Hey Ackman! Take my Burrito, Please

I guess given Bill Ackman’s high profile and drama surrounding some of his recent missteps in Valeant Pharmaceuticals (VRX) and Herbalife (HLF) it’s not surprising news of Pershing Square taking a 9.9% stake in Chipotle (CMG) is dominating business news headlines. Maybe they’re hoping to lure in a call from Carl Icahn to bring the feud to food.

But what is not only surprising, but downright shocking, is the response from investors with actual money on the line, which initially sent shares up 7%, or some $27. Who in their right mind thinks Ackman’s stake, before hearing a word about a plan beyond some platitude the “brand is undervalued”, suddenly turns the beleaguered fast food chain’s fortunes around.

Two things to be clear about: 1) Chipotle was already facing many challenges prior to last summer’s tainted food issues. Ackman has demonstrated no skill set for fixing or transforming consumer facing retail operations. Ackman’s best successes have come from balance sheets, such as identifying value in General Growth, shorting MBIA, or simply fixing the overleverage of his recently exited Canadian Pacific.

His biggest failures come in trying to fix the brand, structure or operations of retailers such as Target (TGT) and JC Penney (JCP). So if I was a shareholder I’d be turning a shade of Guacamole on hearing Ackman plans on taking an activist role, gaining board seats and telling management how to run their business.

That said, here are another three things Ackman might be able to bring to the table and be right about 1) CMG’s board could use a shakeup. The tenure of its members is getting stale and lacks both true independence or industry expertise. 2) Refocus on the flagship rather than new concepts or opening new locations. 3) The chart showed good support at $400 level.

CMG Chart 9.7.16

OK, this last one is more from me as I don’t believe Ackman uses much technical analysis. But my point is, yes CMG might be a good turnaround story and worth a shot near the $400. By why buy it at $430-$440 because Ackman already bought shares, most likely at a much lower price! Just based on the chart the $440 level is a sell point.

That aside, CMG did not seem like an Ackman type of investment (especially as some consider shares pricey despite the recent decline) even though his hedge fund has or had some big holdings in food companies such as Nomad’s, Wendy’s, Burger King, Mondelez etc. which he initiated as value propositions.

CMG by comparison, despite its recent stock slide still carries a rich multiple of 29x forward earnings. As I noted in this article over a year ago and some $300 higher, Chipotle’s days of high double digit growth are over. It had nothing to do with the food illness. It’s same store sales and return on capital which had already been in decline.

CMG ROC image 9.7.16

But that certainly accelerated the decay of market share and will make any “turnaround” more difficult. I don’t see how CMG regains its premium in terms of margins, growth of p/e over the rest of the industry.

A report from Stifel does well to sum the issues (emphasis mine):

Pershing Position Creates Excellent Selling Opportunity: We emphatically reiterate our Sell rating on CMG shares following news that Pershing Square has started a 9.9% activist position. We cannot fathom Pershing’s operational or mathematical investment thesis. Frankly, we predict that Pershing’s activist effort is most likely to accelerate and further assure CMG’s “tail operational risk” of increasing management and hourly turnover rates (the number one determinate of a restaurant’s profitability).

Mathematically, we continue to assert that to justify CMG’s current $414/sh valuation, some combination of the following two irrational assumptions must be made:

(1) that the economic laws of diminishing returns (market-maturation curves for Restaurants) do not apply to the Chipotle Mexican Grill brand; and/or

(2) that the mathematical laws of Discounted-Cash-Flow do not apply to CMG, the stock.

My hope is other investors buy into the myth Ackman can conjure some magical override of basic business math and send shares back toward the $500 level. I’ll be waiting in line, burrito in hand, ready to sell.

— Steve Smith

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About the Author: Steve Smith