Is Chipotle Special?

Amen of the week:

“So many people told me it was not a good idea to start a restaurant, especially a fast-food restaurant. There was so much wrong with it—it was too spicy; everything was done by hand, from scratch. Everything was wrong. But that’s why customers liked it; it’s different, in the right way. If you have an idea, just go for it. If everybody is telling you that it’s wrong, maybe that’s an indication that it’s an original idea.”

- Steve Els, founder of Chipotle (The Wall Street Journal, 9/22/09)

If you’ve ever eaten at a Chipotle, chances are you fell in love. Since its IPO in 2006, the company has gone from ~500 to over 2,000 stores, and its stock has gone up over 10x. Last year, however, Chipotle experienced several outbreaks of food-borne illness – the first major food safety incidents in its more than 20 years of operations. The stock is thus down ~40% from its earlier highs.

So the key questions are: First, is this a special company? If so, does this cheaper stock price offer us an opportunity to buy shares at a “good”, perhaps even “great”, price? As you know, Fielder is constantly hunting for special businesses run by special people. Typically, these are companies where the founder is still in charge. Here, at least, we can check the box on Chipotle: Founder Steve Els continues to lead as Chairman and co-CEO.

It is not hard to believe that Chipotle should ultimately win back its customers' confidence, and with that, their foot traffic. Customers ultimately flocked back to Wendy’s, Taco Bell, and Jack-in-the-Box after their own food safety challenges. The bigger question is whether there is anything truly special about this business. Restaurants are notoriously tough businesses. Barriers to entry are low and customers are not sticky. In fact, they crave variety. The stocks of hot new concept restaurants can skyrocket, yet then crash as either customers tire of the concept and/or competitors ape the concept. (Remember Boston Market? … and Krispy Kreme?) Indeed, it was this bias that kept me from ever owning Starbucks.

In reflecting on why I missed Starbucks, I keep coming back to one reason: Howard Schultz. This special founder was building a special company. By 2007, we all knew Starbucks was special but felt that we had “missed it”. Investors feared the big growth was over (in part due to a slowing economy), so the stock traded down 40% below its earlier highs. As it turned out, investors were right: Starbucks’ sales stalled for about 4 years. (Sales in 2010 – a full 3 years later – were up only 14% above 2007’s).

But Howard wasn’t done building yet. He experimented with serving hot food in the stores, with selling Starbucks beans and pre-made drinks in groceries, with expanding internationally. Starbucks the company, as it turned out, wasn’t confined to selling a $4 cup of coffee in physical stores in urban locations. It was a real brand. And the brains (and heart and soul) behind this brand was Howard. He was relentlessly experimenting to discover great customer experiences. And then he could execute. Well. That's why the stock is up more than 5-fold since the end of 2007. (It’s up over 10-fold since the doldrums of 2009.) So much for secrets.

Recall from my earlier note “Starbucks Shouldn’t Exist”that I missed owning Starbucks stock. The reason was that I mis-framed the company. I perceived investing in Starbucks back then was investing in a fad restaurant chain, rather than what it really was: investing in Howard Schultz. The older I get, the more I realize that investing in a company is actually investing in its people. Some are special; most are not.

And so … is Steve Els special? His performance to date with Chipotle suggests he might be. But that alone wouldn't make Chipotle a good investment. Remember, there are 3 ingredients to a good investment: people, business, and price. As for business quality, I remain a skeptic that Chipotle is anywhere near as good as Starbucks. Any hot new restaurant concept faces competitors coming out of the woodwork to copy the model. Chipotle sure has. It was unique, but it was copy-able. Starbucks too was copy-able, but what many missed (I certainly did) was that Starbucks had a degree of customer “stickiness” uncommon among typical food service concepts. It does, after all, sell a legal stimulant. Chipotle’s food is famously good, but it’s not that addictive. Few go in every day to get their Chipotle “fix”. Furthermore, it is unclear the magnitude to which the company’s famously strong unit economics will suffer from the new food prep and sourcing changes recently adopted (to prevent future food illness issues). Finally, there’s price. Chipotle is cheaper today, but it’s nowhere near as cheap as Starbucks was in late 2007 (CMG today trades at almost double the sales multiple that SBUX did back then).

If you (or someone you know) has experience in fast-casual restaurants, we would like to compare notes on Chipotle’s potential from here. Let me hear from you. We’re trying to figure out if Chipotle and Steve Els are special. If so, perhaps this hints at why that might be:

“We're not best in the world at burritos and tacos. What we're best in the world at is building a people culture, sourcing really great ingredients, cooking according to classic cooking techniques, understanding the corresponding economic model and how to tweak that and drive that and provide this really great, new fast food experience. That's what we're best in the world at.”

- Steve Els (Fast Company, 10/14/14)

Yours in the Field,

Frank Byrd, CFA

Note: The above does not constitute a recommendation for any stock, especially for Chipotle or Starbucks. Either or both of these stocks could prove to be very poor investments in the future. This note is for informational purposes only. Fielder's employees or its clients may hold a position in some of the stocks mentioned herein.

Disclaimer:

While the information presented herein is believed to be accurate, Fielder Capital Group LLC (Fielder) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Fielder is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Fielder makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Fielder or its employees may have an economic interest in securities mentioned herein. This information is intended only for the recipient of this email. Under no circumstances should this report be shared with or forwarded to anyone else without the express permission of Fielder.