Submitted by David Stockman – The Contra Corner Blog
During the 150 days since August 4th, Chipotle’s share price has plunged by 45%. Nearly $11 billion of market cap has been obliterated——including $4 billion in the last three weeks.
Accordingly, its market value has now retraced back to March 2012 levels. The hyperventilating CMG bulls who rampaged for 1250 days in the interim have now been taken out back and summarily shot.
Stated differently, what had been $12 million per copy burrito shacks are now on sale for just $6.5 million each and are heading far lower, very fast. But the culprit in this stunning markdown is not the alleged once-in-a-blue-moon outbreak of E. coli, as CMG’s apologists claim.
Chipotle’s recent $24 billion market cap, in fact, is the bubble in extremis which explains the entire financial bubble at large. It is surely the poster boy for the manner in which the Fed-sponsored Wall Street casino has hyped the mundane into the miraculous; and substituted paint-by-the-numbers hockey sticks for substantive analysis and judgment.
That is, a financial market which can value rented burrito joints which generate just $750k of store level cash flow at $12 million per copy is just plain off it rocker; it’s a greater fools gambling den that would make the moguls of Los Vegas envious.
Yet the astonishing level of complacency that took CMG shares to a peak of $750 a few months ago, is not a one-off aberration. It embodies the sum and substance of financial markets that have been destroyed by massive central bank intrusion and systematic falsification of interest rates and asset prices.
Thus, at its early August peak, CMG’s $24 billion market cap represented 48X the $500 million of net income it had posted in its most recent LTM filing. But the 1,900 Chipotle restaurants that fetched this nosebleed PE multiple are not high-end food emporiums serving gourmet fare at luxury prices to the top tier of affluent households.
Actually, they slop out burritos, tacos, salads, black beans, salsa and chips at $9 per ticket. Its customers are mostly millennials, who have an average of $155 per month of discretionary income, including the ones living in mom and pops basement.
The business has no barriers to entry and miniscule brand advertising. It is being assaulted by an army of competitors including established chains like Taco Bell, and newcomers like Qdoba and countless more, who have belatedly discovered the popularity of Tex-Mex fare. And CMG is also now running into saturation of prime locations and markets—–the fate that always and everywhere brings down high-flying retail and restaurant roll-outs.
Yes, CMG has a clever marketing gimmick and value proposition. That is, that its food is fresh, organic, locally sourced and that the pigs and chickens which end up in the burrito bowls have not been ill-treated on an industrial farm.
So what? Is there anything in that proposition that could not be eventually duplicated by aggressive competitors——even if they needed to play catch-up ball for awhile?
The fact is, no company has ever permanently dominated a new chain restaurant category indefinitely——-from hamburgers joints to pizza chains, seafood eateries, pasta places and high end steakhouses. Nevertheless, Chipotle’s absurdly high PE multiple reflected exactly that proposition—–hyper-growth and complete dominance, world without end.
In fact, Chipotle’s approximate 25% annual earnings growth since 2009 was taken exactly out of a tried and true cookie cutter. Profits were growing because the company was rolling out 200 new stores per year based on leasing costs that were dirt cheap due to the Fed’s repression of interest rates and an abundance of gig-based labor at the minimum wage.
During that period they also aggressively raised menu prices by capitalizing on their first mover position in chain-based Tex-Mex segment and the temporarily faddish popularity among millennials of their purportedly unique “quality” proposition.
But the latter was the obvious Achilles heel of the whole operation. CMG promoted itself as being in a quality tier way above all of its competitors. Yet it did not spend much more on food and its supply chain than most of its competitors.
For instance, Panera’s food costs is 34% of sales compared to 33% for Chipotle. Even in the case of the burger chains, food and paper costs run in the same zone, and were about 32% in Wendy’s most recent quarter.
Now, there is a reason that most national restaurant operations are based on centralized supply chains fed by industrial farm production of meats and other major menu ingredients. Namely, foods costs are far cheaper and centralized supply chains are more efficient, reliable and bureaucratically stable than decentralized procurements from neighborhood farms.
That’s especially true for a wholly owned restaurant operation that now has upwards of 2,000 locations and 53,000 employees paid at an average rate of just $20k per year.
In a word, CMG was selling a quality-based, anti-industrial, healthy life-style value proposition, but wasn’t paying for it. And since it didn’t have the organizational infrastructure and cost levels needed to deliver on its brand promises, it was essentially harvesting phantom profits that weren’t sustainable.
It was only a matter of time before E. coli or dozens of other potential supply chain assaults on its fundamental brand equity erupted into the public domain.
That time has now arrived with a vengeance. According to its most recent 8-K filing, the former king of comps experienced a 30% same store sales plunge in December and there is no relief yet in sight. Accordingly, management has now slashed it Q4 outlook to $2 per share and does not expect improvement any time soon.
Well now. Annualize the current run rate and throw in two bucks of windage—–so you get an annualized run rate of $10/share. At its fevered peak last August, CMG was trading for what is looking more and more like 75X current earnings per share.
Here’s the thing. Like in the case of the scores of high flying retail and restaurant concepts in full national roll-out heat that have come before, there is no rational economic basis for capitalizing the one-time earnings growth from store openings at a nosebleed multiple. This high flyers always crash or their stock price hits the flat-line as PE multiples shrink back to earth even as organic same store earnings might continue to expand.
In Chipotle’s case, there was even more foolishness embedded in its high PE multiple. Competitor risk was coming. Supply chain risk was self-evident. Constant prices increases to its less than affluent customer basis were a ticking time bomb. Choice locations in most of the US had been used up. Tex-Mex wasn’t catching on abroad.
And most importantly, CMG has no assets except customer goodwill. It is a pile of off-balance sheet operating leases populated with relatively trivial amounts of equipment and improvements per store. So it can’t even pull an Eddie Lambert and claim that empty stores don’t matter because the underlying real estate is invaluable.
Stated differently, the earnings from intangible goodwill not backed by brick and mortar assets, patents, proprietary know-how, breakthrough technology or super-heavy advertising and marketing on a permanent basis cannot possibly be worth 48X. The fact that CMG reached this lunacy only a few months ago is screaming evidence of the monumental complacency that prevails in the casino.
The rest of the market, in fact, is only a slightly less exaggerated case. Just as in the case of CMG, cap rates at the recent peaks make no sense whatsoever except on a paint by the numbers forward hockey stick basis, reflecting a world in which nothing could go wrong and the business cycle had been miraculously repealed.
Yet you don’t have to be excessively observant to recognize that the 20-year global credit and economic boom led by the Red Ponzi in China is coming to a screeching halt because the central banks have well and truly run out of dry powder and credibility. The world economy is self-evidently in the midst of the greatest commodity deflation since the 1930s, while industrial prices and profits are getting whacked hard and CapEx is plunging into a veritable depression.
All of this is causing worldwide income to fall and the difference can’t be made up this time by phony credit expansion because virtually every economy in the world has arrived hard upon the shoals of “peak debt”.
Forget the fact that China allegedly grew at just under 7% last year, when power consumption did not grow at all and rail freight volume plunged by an unprecedented 10%. Or that Korean exports are now down by 15% on a Y/Y basis. Or that crude oil, copper, iron ore and ocean freight rates are in a death plunge.
Already honest GAAP earnings for the $&P 500 companies have plunged from a peak of $106 per share in the September 2014 LTM period to $90 in the most recent LTM period—–or by 15% and the bottom line weakness is just beginning to spread outward from energy, materials and industrials. Macy’s anyone?
Even then, the broad market multiple at 22X is not the half of it.
( To be continued)