Wednesday, July 6, 2016

A Love Story

Monday, May 9, 2016

Chipotle Mexicon Grill (CMG) presents a clear opportunity

It has no debt. It's a cash flow generator. It is facing a fixable problem from food viruses. Market is assuming that the management would not be able to take care of these problems effectively. Even without valuing its growth options in creating chains that operate in the same way but with different types of fast healthy foods, the current business appears to be valued at a significant discount.

Read the debate over CMG.
[Tseng] Chipotle invests about $880,000 in cash costs to open a new restaurant and earns about $650,000 in pre-tax restaurant profit per year within about two years. That’s a cash-on-cash return of over 70%, which is phenomenal and best-in-class among restaurants. 
After accounting for incremental corporate costs, depreciation, maintenance capex, a very small working capital benefit, and taxes, I estimate real after-tax cash flow is well over $300,000 per year by year three and growing. By my math, the net present value of that cash flow stream is around $5 million. Clearly, new restaurant openings create a tremendous amount of value.

Management thinks they can open over 2,000 more Chipotles in the U.S. alone over time. That growth has a present value of more than $8 billion. As for the 2,066 existing restaurants, I assume the unit economics recover within a few years, and I value that at about $11 billion. That makes the business worth about $19 billion.

After certain balance sheet adjustments, I reach an equity value of around $640 per share.
And here are two similar arguments why the food-borne illness crisis will not stop restaurant chains from thriving again:

It's Absurd to Think That Chipotle Mexican Grill Won't Thrive Again.
Chipotle: Primising Deja Vu.

The one single biggest risk to CMG is another outbreak of E. Coli or other food contamination. So it's really critical that they have it under control, even though nobody can really guarantee 100% food safety. I see hiring its former critic and food safety experts as very positive steps.

It's Deja Vu All Over Again. Don't let a crisis go wasted. It's time for the company to repurchase its own stocks. Agree! From Nov 1 – Mar 14, the company has repurchased $787 million at $493 per share. It has another $180 million authorized for repurchase. Note the striking parallel to the repurchases following the 2012 price crash due to growth and margin scares.

Some critics have argued that Chipotle is facing a more fundamental crisis than E. Coli, namely that its menu has been "stale." I disagree. The company has been innovative, testing new items as part of their practice. The reason that they had not had any big changes in menu was because their customers wanted to keep it simple. However, with the E. Coli crisis hitting the business hard and many formerly loyal customers hesitating or leaving, it's the perfect time to introduce new menu items that can help attract a new cohort of loyal customers. I believe the management have this figured out. (5/23/2016)

(Chipotle story in three minutes)


It's really interesting to note that people actually CRAVE Chipotle burritos. Do a search on twitter or google to see those discussions. Sometimes it seems the craving is worse than Starbucks! You don't think the customers will come back in drove?

Why Millennials Love Chipotle?

A good interview about how Chipotle serves its food in integrity. Any other company able to do this?

The company has no plan to suspend its store expansion (about 220-235 new restaurants in 2016). It's not laying off any worker due to the food scare and slower traffic. Fully staffed.

Wall Street continues to be very skeptical on its turnaround prospect. Analysts have been cutting target prices, sometimes severely. The stock has been hovering in the range of 420-460 post earning report on April 26. It will require significantly good news to break out of this range to get close to 500.

Not surprisingly, mutual funds like Fidelity's Contrafund has been unloading the shares. I remember three years ago when AAPL was hammered down to $400 level from $700+ level pre-split, they were also selling the shares like crazy. Of course in that case, AAPL went on to new high after the release of a larger screen iPhone and a bunch of new products and services. This is another eerie parallel, between AAPL in 2012 and CMG in 2016. A chance for small investors to play contrarian!

It might be hard to believe now, but in two years, CMG is very likely to see new highs.

(6/8/2016)
A downgrade today by the pessimistic Maxim Group. Here is the rationale: traffic may disappoint.  It's hard to tell if Chipotle's efforts have been enough to woo back the customers. Patience is required for the ultimate recovery.

(6/10/2016)
Business Insider reports today that foot traffic has returned. Peak lunch hour. Long lines. Costly promotions started to take effects. Brand perception is back up after the devastating E. Coli outbreak.

(6/13/2016)
Another downgrade from a pessimistic banker, Deutsche Bank, with a new price target of $340. This is the second most pessimistic IB after the Maxim Group. They're clearing out of the way. The more optimistic traffic news has not received due respect from the market or analysts yet. I believe if the traffic is improving, the sales result could surprise on the upside for Q2.

(6/13/2016)
The Harris Poll on restaurants still has a very negative effect on the market as many reporters keep referencing it. But, note that the annual poll was based on a sample of 97,120 U.S. consumers ages 15 and over surveyed online, in English, between December 22, 2015 and February 1, 2016. It was during the aftermath of the widely reported E.coli outbreak (the trough in the graph below). Since then the brand has already made a substantial comeback according the YouGov survey (YouGov BrandIndex has measured Chipotle's "Buzz score" daily):


So the reports are focusing on very lagged impression of the consumers.

The stock is hitting a new 52-week low today. Sentiments are extremely negative. Load it up!

Chipotle is testing Chorizo in Kansas. Un-informed reporters kept saying Chipotle menu never changes. But they introduced tofu last year. And looks like chorizo may be coming soon. It will help sizzle up sales. 

(6/15/2016) 
The stock took a beating and fell below $400, a new 52-week low. Today it was recovering, but went lower after this Bloomberg article came out: No News Is Bad News For Chipotle Stock. It contains no new information, but an important error in stating the forward PE = 50. No, it's not 50. Analysts consensus estimate for 2017 earnings is $11.81. At $400/share, the forward PE is about 33-34, the low end of CMG historcal PEs. 

Market is pricing in excessively negative news, ignoring positive developments over the last three months. It's therefore very reasonable to expect a positive surprise in Q2 earnings, to be announced on July 19.

(6/16/2016)
A positive comment with target $549. 40% upside.

(6/21/2016)
The sentiments have been decidedly negative for weeks if not months. This article is an example. Analysts, short-sellers, restaurant reviews/surveys/polls, fund managers, ...even insiders,  almost all negative! The only thing that could drive more negativity would be another outbreak... When everyone is so fearful about a leader/innovator, it's probably as bad as it gets.  

(6/22/2016)
SunTrust optimistic that Chipotle will recover in two years. Price target for 12 months: $550. If you believe the recovery story here, then the price target is likely to be reached as soon as investors see evidence that the SSS inches up after stabilization. Market don't wait that long.

(6/28/2016)
The highly anticipated temporary customer loyalty program is finally here for the summer quarter. It's designed to encourage repeat store visits, and help Chipotle collect data for future marketing. Better than random Buy One Get One (BOGO) sort of deals they've done earlier. This is more systematic, and should create lots of buzz and traffic. Most importantly, the program encourages those frequent customers to come back and enjoy the food safely.

This article provides a detailed analysis of the loyalty program and its potential impact on earnings. The author has also come up with a valuation of $600/share for CMG.

(6/29/2016)
Chorizo has been added to the menu.  How good is it? Here is a polite earlier review.

Another thumps up for early testing run.

Two recent negative reviews: Tastes like garbage; Flavors fail to show up.

Customers Going Bonkers (Thumbs up, exceeding expectations... "40% of locations indicated they ran out of chorizo due to stronger-than-expected demand and employees at several locations mentioned chorizo was the second most frequently ordered protein behind chicken.").

Business Insider provides another review with more people tasting it: mixed.

(6/30/2016)
3 Reasons Why Chorizo Will Spice Up Chipotle. Interesting take from Motley fool.

(7/1/2016)
I got my Chiptopia card today. Have to register it separately from your regular Chipotle account. A bit of a hassle to maintain two accounts.

I was thinking about the "Hot" status, as it appears to be the most generous -- you pay for 27 meals and they'll award you 29 meals. A tiny bit better than BOGO deals. But there is a catch: You have to redeem the catering bonus at once. Unless you have a large family, you can't just have that much food as a regular lunch or dinner, and you can't store it. The company suggests that you throw a party. I suspect that's what most winners of Hot status would do. It sounds like a marketing event for Chipotle to potential new customers!  Ingenious! With that in mind, the catering bonus isn't so much of a giveaway at all.

(7/1/2016)

In the news also: Some employees have started to complain about being understaffed and overworked, as customers returning. One can read positive traffic news out of this.

Here is the link to the employee campaign letter. It probably started about a month ago, and is just now receiving media attention. Signed by 947 people as of today. Not all of them are employees.

What's remarkable is this claim: "After months of changes which included new safety implementations and our restaurant to undergo new management, our sales picked back up to almost an all new high." New high in sales? We don't know how much that's true across the country. I can't imagine that management would not step up hiring or expand work hours if sales have indeed gone up to new high.

But the letter was written after the Q1 earnings report. Perhaps traffic did improve substantially in May and June...

(7/6/2016)
Chipotle Will Be Back.
Chris Arnold, Chipotle’s Communications Director, told me that the company is seeing “encouraging signs” of recovery. In many restaurants, customer traffic is now approaching their pre-crisis thresholds. Business Insider moreover, recently referenced a YouGov study that shows Chipotle’s “daily buzz” and consumer sentiment metrics are on the upswing. The reassuring messages that customers are hearing from social media, earned media, and – most importantly – the word-of-mouth they’re hearing from friends and work colleagues appears to be steadily improving Chipotle’s image.
(7/8/2016)
Chipotle's new video will lure back customers.

(7/13/2016)
Survey: Concern about food safety hit 2016 low. This survey from William Blair looks quite revealing and shows a clearly improving trend. July could be key to the acceleration of the turnaround.

(7/152016)
Today, Morgan Stanley came out with a survey and a note saying that the recovery would take "years" and downgraded the stock and lowered the price target.


(7/19/2016)
CLSA upgraded CMG ahead of earnings report on Thursday (7/21). Price target remains at $460/share. Traffic is key, margin pressure can be dealt with later.

What to expect from the 2Q earnings report? 


For example, with comps at the current level (down 26.4% yoy) our average unit restaurant volumes are about $1.9 million on an annual basis, and our restaurant level margins should improve to the low double digits in the next few quarters as the nonrecurring costs begin to level off. If comps are around negative 20%, AUVs would be about $2 million and margins would be around the mid to high-teens. If comps recovered around negative 10%, AUVs would be about $2.2 million and our margins should be in the low 20%s. And if we fully recover our sales with AUVs in the $2.4 million to $2.5 million range, we would expect margins in the mid-20% range which accounts for the recurring cost of new procedures and protocols that relate to food safety.
(7/26/2016)
CMG missed Q2 top and bottom, yet the stock rose 5.8% last Friday after the earning report. Big part of it could be short covering. But perhaps investors also saw promising efforts that will help to bring back traffic in Q3, Q4. These efforts include Chiptopia, Chorizo and marketing campaigns. 

Today Stifel Nicolaus downgraded a bunch of restaurant stocks including PNRA and CMG. They set a low low low PT of $215 for CMG when the stock was trading at $440/share. Their reason is "recession. I don't think recession is likely over the next 3-9 months.


(8/3/2016)
A update on the ShopHouse sister restaurants. There are now only 15 ShopHouses, after 5 years. Most of them were opened in the last 3 years. The main bottleneck is certainly not capital, as Chipotle has plenty of long-term investments, and can readily borrow. It appears the biggest challenge is managerial talents.

ShopHouse is still considered a “growth seed” within Chipotle Mexican Grill Inc., Wildin said, but 14 of the chain’s 15 locations opened over the past three years.
“To me, that’s quite fast,” said Wildin. “It has been challenging, and one of the challenges has been developing top-performing people to lead these efforts and run these restaurants.”



Wednesday, February 24, 2016

Very tricky time at the Fed

I like Tim Duy's recent summary:

Despite some hawkish talk, the Fed will find themselves in risk management mode at the March meeting. Some will not like it. There will remain a contingent that fears standing still risks excessive overshooting of the inflation target.

Fed to stay neutral/dovish and tread cautiously(3/7/2016).

On Yellen's New Pivot to Go Slow on Rate Hikes and Said it Firmly (4/1/2016).

Analysis of the Fed minutes. (4/6/2016)


Still too much slack, unemployment rate moving side way (5/23/2016). Market now looking for a rate hike in July. This hike may not do as much damage to global economy as the one in December, but will slow down recovery progress. Look at oil market for hints.


David Rosenberg calls a summer rate hike "reckless and unnecessary." (5/24/2016) Strong words coming from a former bear, but he gives very good arguments against the hot heads in the Fed, especially the regional heads.

Monday, May 11, 2015

Zillow deserves a higher valuation than $100

As the housing market shows signs of revival, perhaps due to jobs or low rates, the biggest bargain is not in home builders, probably not in housing-related services such as HD/LOWS, but in the newly enlarged and dominant online real estate information site Zillow (Z).

Suntrust has come out today to upgrade the stock from neutral to buy and raised its target from 110 to 130. It listed six key positives:

1) Secular shift – growing trend of researching and discovering properties online, enabled by greater information, data and attribution, esp. in the younger generations;

2) Mobile usage increasing – smaller brokers and MLSs will have a tough time justifying continued tech spending to keep up;

3) Dominant position – Z/Trulia combination creates a scale that is unmatched and creates a “must buy” for agent advertisers and a “must be on” for home sellers;

4) Strong ROI – we believe that as the better performing agents get more leads, conversion rate and ROIs will rise, creating significant pricing power for Z;

5) Optionality - around Rentals, mortgages, and digs are underappreciated;

6) Margin leverage – we think the margin profile is misunderstood and can approach levels >45%.

When the merger with Trulia was announced last July, the stock promptly jumped from 125 to over 160. But as the merger was finally completed with most potential in tact, the stock was punished to below 85 at one point on January 27. We couldn't resist and bought into it in a big way. As the stock recovered somewhat, the short interest rose to 50% of float according to Yahoo Finance. Short-covering can make this stock soar like any hot dot-com high flyer.

When Zillow reports tomorrow we'll have a chance to see how much progress it has made since the merger with Trulia in terms of numbers. It could still be a transition story, but as long as the six  points above are in tact, we should be unfazed by any short-term negative.

And then there is the threat of Realtor.com and Murdoch. But judging from the spectacular failure of MySpace, how much credibility would you give Murdoch this time?

(2/7/2016 Note)

The stock has dropped below $20 (or $60 before the share split into Z and ZG). This is very surprising development. For a completely different take on the Zillow story, see Barron's article:
Zillow Share Could Fall By Half.

Safalow believes that the real market for Zillow and its rivals is much smaller than their fans suppose. Residential real estate is an "80/20" business, where a small portion of the nation's 500,000 active real estate agents do enough business to justify advertising with Zillow. He thinks it could be 15% or less. With Zillow claiming more than 55,000 agents as advertisers and Trulia, more than 70,000, the two portals may be reaching saturation -- especially given the companies' assertion that their customer overlap is modest.

It has already fallen more than half from the $140 level. It looks cheap. But if we believe the story of agent saturation in the article, and given how internet stocks have been hammered in the market, we may very well see further weakness of the shares.

Thursday, January 29, 2015

End of my landlordship

Today marks the end of my endeavor of being a landlord as I sold the last piece of my investment properties.

I got into this in early 2008. Nice timing! But I picked Dallas as the spot. The rent-to-price ratio have been high. On paper, things should work out in terms of cash flow.

But it wasn't nearly as profitably as expected. The maintenance costs ate up all potential profits and then some.

Plus, you get to deal with all sorts of tenant issues, weather issues, insurance issues, repair this and repair that, ...... and, the tedious tax reporting issues... I have to say I hated it.

The only upside, I guess, is I get to learn more about property markets, and why I should stay away from ever engaging directly in this business. Way too much hassle for my time.

There are better ways, more liquid ways, such as investing in home builders and related housing businesses, REITS, and home furnishing businesses...

It took me a couple of years to realize it's not my cup of tea. It took me another five years or so to get rid of the investment properties.

Bye bye. Thank you very much. I don't want to be a freaking landlord!   

Tuesday, September 16, 2014

Charlie Rose Interview of Tim Cook

There are two parts.

PART I



PART II