Ackman’s Chipotle Playbook: Part I

Pershing Square took a large position in burrito chain Chipotle Mexican Grill in September of last year. The company announced earnings in April and beat expectations, sending shares up 6.5%. Year-to-date the shares have now gained 25%. The position makes up 13% of Pershing Square Holdings. We will take a look at how Ackman has been approaching the position.

Superb brand

Ackman views Chipotle as a superb restaurant brand with an outstanding product offering, unique culture and powerful economic model. The company was founded in 1993 by Chairman and CEO Steve Elis and is active in the ‘fast casual’ category (between fast food and casual dining). The firm has the ambition to change the way the world thinks about and eats fast food and to ensure that better food is accessible to everyone. The company offers fresh, non-processed food with chef-quality taste. The one restaurant in 1993 grew to 2,200 today.

The opportunity

Chipotle is a high quality, simple, predictable, unlevered, free-cash-flow-generative business, which puts it right in Pershing’s sweet spot. The opportunity to enter the company at an attractive price presented itself as a result of food safety issues beginning in the fourth quarter of 2015. These caused a peak-to-trough decline in average unit sales of 36% and more than halved Chipotle’s share price.

While Chipotle’s reputation has been bruised, Ackman believes the business will ultimately recover and become stronger, aided by improved governance, increased focus on operations, marketing and technology initiatives and simply the passage of time.

Ackman believes that all of the key drivers of Chipotle’s powerful economic moat and long-term success remain intact:

• Strong and relevant brand built by visionary leadership;
• A differentiated product offering with a highly attractive value proposition;
• Substantial scale in fast casual and first-mover advantage in real-estate;
• Strong unit economics and extremely high returns on capital, driven by a well-honed model that facilitates excellent throughput;
• Significant growth opportunities including new units and operating enhancements.

According to Ackman, Chipotle has a number of other attractive attributes that help to mitigate investment risk:

• Limited global macro-economic sensitivity and FX exposure
• A simple business model with limited non-GAAP earnings adjustments
• Chipotle would be a big beneficiary of U.S. corporate tax reform with 40% effective tax rate
• The company has an unlevered balance sheet with a strong net cash position

Time-line of events

Since initiating the position Pershing Square has been the driving force behind several important developments at the company:

Sep 6 ‘16:
Pershing files 13 D announcing 10% stake in Chipotle

Mid- Sept ’16:
Constructive dialogue begins between Pershing Square and Chipotle Management and board

Dec 12 ’16:
Chipotle names Steve Ellis sole CEO, co-CEO Monty Moran resigns

Dec 16 ’16:
Chipotle announces a board refresh with four new directors including two Pershing nominees (Ali Namvar of Pershing Square and Matthew Paull, ex-CFO of McDonalds.

Mar 13 ’17:
Four legacy directors do not stand for re-election, reducing board size to eight

Apr 10 ’17:
Chipotle announces the launch of its largest-ever advertising campaign: “As Real as it Gets”

Recent sales trends have been very positive (see above) and Ackman appears to have picked the bottom in the stock quite well. The average purchase price of the stock was $397. On April 25th Chipotle reported a big earnings beat of $1.60 per share versus $1.27 expected by analysts. On Tuesday, May 16th Chipotle shares traded at $496.