Bill Ackman (Trades, Portfolio) purchased a 9.9% stake in Chipotle (NYSE:CMG) last week with intent to push for changes. While the investing world has largely bemoaned his involvement after a string of misadventures with stocks such as Valeant Pharmaceuticals (NYSE:VRX), some other managers of big funds hopped in and out of the Chipotle boat last quarter after its widespread food poisoning scare.
A purveyor of “responsibly raised” and fresh ingredients, Mexican food chain Chipotle was home to food-borne illness causing pathogens norovirus, salmonella and E. coli in 13 states from August through December of 2015, according to its information website festooned with bacteria shapes. Over those five months, the stock fell by 33% and to date has declined 42%.
The outbreaks had an undeniable effect on Chipotle’s customer traffic. A company that has grown revenue at a 20.9% tear over the past 10 years saw it fall 6.8% year over year in the fourth quarter, with comparable restaurant sales down 14.6%. Net income of $67.9 million had declined 44%. The company’s chairman and co-CEO Steve Ellis called the quarter, “the most challenging in Chipotle’s history.”
During the quarter, the Centers for Disease Control and Prevention concluded its investigation of the incidents during the quarter and the company made promises of becoming “industry leader in food safety.”
During that period, George Soros (Trades, Portfolio) and Spiros Segalas (Trades, Portfolio) sold out;Steven Cohen (Trades, Portfolio) and Frank Sands (Trades, Portfolio) reduced their positions. Yet thus entered more investors of recognizable names: Mario Gabelli (Trades, Portfolio), Joel Greenblatt (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), Stanley Druckenmiller (Trades,Portfolio) and Andreas Halvorsen (Trades, Portfolio).
But by the first quarter, revenue suffered a 23.4% year-over-year drop as customers scattered. Chipotle reported its first quarterly net loss in more than 10 years at $26.4 million and 88 cents per share, as operating margins were squeezed to 6.8% from 27.5%.
Many investors then gave up on the company. Joel Greenblatt (Trades, Portfolio), Steven Cohen(Trades, Portfolio), Stanley Druckenmiller (Trades, Portfolio) and Andreas Halvorsen (Trades,Portfolio) already backed away from the stock. Several started positions, including Louis Moore Bacon (Trades, Portfolio) and Pioneer Investments (Trades, Portfolio).
Most notably, the investment firm hard hit by the price collapse of another Bill Ackman (Trades,Portfolio) company took a stake in Chipotle in the first quarter: Ruane Cunniff (Trades, Portfolio). A traditionally conservative firm endorsed by Warren Buffett (Trades, Portfolio), its outsized position in Valeant Pharmaceuticals, where Ackman had involved himself, led to significant losses in its Sequoia Fund last year.
Ruane Cunniff (Trades, Portfolio) purchased 93,880 shares in the quarter at a price averaging $475 a share. It then increased the position by 522.5% in the second quarter as the average price declined to $434 a share. As of the end of the second quarter, Ruane Cunniff (Trades, Portfolio) owned 2.01% of Chipotle’s shares, representing 2.24% of its portfolio.
The firm also discussed its view on Chipotle in its second quarter shareholder letter:
Prior to the outbreaks, Chipotle was one of the most successful restaurant concepts of the past thirty years. CEO Steve Ells, a classically trained chef, helped pioneer the concept of high-quality food made from fresh ingredients in a fast casual environment. Chipotle’s high quality product, simple menu, and efficient service combined to make its restaurants extraordinarily profitable, and this in turn has allowed Chipotle to expand its footprint at a rapid pace without resorting to franchising or borrowing money.
In the wake of the pathogen outbreaks we contacted a number of food safety experts to verify that Chipotle management had established industry leading food safety practices in all of its stores. We reviewed the history of outbreaks at public and private restaurant chains and tallied the long term impact each outbreak had on each chain’s franchise value. Most importantly, we held conversations with dozens of industry veterans to develop a timeline for Chipotle’s recovery. While we expect Chipotle to suffer through a slow and bumpy recovery, we believe the company has an opportunity to more than double its U.S. store base over time at terrific unit economics.
The most recent quarter saw a slight easing in Chipotle’s drain and new food safety procedures put in place. Year over year, revenue decreased 16.6% to $998.4 billion and it returned to profitability with $25.6 billion in net income and 87 cents per diluted share, but still decreased from $140.2 million and $4.45 per diluted share. Sales at comparable restaurants slid a further 23.6% as its operating margin fell to 15.5% from 28%.
The second quarter also brought some improvement in comparable sales trends, according to comments by Ells. He partially credited the trend to the company’s invigorated marketing efforts in the form of a program that gives customers their every fifth burrito free, known as Chiptopia.
Chipotle’s prospects reeled in new investors Mario Cibelli (Trades, Portfolio), Steven Cohen (Trades,Portfolio) and Manning & Napier Advisors, while Jeremy Grantham (Trades, Portfolio), Jim Simons(Trades, Portfolio) and Louis Moore Bacon (Trades, Portfolio) moved on in the second quarter. As of the end of the quarter, tracked investors with the largest positions in Chipotle are Frank Sands(Trades, Portfolio) with 6.17% of shares, Ruane Cunniff (Trades, Portfolio) with 2.01%, and Steven Cohen (Trades, Portfolio) with 0.7%.
Aug. 24 saw Bill Ackman (Trades, Portfolio) initiate his activist campaign against the company. In the related regulatory filing, he talked about the company’s “strong brand, differentiated offering, enormous growth opportunity and visionary leadership” and called its common stock “undervalued.” He also said he would begin giving the company his ideas to change its “governance and board composition, business, operations, cost structure, management, assets, capitalization, financial condition, strategic plans,” and future.
The market reaction was to raise Chipotle shares 3.17% in the short span since Ackman’s disclosure, including a slight uptick on plans announced two days later to drop burritos via drone on college campuses.
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