines during the past three quarters. 

Instead of gaining back customers, efforts to give away free burritos have conditioned restaurant-goers to eat at Chipotle only on discount. The chain is in dire need of a new message at a time when its marketing chief is on administrative leave for allegedly buying cocaine, and it's still embroiled in a federal criminal probe of its food-safety issues.

Chipotle's management, meanwhile, seems out of touch. The company has spent more than $1 billion on share buybacks in the past year to shore up its stock price, to no avail. And it continues to sink money into capital spending projects like building more Chipotle locations, even as it makes less money with each new restaurant. 

Empty Calories

Chipotle's return on invested capital, a measure of how much bang the burrito maker is getting for its buck, used to be much higher than the industry average. No longer.

Source: Bloomberg

Indeed, Chipotle's average unit volume -- which helps measure how new restaurants perform relative to the overall chain -- dropped by 18.4 percent in the quarter ended June 30 from the quarter ended Sept. 30, 2015. 

Going Stale

Chipotle's overbuilding is causing its newer locations to underperform its total restaurant fleet

Source: Bloomberg

AUV is a measure that helps restaurants keep tabs on how new units are performing relative to the overall chain.

Hedgeye restaurant analyst and Chipotle short Howard Penney on Tuesday called for Chipotle's stock to fall another 50 percent. He said the burrito maker is in no position to raise prices, and that it will be difficult to cut labor, food and marketing costs -- some of the levers Ackman typically tries to pull. Only sales growth will help Chipotle regain healthy profit margins, Penney said. 

But Chipotle's sales funk isn't happening in isolation. The entire restaurant industry has entered a recession, as consumers shift dollars to lower-priced grocery stores.

Sales Crunch

This is what the start of a so-called restaurant recession looks like

Source: bloomberg and MillerPulse

Meanwhile, Chipotle's claim to offer uniquely healthy fast food is being challenged by other chains, which are increasingly serving antibiotic-free beef, non-GMO vegetables and other better-for-you fare.

Chipotle could certainly use some help. An activist could help halt store openings, accelerate a shareholder push to overhaul Chipotle's entrenched board, and oust Chipotle's marketing chief and CEO, who were slow to offer contrition for the food-safety crisis.

But Ackman doesn't tend to get his hands dirty to understand consumer businesses -- unlike Starboard Value's Jeff Smith, who educated himself about Olive Garden parent Darden Restaurants by waiting tables and helping in the kitchen. 

As Starboard found out at Darden, restaurants are tough businesses to turn around. Ackman is about to learn that the hard way. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the authors of this story:
    Shelly Banjo in New York at
    Tara Lachapelle in New York at

    To contact the editor responsible for this story:
    Mark Gongloff at

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