Ackman and Chipotle Are a Recipe for Indigestion
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.
It's a curious play for Ackman, who has notched more misses than hits lately with a menu of souring bets.
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.
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.
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.
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.
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.
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Mark Gongloff at email@example.com