Chipotle Mexican Grill (NYSE:CMG) has failed in its efforts to bring back customers because, overall, its senior management has been tone-deaf to how damaged the brand was by last year's events.
I wrote last year about the CMG food safety crisis and how damaging it had been to the "Food with Integrity" brand ethos that had been instrumental in fostering growth among more health-conscious millennials. The "Integrity" branding also allowed CMG premium pricing as CMG food was widely viewed as superior to most other QSRs.
But in the food crisis, CMG's management buckled and failed. The company's senior management had been, at least originally, somewhat dismissive of the crisis, blaming the CDC and the media in what AdAge labeled "CDC hype" *. Management seems so tone-deaf that, even in the CMG 10-Q filed for 2016Q1, CMG management blamed the downturn in sales not on the outbreak of food borne illness, but on the publicity surrounding it!
Money that management and the board chose to spend on financial engineering, by buying back shares, and free burritos and bowls would have been better spent on deep, days-long training of staff and managers in food safety and on a much larger, much longer, and far more extensive public and media relations effort to restore credibility.
The CMG food safety crisis was spread over several months, multiple states, and with different types of outbreaks (E-coli and Norovirus). The cause of the E-coli was never discovered. A few newspaper ads, a few TV appearances, and free burritos and bowls will not fix the public perception that eating at CMG is a risk to your health.
Indeed, CMG's laser-like focus since 2015Q4 should have been earning back the public's trust through apology, assurance, and education. It has done those things, but not widely enough and without sufficient penetration and repetition to assuage the public's concerns.
It almost seemed that by not talking about the E-coli and Norovirus outbreaks in their immediate aftermaths, CMG was trying to start running the clock to realize a misguided hope that customers would forget the restaurant chain's troubles; they won't.
The messaging - "Chipotle will make you sick" - has been too deeply ingrained by multiple, negative, media reports across multiple media platforms.
At this point, the public has to be convinced that CMG has returned to safety and the convincing needs to be reinforced, multiple times. But the only management team member who seemed to understand that in Tuesday's conference call was John Hartung, the CFO, who said an outbreak of Norovirus among workers at a Massachusetts location showed "the recovery can be fragile… we need to rebuild trust with our customers - every single customer, every single day in every single restaurant."
The Sad Numbers
According to the CMG press release:
- Revenue decreased 23.4% to $834.5 million
- Comparable restaurant sales decreased 29.7%
- Comparable restaurant transactions decreased 21.1%
- Restaurant level operating margin was 6.8%, a decrease from 27.5%
- Net loss was $26.4 million, a decrease from net income of $122.6 million
- Diluted loss per share was $0.88, a decrease from diluted earnings per share of $3.88
And while all this was occurring, CMG management was opening 58 new stores! Sorry, but that's like making sun shade umbrellas for the deck of the Titanic.
To Stop the Bleeding:
Right now, Chipotle faces three major problems.
Operationally, Chipotle needs to make some big changes to return to a more stable, more sustainable growth and to allow it to eventually fill a niche somewhere between Taco Bell and Panera Bread (NASDAQ:PNRA). CMG's pretentious claim to offer "Food with Integrity" is mostly over. CMG will have to sacrifice some of the freshest tastes of its offerings and its locavore brand ethos to customer safety and to ensure the stability of its stock price. Another outbreak of food borne illness, no matter how minor, within about the next 18 months would be catastrophic.
But senior management doesn't seem to "get it" in that regard.
In the earnings call, co-CEO Monty Moran said that CMG would be returning lettuce cutting to the local restaurants to improve taste that had been lost when CMG went to centralized cut lettuce. But lettuce, even though washed, is one of the leading carriers of E-coli bacteria. CMG would do better to sacrifice some taste by cutting lettuce at a central location, washing the cut lettuce with a highly effective disinfectant like peroxyacetic acid ("Tsunami") and sending it on, bagged, to the restaurants. It will certainly affect taste in that it will not taste as fresh-cut lettuce, but consumers will eventually adjust to the change. (I understand, but cannot confirm, that the current plan is to have CMG wash full heads of lettuce at a central location with a chlorine wash that is standard in the industry, but less effective than Tsunami. Then, cut the lettuce locally at the restaurant.) There is too much risk of food-borne illness from the lettuce and the peppers that CMG wants to continue cutting in the kitchen.
From the C-Suite, CMG needs to do a far better job restoring customer confidence. CMG's executives should be talking about efforts to constrain E-coli, Norovirus and CMG's food safety procedures in earned media at every opportunity: morning shows, "60 Minutes," talk radio, etc. Bring the cameras into the kitchens. Invite investigative reporters to come in unannounced. Show the world CMG is safe.
Magazine essays or interviews in popular periodicals and newspapers should be the order of the day and should continue to be for all the CMG executive management. On the anniversaries of outbreaks at restaurants, Dr. Jim Marsden, the new CMG Executive Director of Food Safety, should do interviews with regional media where the outbreaks occurred to talk about how much things have changed and how CMG will continue to diligently address the problems. On the same anniversaries, CMG executives should appear on business and popular morning TV shows, like the "Today" show. CMG should even lend its food safety expertise to its competitors to truly realize its stated vision of leading the industry in food safety.
CMG executives should stop expanding restaurants until it is at least one year beyond its food safety troubles. The freeze on expansion should have happened at the end of 2015, in my opinion, until the public and shareholders could be entirely confident that CMG had arrested its food safety problems.
Frankly, there is enough on CMG's executives' plates right now.
Among other things, CMG announced early in 2016Q1 that the U.S. Attorney's Office for the Central District of California had expanded its investigation of food borne illnesses in California to a company-wide investigation.
Additionally, another securities class action law firm announced on April 18th that it is soliciting shareholders who bought the stock from February 2015 to January 2016. The class action lawsuit alleges that Chipotle "made materially false and misleading statements and/or failed to disclose that: (NYSE:I) Chipotle's quality controls were not in compliance with applicable consumer and workplace safety regulations; (ii) Chipotle's quality controls were inadequate to safeguard consumer and employee health; and (iii) as a result of the foregoing, Chipotle's public statements were materially false and misleading at all relevant times."
If CMG wants to expand shareholder value over the long term, it should consider reducing its prices (especially given this week's consumer confidence figures). A $14 average check is simply too high in a QSR that most customers no longer believe to be something special. Prices can move back up gradually at some later point, but not in the first year - and certainly not the first quarter - after CMG had a food safety disaster.
The board should also consider a stock split to make shares more attractive so that smaller retail investors can buy full blocks. A 5:1 or, better, a 10:1 split would bring blocks much closer to the level retail investors prefer. It would also allow longer-term investors to "fine tune" their portfolio, by buying up (or selling off) smaller percentages of their holdings.
CMG executives should start to embrace the loyalty program they're planning to roll-out on a "temporary basis." Instead, they should make it permanent, make it a data-gathering, customer-focused experience (a free burrito on your birthday?) that can alert customers to specials, new store openings in their area, and customer-focused news. It's a great way to identify CMG customers and address them on a periodic basis (or to alert them if there is another food-borne illness outbreak.)
As I wrote in December, I don't see Chipotle ever recovering from its once-venerable (and overtly pompous) "Food with Integrity" position. Losing that standing should cause it to lose its premium pricing advantage and its astronomical growth prospects, both in terms of the number of restaurants it operates and the value of its shares.
Should the company suffer another food-borne illness blow, and should management not undertake some or all of the changes I have suggested, I look for the company to fall back, over time, to about $300 to $350 per share, based on lower margins, lower growth, and higher customer retention costs.
* I wrote (in a comment to my article) that
"The full page ads and apologies and public assurances that customer safety is Chipotle's 'highest priority' ring fairly hollow if senior management is not taking every step - immediately - to resolve the issue and to prevent anyone else from getting sick. I was appalled to read in the Bloomberg piece that the Chipotle executives say that halting expansion "never entered our mind." One has to question the "integrity" of such a decision - both in terms of management and PR.
Chipotle could hit a home-run in terms of restoring, retaining and even enhancing brand integrity and value and, in the process, create the industry / textbook standard for how to deal with these outbreaks, akin to J&J's handling of the Tylenol's product tampering 30 years ago.
Or, it could buy back stock from its shareholders and support its stock price. One choice commits to customers; the other to shareholders. One choice commits to the value of the brand; the other to the value of the stock. I know which I would choose.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The foregoing is only the author's opinion about a company and its operations, market, and management. It is not intended as investment advice, and you should not use it for that purpose. You should consult your own personal financial and investment advisers before undertaking any changes to your investment portfolio.