A year ago, I wrote an article on Chipotle Mexican Grill Inc. (CMG, Financial) titled “A Quick Look at Chipotle.” I discussed the company’s history, the unit economics of the business and the food safety issues that led to a significant decline in the stock price. This is from the conclusion:
“From $750 in August 2015, Chipotle stock is now down more than 50% (to $340 per share).
The model I have built for Chipotle suggests a price in the low to mid-$300s per share makes sense with some pretty reasonable assumptions (at least, they are reasonable to me).
While I am tempted to buy some Chipotle shares, I have not (yet). Even if I did, it would be a relatively small position (to account for the fact it is unlikely I would ever make the stock a large holding in my portfolio). If the market is kind enough to keep pushing the stock lower, it will make my decision easier (fingers crossed). For now, I think I will stay on the sidelines.”
Mr. Market obliged, pushing the stock down another 10% over the next few weeks to roughly $300 per share. In early August, I thought the stock price had reached a point where it was worth buying, so I added a few shares to my portfolio. The position wasn’t very large (roughly 2% of my account) and, as I noted in my previous article, I had no plans on adding more if it got cheaper. Simply put, I didn’t want to be in a position where Chipotle was a meaningful part of my portfolio.
When the company reported third-quarter results a few months later, the stock took a big tumble. As I noted at that time, I didn’t find that outcome unreasonable considering the weak quarter:
“My concern as a long-term investor is the results in the out years are largely dependent upon continued comp growth to drive improved unit economics. If sales per location remain a few hundred thousand dollars below where they were in 2014 and 2015, you will see a disproportionately large hit to unit profitability. Said differently, if Chipotle does not improve its average unit volume, the road back to historic restaurant level margins will be a difficult one.”
The more I thought about the impact of comps on unit volumes, margins and the value of the business, I became increasingly uncomfortable (I discussed this in some detail in an article about individual stock risk and Zoe’s Kitchen (ZOES, Financial) last month). In this business, comparable store sales drive much of the discussion and are subject to meaningful changes in trends over relatively short periods of time. When you extrapolate quarterly comps and their impact on margins, unit economics and the long-term opportunity for a chain to add locations, you will see huge swings in your fair value estimate. Unsurprisingly, that means significant stock price volatility. The range of outcomes spans from dire to euphoric; where you land largely depends on last quarter’s comps.
In early 2018, Chipotle shares fell to a low near $250 per share. That changed when the company announced that Brian Niccol, the former CEO of Yum Brands' (YUM, Financial) Taco Bell division, was set to become Chipotle’s next CEO. Based on Niccol's track record, market participants viewed this as an intelligent decision. Over the next week, Chipotle's stock price increased by roughly 25%.
Two months later (end of April), Chipotle reported strong first-quarter results. The next day, with a renewed sense of optimism among investors, the stock price increased by 24% (remember what I said before about the impact of comps on unit volumes, margins and long-term business value).
With the run up in the stock to well over $400 per share, I no longer believed CMG was undervalued (I still thought the assumptions in my model were fair). In addition, as discussed earlier, I became increasingly uneasy with the idea of trying to beat others to the punch on next quarter’s comps. Finally, with a roughly 2% position, and one that I did not want to become larger, I thought it was better to spend my time and energy elsewhere (on positions that could be four to five times larger).
While the stock worked out in the short term, I don’t leave it with a sense of accomplishment. With more experience under my belt, I’ve come to the conclusion that I much prefer positions like Microsoft (MSFT, Financial) and Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial), where I make a large investment and partner with the company for many years. My unwillingness to make this a large position from day one (which I could “feel” before I even owned the stock) was a telling sign.
That’s a long way of saying this isn’t a game I’d like to keep playing in the future. I’ll happily take the outcome I got on Chipotle – but my suspicion is that it would not be a recurring one.
For those reasons, I sold my shares a few weeks ago.
Disclosure: Long MSFT and BRK.B.
