On September 6, 2016, we announced a 9.9% stake in Chipotle Mexican Grill (CMG, Financial) which we purchased at an average price of $405 per share. Chipotle has built a superb brand pioneering the “fast casual” restaurant industry with the success of its outstanding product offering, unique culture, and powerful economic model. We have followed the business for years, noting how it has disrupted the fast food industry with its high quality, delicious and customizable hot meals that are prepared quickly and sold at affordable prices. The company has been significantly negatively impacted by food safety issues beginning in the fourth quarter of 2015 which caused a peak decline in average unit sales of 36%. In response, the company has implemented enhanced food safety protocols over the past year, and worked to win back lost customers. While traffic and sales have begun to recover, average unit volumes were still 19% below peak levels as of the fourth quarter of 2016.
We have always believed that a good time to buy a great business is when it is in temporary trouble. While Chipotle’s reputation has been bruised, we think that with the passage of time and improved operations, marketing, technology, and governance initiatives, the business will not only recover but become much stronger. Chipotle’s sales recovery will be neither smooth nor predictable over the next few quarters; yet, we believe that all of the key drivers of Chipotle’s powerful economic moat and long-term success remain intact. These drivers include:
- A strong and relevant brand built by visionary leadership;
- A differentiated product offering with a highly attractive value proposition;
- Substantial scale in the fast casual industry and first-mover advantage in real estate;
- Strong unit economics and extremely high returns on capital, driven by a well-honed model that facilitates best-in-class throughput; and
- Enormous growth opportunities including new units and operating enhancements such as mobile ordering and catering.
Strong Brand
The Chipotle brand was developed by founder Steve Ells with the philosophy that food served fast does not have to be a traditional “fast-food” experience. This vision later evolved into an ambition to change the way the world thinks about and eats fast food. Chipotle’s authentic brand developed a loyal following, which allowed the company to grow from one restaurant to more than 2,200 relying primarily on customer word of mouth, supplemented by non-traditional marketing techniques including digital and social media, owned content, and local events. Today, we believe that Chipotle is one of the most compelling and authentic large-scale food brands in the U.S.
Differentiated Product Offering
Chipotle’s product offering is differentiated by the fact that it successfully competes in all of the desirable attributes of out-of-home fast food. As part of our research, we compared Chipotle’s customer value proposition to those of fast casual, quick service, and casual dining competitors across six key metrics: food quality, taste, in-store experience, customization ability, speed, and value. We believe Chipotle’s food quality is superlative given the focus on cooking from scratch with the best available and simplest ingredients. Chipotle’s “burrito line” service format engages customers from the moment they walk in the door, allows exact customization of each order to accommodate individual preferences, and facilitates the fastest throughput in the industry. The product price point offers outstanding value given the quality and quantity of food served. While some other concepts can successfully compete on one or more of these attributes, we believe that few are able to replicate the Chipotle offering at comparable price points at scale.
Enormous Growth Opportunity
Prior to the recent food safety issues, Chipotle’s average unit volumes were approximately $2.5 million, among the highest in the industry, despite only serving two day-parts, and with limited store hours, i.e., 11 versus as much as 24 hours for other fast food competitors. We believe that initiatives such as mobile and digital ordering as well as catering will drive an accelerated rate of same-store sales growth for the foreseeable future, incremental to the impact of recovering lost customers. Returns on capital for new units remain extremely compelling even at today’s lower sales levels. Management believes that the U.S. can ultimately support more than double the current store base of approximately 2,200.
Food Safety
We have researched the initiatives that Chipotle has taken to enhance its food safety policies and procedures. While food safety risk can never be completely eliminated in any restaurant, we believe the company has done an excellent job of significantly reducing the risk of another incident while maintaining the quality and taste of its food.
Chipotle has a number of other attractive attributes which include limited global macroeconomic sensitivity and foreign currency exposure, a simple business model with limited non-GAAP earnings adjustments, a high effective tax rate of nearly 40% (which means the company will be a big beneficiary in the event of U.S. corporate tax reform), and an unlevered balance sheet with a strong net cash position.
Management and Board Developments
On December 12, 2016, Chipotle named Steve Ells sole CEO concurrent with the resignation of former co-CEO Monty Moran. In conjunction with this leadership change, Chipotle announced a renewed focus on delivering an excellent guest experience and removing unnecessary complexity from restaurant operations. The company also announced an expanded company mission to “ensure that better food, prepared from whole, unprocessed ingredients is accessible to everyone.”
On December 16, 2016, Chipotle announced a board refresh in which four new directors were named including Pershing Square partner and investment team member Ali Namvar and Pershing Square advisory board member and former McDonald’s CFO Matthew Paull. On March 17, 2017, the company announced that four incumbent directors will not stand for election at the upcoming annual meeting. The new board will have eight members including the four recent appointees.
Chipotle’s total shareholder return was -6.3% from the inception of the position in August through year-end 2016.
From 2016 annual letter to shareholders of Pershing Square by Bill Ackman (Trades, Portfolio).
