Turnaround Investing Blog

George Putnam, one of the country's leading turnaround and distressed investing professionals, shares his timely insight on the economy and turnaround investing opportunities.

Food, Beverage, & Tobacco

Chipotle To Get New CEO, Checking a Critical Box For A Turnaround

Healthy foods restaurant Chipotle Mexican Grill’s (NYSE: CMG) announcement that their founder and CEO Steve Ells will relinquish his CEO role (although retain his executive chairman title) checks an important box in making the company an appealing turnaround stock candidate.

The company’s food safety problems first came to light over two years ago, in August 2015. Unfortunately, they still linger, reflected by July’s report of food poisoning in the Sterling, Virginia location. Comparable store sales have stalled at a tepid +1% rate (which included some favorable adjustments), while comparable store traffic continued its decline at -2%. The company is struggling to convince customers that a visit to Chipotle doesn’t also mean a trip to the doctor.

Something seems to be wrong at Chipotle, and it’s not just the hazardous food. Perhaps there is an inherent flaw in their current business model that can’t be remedied without changing the essence of the company. It might be that the small-company culture that allowed Chipotle to grow from a single-store start-up in Denver in 1993, with an interim sale to McDonald’s, hasn’t successfully adapted to a nationwide chain (plus Canada and parts of Europe) of over 2,350 stores.

When a founder-led company has a chronic problem, it usually takes a fresh perspective to make meaningful progress. Nearly as important, the change also signals that it won’t be “business as usual” anymore, and that the board is serious about making much-needed improvements. So, Ells’ departure marks an important step in addressing whatever is wrong at Chipotle.

However, more boxes need to be checked for the company’s stock to be attractive as a turnaround candidate. First, an outsider needs to lead the company. Situations like Chipotle’s usually require a completely new approach that an insider wouldn’t likely bring. An ideal outsider would have the skills and experience to directly address Chipotle’s underlying problem.

Related to this, Ells should step away from the company entirely. The new CEO, chosen in part by Ells given his role on the selection committee, can’t feel beholden to the founder/former CEO nor have his shadow as executive chairman linger over every decision.

Along these lines, while the board of directors has some new members, it would likely help to bring some additional new capabilities. Elevating health/medical and technology talent to the board level may accelerate these priorities. Investors might be assuaged if Pershing Square, led by the colorful Bill Ackman and holder of 10% of the stock), relinquished its board seat. Such a high-profile, personality-driven activist often takes the oxygen out of critical internal debates about strategy and dominates the external perception of the company’s approach, particularly given Pershing’s disappointments in recent years.

Other boxes we’d like to see checked would be a credible new strategy to reverse the reality and image of food safety problems and address the more mundane tasks of warding off ever-growing competition and rising food and labor costs. The strategy should include motivating the high-turnover staff and improving the likely-impaired culture. Additionally, the aggressive new store opening rate, including upwards of 180 this year and another 130-150 in 2018, seem to invite more operational problems and weaker incremental profits.

Chipotle does have several turnaround boxes already checked. It has zero debt and produces considerable free cash flow, providing the financial flexibility and endurance to sustain it through the turnaround period. It also has a widely-recognized brand name and loyal customer base – despite its food safety problems, they still sell over $12 million of quesos, burritos and tacos every day.

The final and critical box is valuation. Chipotle currently trades at 45x estimated 2017 earnings and almost 15x estimated 2017 EV/EBITDA. The high valuation leaves little margin for another stumble. A new CEO may create the perception of a stumble by getting all the bad news out early, including higher costs and slower growth. The reduced near-term expectations would provide a lower bar over which the company can later jump over. But, bar-lowering often leads to an unflattering stock price response.

Even on the higher estimated 2018 results, which are no certainty, the 32x earnings and 13.6x EV/EBITDA multiples compares unfavorably to rock-solid and faster-growing McDonald’s, which sports a P/E multiple of 24.6x and an EV/EBITDA multiple of 15.7x. Compared to its fast-casual peers, Chipotle’s valuation looks daunting.

Without the margin of safety provided by a low valuation, Chipotle’s shares lose most of their appeal, almost regardless of the veracity of their turnaround. The stock may never become cheap enough to justify an investment. Fortunately, there are plenty of other turnaround candidates to look at while we wait.

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In nearly every case, the shares of a company in bankruptcy become worthless. In very rare cases, however, they can become great investments. W.R. Grace (NYSE:GRA) shares produced a 75-fold return, as an example. With California utility PG&E (NYSE:PCG) now in bankruptcy, the range of possible outcomes for its equity is wide.

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EV/EBITDA: What Is It & Why Are We Using It More?

In reading recent editions of The Turnaround Letter, you have probably noticed that we are increasingly using EV/EBITDA as a valuation measure, rather than the better-known price/earnings multiple.  We thought it might be useful to describe this measure and why we like it.

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Turnaround Letter Stock Pick Named Top Performer of 2017


stock market advicex


What Last Year's Top Stock Pickers Are Buying in 2018


This Forbes write-up follows up on the recent Top Stock Tips report--naming The Turnaround Letter's Crocs recommendation the top performer of 2017: With 90% gains, CROX beat out 100 other investment ideas included in the report; and the stock continues to have value investing appeal, according to Putnam.


George notes, "We see additional upside for the stock in 2018 as management's efforts continue to bear fruit, though the gains will likely be more muted than we saw in 2017."