Chipotle's Business and Stock

Case Analysis of Chipotle
Introduction
This case analysis of Chipotle (CMG) examines the industry in which the restaurant has risen and looks at the company’s background and core values. The problem that the company has encountered in the last five years is really one of the financial markets and not so much a matter of image, brand, or poor business decisions—at least in terms of what the business was doing prior to 2012. However, when famed investor David Einhorn picked CMG as a potential short, the market decided he was right: Chipotle lost nearly half its market cap over the course of the summer of 2012. Since then the company’s stock price has rebounded to all-time highs in 2015 and fallen again to where it was prior to Einhorn’s short call. The company, in turn, began focusing more and more on what its stock was doing, investing millions in share buybacks. In the past two years alone, Chipotle has spent $150+ million in buying back its own shares and enriching investors. That is money it could have spent on marketing, research and development, building out its supply chain, investing in communities, promoting it sustainability cause and myriad other endeavors that would have been nearer and dearer to its core values. Chipotle’s main problem is similar to that experienced by Hewlett-Packard at the beginning of the 21st century when a revolving wheel of CEOs tried to figure out how best to prop up the ticker of the IT company (Bandler & Burke, 2012). Chipotle is in danger of making the same mistakes that led to HP’s fall from being an innovative leader in the tech industry. In order to get back on track, Chipotle must begin to refocus on putting people before profits and stop placing so much emphasis (and money) on what the stock price is doing. If Chipotle continues to deviate from its core values of sustainability, food with integrity, and cultivating the fast casual dining experience, it may end up losing more ground in the fast casual niche restaurant market to eager up-and-coming competitors.
General Environment/Industry Analysis
In 2012, the restaurant industry held 48% of the food dollar: almost half of every dollar spent on food in the U.S. in 2012 was spent at a restaurant. This figure was well up from the 25% of every food dollar spent at a restaurant half a century earlier (Subramanian, 2013). Today, the restaurant industry consists of three main segments: “full service, quick service, and fast casual” service (Subramanian, 2013, p. 1). Full service restaurants are those in which diners sit down at a table and are waited on by a waiter or waitress. Quick service is also known as fast food any of the national fast food chains with counter ordering, drive-thrus and sit down tables inside qualify as quick service. Chipotle falls into the smallest of the three segments—the fast casual segment, which focuses on delivering portable food using fresh, healthy ingredients. Full service restaurants make up roughly 32% of the restaurant industry. Quick service restaurants account for 28% of the industry, and fast casual account for only 4% (Subramanian, 2013).
As for price points, the fast casual is right in between full service and quick service—higher than fast food prices but lower than full service. Customers know that they are paying for quality when they purchase fast casual food and so they are willing to pay more than they would at a drive-thru. They also recognize that they are getting a portable meal that gives them time to get in and get out without having to tip and allocate time to the full service sort of experience that would be required of them were they dining in somewhere. The average cost of a fast casual meal is between $7 and $10 (Subramanian, 2013).
Given the growth opportunity of the newest segment in the restaurant business—the fast casual segment—several larger restaurant chains, both full service and quick service, have entered into the space. P. F. Chang’s opened its fast casual Pei Wei restaurants. Full service dine-in restaurant Ruby Tuesday now has its Lime Fresh fast casual restaurants. Panera Bread, Five Guys Burgers, and myriad other national and local fast casual restaurants have popped up all over the U.S. in recent years. The combination of counter ordering and high quality, fresh ingredients has made fast casual one of the most preferred restaurant segments among young consumers today (Patel, 2017).
This shift away from fast food towards fast casual, where the emphasis is on fresh ingredients and good-for-you meals began earlier in the 21st century when Fast Food Nation by Eric Schlosser was published in 2001. The book was an in-depth expose of McDonald’s mainly and its less-than-healthy approach to food, ingredients, and hooking customers to fatty menu choices. Schlosser (2012) pointed out how fast food restaurants were trying to pose as sources of all-natural organic meals but were really just duping their clients. The book helped spark the public consciousness and drive consumers away from the staple of the American diet throughout the latter half of the 20th century. The book was followed by Morgan Spurlock’s award-winning 2004 documentary Super Size Me, which again focused on McDonald’s. In the documentary, Spurlock filmed himself consuming nothing but a McDonald’s diet for a month in order to see if the food really did affect his health—and it did. Audiences were horrified and shocked by what they saw and the shift towards healthier but still fast options in the restaurant industry picked up speed.
By 2010, any restaurant offering tasty, fast casual was bound to get noticed by health-conscious consumers. These were the same consumers who generally supported sustainable concepts in retail—whether from Patagonia, Eileen Fisher or Tesla (Elks, 2013; Farris, 2016. They liked the idea of companies engaging in corporate social responsibility and felt that it was about time that organizations, whether restaurant or retail, began to start putting people before profits. These consumers identified fast casual dining options as the type of restaurant that did put people first. They offered great meals at a great value in an easy to order and take home or dine in manner.
Investment is one of the biggest factors in the restaurant industry: where to invest, how to negotiate with suppliers, how much to put into the restaurant’s interior and exterior—these questions have to be answered on a routine basis. Full service restaurants will typically invest more in their interior to enhance the experience for clients. Fast casual restaurants can get away with a bare bones approach because they know their clients are not there to have an experience in the same way guests go to a full service restaurant.
The global economy is another factor that many restaurants have to take into consideration. As is currently being seen, supply chains can become unstable in the face of tense relations between nations, trade wars, and economic uncertainty (Brown, 2017). Supply chains can impact a restaurant business that depends on food items sourced abroad. Restaurants that depend on local sources and farmers may fare better in times of trade war, but it is also likely that their price points will be higher.
Company Analysis
The New Fast Casual
Chipotle has risen to capture the fast casual segment of the restaurant industry in recent years. The firm started out as a taco shop in 1993 in Denver, when Steven Ells set out to reinvent Mexican food (Subramanian, 2013). Five years later, he had 16 restaurants and an offer from McDonald’s to help fund further growth. With the investment from McDonald’s the chain opened 500 new locations by 2005 and the firm became public in 2006, allowing McDonald’s to exit its investment with a tidy profit of more than $1 billion (Subramanian, 2013). While McDonald’s had certainly helped to create the Chipotle chain, at the end of the day, the two companies had completely different philosophies with regard to the industry. McDonald’s still wanted to make cheap food fast. Chipotle wanted to make great food quickly using fresh, organic ingredients.
Sustainability
Like many trending companies, Chipotle wanted to promote the concept of sustainability as its main driving force. Ells wanted to source his meats from open-range, naturally-raised farmers. This was the essence of his “food with integrity” mission (Subramanian, 2013, p. 87). As Ells and the company stated, “Food with integrity is our commitment to finding the very best ingredients raised with respect for animals, the environment and the farmers. It means serving the very best sustainably raised food possible with an eye to great taste, great nutrition and great value” (Subramanian, 2013, p. 87). The concept of “food with integrity” gets to the heart of Chipotle’s core value and it this value coupled with the fast casual concept that allowed Chipotle to attract the attention of investors in the first place.
Sustainable sourcing was part of Chipotle’s success almost from the start. After Ells visited a number of concentrated animal feeding operations, he decided to source his meats from organic, all-natural, open-range farmers. This became part of what differentiated Chipotle from other competition in the restaurant space in the early 21st century. Aside from his reinvention of Mexican cuisine and the fast casual nature of his restaurant, the sustainably sourced meat was a big draw. Chipotle began pursuing sustainability in other ways as well: “in 2009, the company entered into a partnership with a company to install solar panels in its restaurants” (Subramanian, 2013, p. 88). Chipotle was going to become the biggest user of solar panels in the industry, reduce the company’s carbon footprint and cut down on peak energy consumption costs. Consumers liked it because it showed that Chipotle was dedicated to corporate social responsibility. Investors liked it because it was innovative and cost-effective.
Supply Chain
The company’s supply chain also became a part of Chipotle’s success. Chipotle grew its locally sourced produce to 35%, which helped eliminate the use of fossil fuels used in transportation, and improved consumers’ sense of appreciation for a restaurant that actually cared about quality and the local farmer (Subramanian, 2013). Chipotle has a network of over 20 local farms providing produce for its restaurants all over the United States.
Because of the scarcity of all-organic produce, Chipotle could not become a 100% all-organic restaurant. According to Ells, “the supply chain has yet to catch up, organic ingredients are still pricey, and supply is limited. What we are doing is an ‘incremental revolution.’ If we went all-organic and natural now, a burrito would be like $17 or $18” (Subramanian, 2013, p. 88). Thus, Chipotle has at least laid the blueprint for the industry.
Marketing
Today, Chipotle spends more than 6x what it spent in advertising in 2005 when the company was getting ready to go public. Back then, Chipotle’s ingredients and products spoke for themselves. Word of mouth was great, and the novelty of the fast casual restaurant with quality food was enough to attract customers. After competition began heating up and Chipotle came under pressure, marketing expenses rose. However, from the beginning, Ells wanted to rely on word-of-mouth marketing in order to grow the brand (Subramanian, 2013).
In 2009, Chipotle made the decision to avoid old media marketing techniques (such as TV spots) and instead focus on incentive-driven marketing—i.e., loyalty programs (Subramanian, 2013). Loyalty programs like Farm Team were joined by online commercials like the Willie Nelson featuring “Back to the Start” ad, which was then shown in more than 5000 movie theatres and then finally on television. Chipotle also sponsored the “Cultivate” festival in 2011 that “brought together farmers, chefs and music bands” with the goal being “to promote sustainable family farms” (Subramanian, 2013). This type of promotional activity has allowed the company to hit a “sweet spot” among then next generation of consumers who appreciate quality produce and meats, sustainable models of business and companies that truly care for the environment and for local communities (Subramanian, 2013).
Finances
Revenues for the company were stellar during this time and growth was substantial from 2011 to 2012 when the company was entering into its marketing and promotional stride. Competition had not yet increased to the level at which it is today, and the company’s stock value was near where it is today at more than $400 per share. Then notorious short-selling hedge fund manager David Einhorn identified Chipotle as a stock worth shorting—and immediately Chipotle’s ticker CMG began to drop. Einhorn justified his short thesis on the idea that competitors like Taco Bell were moving into the organic fast casual market and would soon be giving Chipotle a run for its money. The thesis was weak at best (as Taco Bell and Chipotle and two entirely different types of restaurants with very different quality menu items)—but the stock suffered and Chipotle executives began looking for a response. Suddenly, the stock price mattered—even though till then the company had been doing everything right.
Ells stated as much when he identified Chipotle as a kind of “burrito assembly line,” where the meat is grilled right in front of the consumer—unlike in fast food chains where the food comes pre-cooked (Subramanian, 2013, p. 91). Taco Bell’s Cantina Bell was not even in the same league as Chipotle and Ells rightly pointed this out. However, the market seemed to disagree. Food with integrity, the market decided, was going to come at too great a price—and the descent of CMG on the tape over the course of 2012 seemed to verify the market’s sentiment. Investors were losing faith in the vision and value that Chipotle had introduced into the restaurant industry at the beginning of the 21st century. Einhorn had drawn first blood and now blood was in the water. The problem was—what should Chipotle do about it? Should it be concerned about the price of its stock? Or should it go about its business as usual and continue to set the bar for fast casual dining?
Problem Analysis
The rather disingenuous comparison of Chipotle to Taco Bell’s Cantina Bell was more of a move by a short-selling shark than astute business analysis. It was the work of a financial investment manager attempting to move the market against a stock he was shorting—and it worked for a period of time. Einhorn was able to short CMG nearly 200 points over the course of summer 2012. However, from its lows of $250 per share in 2012, CMG went parabolic over the next three years, topping out at $750 per share in 2015. It turns out that Chipotle did not have a business problem: it had a Wall Street problem. It had grown fast and had a higher than average P/E (price per earnings ratio) than many other stocks in the market: competition was coming and short sellers saw an opportunity to spook the market and make some money in the ensuing fall.
Chipotle’s stock has since dropped from its highs in 2015 to $466 today—which means it is roughly back to where it was prior to Einhorn’s short recommendation. What does all of this mean? Is it time for the company to be worried once more? Is competition cutting into Chipotle’s profitability? The reality is that Chipotle is still a beloved fast casual chain that still delivers on all fronts: quality meats and produce, organic and all-natural items on its menu and a great recipe that keeps consumers coming back—even when hit pieces in the news threaten to undercut the company’s momentum and steal its thunder.
Nonetheless, Chipotle’s top executives are worried that the company’s stock is the most important piece of the puzzle. They have signed off on share buybacks, which many other companies are engaging in as well—but this is not money that is going back into the company to benefit consumers. It is money that is going back into the pockets of investors. There is a problem with this type of leadership because it means that instead of investing in itself, Chipotle is more interested in seeing that investors get paid. In a way, it is trying to repeat the pay day that McDonald’s engineered for itself when it became an early investor in the company’s growth and exited its holdings after the company went public. Now, every investor wants to hit it big—and executives are no different as their salaries often include stock or stock options. By signing off on buybacks, the company is essentially ensuring nice raises or bonuses for its executives and Board members who are interested in selling their shares in the open market.
Chipotle did not start off as a financial investment vehicle for Wall Street—but if it is making decisions about how to spend hundreds of millions of dollars every year based on pleasing Wall Street investors who own the stock, there is a definite problem in terms of how faithful the company is to its core values. Chipotle’s core values made the restaurant what it is today. When companies deviate from their core values, they tend to fall in value with consumers.
Chipotle’s consumers have not changed since the company first hopped onto the national radar in the early 2000s. They still want the same great recipe, the same reinvention of Mexican food that Ells inspired. They still want their assembly-line burritos and they still want organic, all-natural produce and meats when they are available. They still support the concept of sustainability and appreciate companies that do as well. They still align themselves with the vision of Ells and that original core values of the company—but if the company itself begins aligning itself with the values of Wall Street and chooses to spend hundreds of millions of dollars enriching investors rather than in growing out its domestic network of suppliers or taking ownership of the sustainability movement and really begin investing in the communities it serves, Chipotle may just end up alienating the consumers it attracted in the first place. This is the problem that Chipotle now faces—whether to put people or profits first. The company started off by promising to serve people quality food at a quality price and pace—and it succeeded. The people came and the company profited. Since the company went public, executives and investors up and down Wall Street have used the stock to enrich themselves. When the stock goes up, everything is great. When a notorious shorter like Einhorn takes a bearish position, momentum turns and momentum chasers run the stock price down. A company that bases business decisions on what the stock price is doing is not a business that will be respected by consumers for long. One need only ask Tesla about that.
Recommendations & Implementation
One of the problems with public companies is that the stock price so often ends up receiving the bulk of the focus because of early investors or because stock options and the desire to divest among top-holding executives while the stock is riding high. Numerous public companies in the past have made erroneous business decisions that were meant to inspire investors and fuel a stock rise—such as share buyback programs to the detriment of research and development or market expansion. Hewlett-Packard, Apple, and a variety of others are just a few examples. Chipotle is no different and like many other U.S. companies it is using Trump’s tax breaks to buy back shares by the millions. Chipotle’s Board authorized $100 million in share buybacks in April 2018. This comes on the heels of millions spent the year prior on share buybacks (Lin, 2018). Since then, the company’s stock has increased by more than 200 points. Measuring a company’s health by its stock price, however, is not an appropriate method. For a financial investment officer, stock prices matter. For a business owner, the number one priority should be people and the company’s commitment to its consumers and the core values that attracted consumers in the first place. For Chipotle, those core values are “food with integrity” and the reinvention of Mexican food for a fast casual dining experience.
Chipotle excelled in the early 21st century because of the vision of Ells and the product it provided to consumers: a novelty in the restaurant industry dominated by full service and fast service restaurants. Chipotle kicked off something new—a fast casual approach to food that put quality ingredients and recipes at the heart of its menu. Chipotle promoted the idea of transparency, sustainability and accountability: the counter where customers place their orders allows one to see the food being cooked right before their eyes. Customers see everything because Ells wanted it that way: this was an honest approach to food. It is also a company that believes in sustainability and the need to protect the environment, our natural resources and our human capital—i.e., our farmers, who work hard to bring natural, organic meats to market. Chipotle recognized the value of sourcing only quality organic meats and consumers responded.
Along the way, Chipotle began acting like a public company, focusing more and more on its stock price, which peaked at an exorbitantly high $750 in 2015. Various factors were driving the stock market at the time, such as quantitative easing, which had a spillover effect on the stock market and caused a substantial uptick across equities (Chen, Filardo, He & Zhu, 2016). Associating the stock rise with business decisions would not be entirely effective in assessing what the company was and is doing right.
The number one recommendation, therefore, is for Chipotle to forget the stock for the time being, and reinvest capital into the company—not into share buybacks, which really only enrich investors. In following such a policy, Chipotle is making the age-old mistake of putting profits before people. The company’s growth and success initially was based on the just the opposite approach—that of putting people before profits. When people come first, profits quickly follow. It’s when corporate executives and institutional investors focus only on profits coming now, without regard for people, that companies get into trouble.
Chipotle should, therefore, stop focusing on the stock and begin focusing on ways to improve its relations with customers. Bad press over the years about stores being untidy and consumers getting sick from eating at Chipotle has not helped the chain improve its image. The brand is still well-known and popular: what it needs, however, is a significant boos ala the kind of social media campaign that other companies like GoPro, which used YouTube to launch user-generated content to sell its cameras, have conducted in order to develop their brands.
Chipotle is now coming into maturity and it is also now facing more competition in the niche market of fast casual than ever before—not just from national chains like Pei Wei and Lime Fresh but also from local fast casual restaurants that locally source everything and offer fresh, organic meals at a competitive price point. Chipotle has to find a way to differentiate itself all over again (Trout & Rivkin, 2006) in order to retain market share and beat out competitors in the fast casual segment—and that is where investing its capital back into the company—i.e., in research and development, marketing, and sales—can come into play.
In 2011, prior to Einhorn’s short call, Chipotle was marketing itself well using word-of-mouth marketing, new media (online commercials), promotional activities like the Cultivate festival and incentive programs like the Farm Team loyalty program to get customers coming back on a regular basis. Chipotle was building out its supply chain network in the States and was serving as a leader in the sustainability community. When the short call came, Chipotle panicked. The public company saw its market cap drop nearly by half over the course of a few short months. From a financial perspective, the stock was probably overvalued anyway. Currently it has a higher than average P/E, and its stock value now is close to where it was in 2012 before Einhorn wreaked havoc on the stock price. In other words, CMG, reasonably speaking, should not really be much more expensive than it already is.
Yet executives and investors will always want the stock price to go up because it either validates the job they are doing in their eyes or they seek to enrich themselves off its upward movement. Watching the ticker, however, is not always in the best interest of the consumers, and the consumer is the one who needs to be satisfied in the long run. This means that Chipotle should stop spending hundreds of millions of dollars on boosting its share price just to enrich a few investors. Instead, it should be using that money to invest in the sustainability movement. Ells has pointed out that the price of using all-organic ingredients would cause Chipotle to have to sell $17 burritos. Taking the hundreds of millions of dollars the company is currently using just to prop up the stock and investing in an all-organic network of produce providers would help to bring that burrito price down substantially and Chipotle would then be able to boast that it is the one and only national fast casual restaurant able to provide its consumers with 100% all-organic, all-natural items for every single thing on its menu. That would enhance its brand and its value in the eyes of consumers more than anything else. Unfortunately, as of now, the company has thought it better to enrich investors by propping up the stock price via buybacks. That may make Wall Street happy for a short time—but there will always come a day when another popular short seller decides to take a crack at CMG. Chipotle is not in the restaurant business in order to profit off its stock. It is in the restaurant business in order to give consumers something different and something they will enjoy. Chipotle must return to its core values and get back to growing its sustainability community and promoting the concept of quality food at a quality price and pace.
Conclusion
Chipotle (CMG) started off as a small taco stand in Denver in the late 1990s and quickly became a small but popular and profitable chain of 16 stands. When McDonald’s invested heavily in the business and helped Chipotle to expand up to 500 store locations by 2005, Chipotle became a household name and a favorite stop among young consumers who appreciated the new fast casual dining experience and the quality food that made every other fast food restaurant’s items pale in comparison. Chipotle demonstrated that when a restaurant’s core values are quality food and recipes, sustainable practices at quality prices, it can revolutionize the way the industry operates. Indeed, consumers were tired of cheap fast food and they were becoming more informed than ever about the toxicity inherent in the fast food chain. Chipotle was like a breath of fresh air. However, six years after going public, Wall Street began shorting the company’s stock and Chipotle began reassessing what it valued more—its people or its stock. Since then Chipotle has invested heavily in propping up it stock through share buybacks. This means it is not allocating capital where it should—its people, its farmers and its community. Unless Chipotle gets back to its core values, the company will not last in the long run.

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