Learn From Chipotle!

I have never eaten at Chipotle only because as a fast food joint I assume I can't get a cerveza with my combo plate, and a Mexican meal is incomplete without a Negra Modelo.  And anywhere there is a Chipotle, there is a mom and pop taquiera with beer.

Now Chipotle is billed as "fast and fresh" and I have to admit the fast food aspect of their stores is also a bit off-putting.  But never mind, fast is part of their thing, and so is fresh.

The problem with fresh is it takes big Ag to supply 1900 stores with "fresh" and e-coli outbreaks come with big Ag, not small mom and pop.  In modern "insurance" big biz assumes a certain amount of death of customers, and credit is set-aside for payouts (as opposed to insurance companies regulating how and when they will cover a risk. )  Mom and pop cannot afford to kill customers, they being more free market, as opposed to the capitalists who can afford to do so.  Mom and pop just make sure the food is wholesome.  Chipotle just makes sure the shift is covered.

Now Stockman, ever interesting, has taken apart the financial success, and distress, of Chipotle, which has become McDonald's bete noire.  While interesting to rentiers, we who actually must produce may take a additional very important lesson Stockman does not offer.

Thus, at its early August peak, CMG’s $24 billion market cap represented 48X the $500 million of net income it had posted in its most recent LTM filing. But the 1,900 Chipotle restaurants that fetched this nosebleed PE multiple are not high-end food emporiums serving gourmet fare at luxury prices to the top tier of affluent households.
Actually, they slop out burritos, tacos, salads, black beans, salsa and chips at $9 per ticket. Its customers are mostly millennials, who have an average of $155 per month of discretionary income, including the ones living in mom and pops basement.
The business has no barriers to entry and miniscule brand advertising. It is being assaulted by an army of competitors including established chains like Taco Bell, and newcomers like Qdoba and countless more, who have belatedly discovered the popularity of Tex-Mex fare. And CMG is also now running into saturation of prime locations and markets—–the fate that always and everywhere brings down high-flying retail and restaurant roll-outs.
Yes, CMG has a clever marketing gimmick and value proposition. That is, that its food is fresh, organic, locally sourced and that the pigs and chickens which end up in the burrito bowls have not been ill-treated on an industrial farm.

Those metrics, $9 fresh mex meals to $155 discretionary income are useful to anyone contemplating self-employment by means of a restaurant.  Keep in mind just becasue nominal stock valuation changes does not mean the productive capacity of the chain, or its survivability is in question.  Cisco never returned to its high valuations of 15 years ago, but it is still a productive powerhouse. Stockman is only pointing out you'd be nuts to invest in Chipotle (or have been nuts) at this stock price.

So what? Is there anything in that proposition that could not be eventually duplicated by aggressive competitors——even if they needed to play catch-up ball for awhile?
The fact is, no company has ever permanently dominated a new chain restaurant category indefinitely——-from hamburgers joints to pizza chains, seafood eateries, pasta places and high end steakhouses. Nevertheless, Chipotle’s absurdly high PE multiple reflected exactly that proposition—–hyper-growth and complete dominance, world without end.

Now David, hold-on...  at 50 years and counting, Micky D has had a run that was great to many who have come and gone from that org.  But true, there are far more gone in each category than surviving, but that was the point of the last 40 years of capitalism: collectivization.

In fact, Chipotle’s approximate 25% annual earnings growth since 2009 was taken exactly out of a tried and true cookie cutter. Profits were growing because the company was rolling out 200 new stores per year based on leasing costs that were dirt cheap due to the Fed’s repression of interest rates and an abundance of gig-based labor at the minimum wage.

Since 2009?!  It took McDonald's 50 years to get to 2000 restaurants.  But then came Nixon, and McDonald's started opening 1000 a year (McD donated a quarter million to Nixon's re-election).  MeDonald's never experienced that crazy valuation, but it is exactly that lending credit that incites crazy valuation and excess production capacity.

McDonald's was started in the 1950s, along with a million other burger joints, all building on vendor financing...  so with KMart and WalMart in 1962, and countless other companies who had built management teams that had coalesced into tight machines, and could take advantage, right place at right time, of Nixon going off the gold standard, one mistake, and then banks lending credit, another.  Not all teams could manage it, In the 1950s, A&W Root Beer, started in 1919 in Lodi, had 450 shops, already the biggest.  The Marriotts, of hotel fame, got started as an A&W franchisee. By 1960 they had 2000 restaurants, but no standardized menu (the Root Beer was the only common thing).  Although each was essentially a burger joint, a non-standard menu meant each store could buy local, wholesome.  it is the only chain where you can approximate the better quality food of the 1960s, and accordingly, you see hot Rod conventions with geezers and their vintage cars at the few remaining A&W locations.  Point being, when the right time and place was there, A&W's original team had broken up, and so they could not act on the new regime.

Now, note, just because Nixon did something wrong, does not mean the banks must do something wrong too.  Bankers might have shown some integrity, but they didn't, or the ones who did were obliged to eave banking.  There were some test runs of lending credit at a very high level, and then the rot began to work down to this day where welfare is generated on the fly at places like ExImBank and at gas stations when someone buys a meal with an EBT card.

Economics is taught as though it is value free, like math, but it is not, it is a subset of ethics on the field of philospohy.  A dead give-away is the economic term "moral hazard."  The fact that bankers could not resist making something for nothing shows going off the gold standard is not a value neutral event, it has consequences that matter.  One might study it dispassionately, but once known, one is obliged to act accordingly, right or wrong.

But back to the data:

For instance, Panera’s food costs is 34% of sales compared to 33% for Chipotle. Even in the case of the burger chains, food and paper costs run in the same zone, and were about 32% in Wendy’s most recent quarter.

As long as I can remember the metric for restaurant is 1/3rd of the cost is food.  I wish I could find the source, but somewhere there is a proof that all competitors eventually fall within key business rations... profit margins, cost of goods sold, ROI, etc.  An autographed book to the first person who can remind me of it!

That’s especially true for a wholly owned restaurant operation that now has upwards of 2,000 locations and 53,000 employees paid at an average rate of just $20k per year.

Ach!  Who can live on 20k per year as an employee?!   On the other hand, as self-employed (customer employed) you would never want to make more than say $20,000 per year.  Whereas mmost people work as employees to earn enough to live a given lifestyle, after giving their best hours making someone else's dreams come true, for the customer-employed the work is the lifestyle.  And just about everything personal is also a business expense.   In Seattle a surviving 1950s burger shack chain called Dick's pays probably in the $20,000 per year range, but also pays the Community College tuition of any worker with more than 6 months seniority.  This is family stuff...  instead of paying someone $25K and that person taxed on it, make a donation before tax as a business expense and make the employees' earnings go farther. (Two new rules may ruin this: 1. The IRS now taxes scholarships as income.  2. Seattle's $15 and hour min wage, a 50% increase at Dick's, will no doubt wipe the company out.)

In Chipotle’s case, there was even more foolishness embedded in its high PE multiple. Competitor risk was coming. Supply chain risk was self-evident. Constant prices increases to its less than affluent customer basis were a ticking time bomb. Choice locations in most of the US had been used up. Tex-Mex wasn’t catching on abroad.

Tex-Mex saturation?  Maybe so, but maybe your flavor is Peruvian...  or, who knows.  I watched Dick Clark interviewing a singer in 1981...  Clark could not remember the word for raw fish on rice at Japanese restaurants, because it was so new.  In 1978, Japanese restaurants were pretty exotic, but only served sukiyaki and tempura.  By 1981, they were becoming hip and cool and a new thing.

Stated differently, the earnings from intangible goodwill not backed by brick and mortar assets, patents, proprietary know-how, breakthrough technology or super-heavy advertising and marketing on a permanent basis cannot possibly be worth 48X. The fact that CMG reached this lunacy only a few months ago is screaming evidence of the monumental complacency that prevails in the casino.

So those are the key elements in a mass food chain success?  As a mom and pop, or as I prefer, specialty, you'll need brick and mortar, but rent, down own it,  you won't need patents, you'll have your know-how, as to tech, well, a griddle and folding card tables and chairs to start?  As to advertising, well, your every customer is within 5 mile radius, and they will be reached with your business sign, and maybe a 2-1 intro coupon in the local mailer.

Yet you don’t have to be excessively observant to recognize that the 20-year global credit and economic boom led by the Red Ponzi in China is coming to a screeching halt because the central banks have well and truly run out of dry powder and credibility. The world economy is self-evidently in the midst of the greatest commodity deflation since the 1930s, while industrial prices and profits are getting whacked hard and CapEx is plunging into a veritable depression.

This is not 20 years old, it is 40.  I wonder at his mantra "China Ponzi" scheme.  Deng Xiaoping took a world tour victory lap in '79 and was schooled on how to play the hand the USA hegemon dealt 7 years earlier.  Deng played it masterfully.

Forget the fact that China allegedly grew at just under 7% last year, when power consumption did not grow at all and rail freight volume plunged by an unprecedented 10%. Or that Korean exports are now down by 15% on a Y/Y basis. Or that crude oil, copper, iron ore and ocean freight rates are in a death plunge.
Already honest GAAP earnings for the $&P 500 companies have plunged from a peak of $106 per share in the September 2014 LTM period to $90 in the most recent LTM period—–or by 15% and the bottom line weakness is just beginning to spread outward from energy, materials and industrials. Macy’s anyone?
Even then, the broad market multiple at 22X is not the half of it.
( To be continued)

This bad part is USA policy of lending credit at interest inevitably, inexorably gutted USA manufacturing and transferred technology (know how) out of USA.  The coming crash is condign punishment, and those who believe they have savings or financial assets are going to be fighting over the productive capacity of Chipotle to support them in old age, or on disability, or provide for retirement health care, or whatever promises made but impossible to keep.  Your best bet: get slef employed (customer employed.

I look forward to his 2nd instllemtn

In the meantime, all that talk of Mexican food has me yearning for Mexico.    I first heard this song in Puerta Vallarta.

Ladies and Gentleman, Luis Miguel:


Feel free to forward this by email to three of your friends.

Bookmark this post --- Email this post