Among holdings Bill Ackman (Trades, Portfolio), leader of hedge fund Pershing Square, discussed in his third-quarter conference call Thursday was Chipotle (CMG, Financial), a fast-casual restaurant chain bruised by several food poisoning incidents and his latest new stake.
Ackman started the Chipotle position, worth 10-11% of Pershing Square’s capital, on Sept. 6 for $405 per share, after it fell 47% from its all-time highs in 2015 as reports arose of food-borne pathogens sickening customers in 13 states from August to December 2015. The stock trades around $392 early Thursday, a 3% decline for Ackman.
“The best time to buy a business is when it’s in temporary trouble,” a Pershing Square analyst on the phone call said. “We believe it will recover and become much stronger. The timing of the sales recovery will be neither smooth nor predictable.”
According to the analyst, the hedge fund believes Chipotle “disrupted” the fast food industry and its key drivers were Chipotle’s differentiated products, scale, returns on capital and huge growth potential, estimating the chain could increase store count to 5,000 from its current 2,000. Pershing also expects growth through menu innovation including desert, mobile ordering and catering. Unlike other fast food chains, he said, Chipotle competes in “all desirable attributes of out-of-home dining: food quality, taste, speed, value and customizability.”
Concerning the food safety scares that drove customers from its once crammed stores, the analyst said Pershing’s research showed it had taken adequate steps to address the issue, though “food safety can’t be totally eliminated in any restaurant.”
Pershing’s value analysis for the company did not use a simple model of next year’s earnings, but of a discounted cash flow over its life. Food safety issues would place a moderate discount on profit margins, but it would still offer an attractive return over time.
Going forward, Pershing said it expects Chipotle will benefit from limited global macroeconomic sensitivity, foreign currency impact, a clean business model and a high tax rate of 40% that could fall due to any tax reform. Chipotle also has a unlevered balance sheet and strong net cash, he said.
Ackman stepped onto the call to quell investor worries about a press leak that Chipotle had hired a group of people, including Goldman Sachs and a PR firm, after he bought his stake, calling it “standard procedure to hire a group of advisers” when an investor begins to build an activist stake.
“Investors shouldn’t be concerned that we’re in some kind of hostile engagement here,” he said.
Chipotle saw its revenue decreased 14.8% year over year to $1.0 billion, according to its third-quarter results announced on Oct 25, as comparable restaurant sales decreased 21.9%. Net income also fell to $2.8 million, or 27 cents per share, from $144.9 million, or $4.59 per share, as operating margins slipped to 14.1% from 28.3%.
The results put Chipotle’s revenue down 18.1% for the first nine months of 2016, restaurant sales down 24.9% and net income down to $7 million from $407.7 million from the first nine months last year.
Some improvements may indicate that Chipotle is inching toward a turning point. In September, its sales decline rose 16.3% from its trough of 36.4% in January, to 20.1%. Comparable restaurant declines rose 20.3% from a low of 33.4% in January, to 13.4%.
Chipotle is forecasting comparable restaurant sales increases in the high single-digits, operating margins of 20% and $10 EPS for 2017.
Some prominent investors have had the opposite view on Chipotle from Ackman. In the second quarter, Joel Greenblatt (Trades, Portfolio), Stanley Druckenmiller (Trades, Portfolio) and Andreas Halvorsen (Trades, Portfolio) were among those selling out of their positions in the second quarter. Others, such as Ruane Cuniff, increased its position by more than 500% in the second quarter and owned 2.01% of its shares. Third-quarter portfolios will show how they acted on the stock as they are reported in the coming week.
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