Chipotle: Corporate Disruption

Only a few months ago, Chipotle Mexican Grill (CMG) announced that Brian Niccol would take over as the new CEO from the co-founder. The stock has surged on this news rising $100 now, but my investment thesis has maintained that investors need to dump shares on this rally as the most likely outcome is disruption of the business model and cultural change from the hiring of an exec from Taco Bell that was at odds with the people at Chipotle. Today, the new CEO fired the first warning sign on this disruptive period.

Source: visitnewportbeach.com

Moving Headquarters

The restaurant chain announced the intention to move the headquarters from Denver to Newport Beach, CA. The move goes as far as to close the corporate offices in Colorado where Chipotle was founded 25 years ago. A costly move considering the company recently signed a 15-year lease at a new skyscraper in downtown Denver covering 5 floors.

The company plans to shut operations in New York and consolidate back-office operations into a Columbus office. Employees at that location will grow from 100 to 250.

The company had the following to say about the move but seemed to skip one key point that employees will quickly figure out.

We have a tremendous opportunity at Chipotle to shape the future of our organization and drive growth through our new strategy. In order to align the structure around our strategic priorities, we are transforming our culture and building world-class teams to revitalize the brand and enable our long-term success...The consolidation of offices and the move to California will help us drive sustainable growth while continuing to position us well in the competition for top talent.

In essence, new CEO Brian Niccol claims that top talent exists in the Los Angeles area, but he makes the same statement regarding access to talent in Columbus. The point not mentioned and quickly outlined by Business Insider is that the new headquarter location in Newport Beach is only about 10 miles from his previous job in Irvine at Taco Bell.

Existing employees will no doubt realize the move is to accommodate the new CEO not wanting to move his family and a decision to possibly poach more employees from Taco Bell on top of CMO Chris Brandt. Low employee moral or inexperienced employees isn't an ideal solution for turning around the brand. Difficult to serve the "food with integrity" concept while the corporate office just laid off most of the employees so the new CEO didn't have to move.

The CEO hire ironically continues to have an eery mirror with the Ron Johnson debacle at J.C. Penny (JCP). Both companies hired an outsider with related industry experience, but at retailers with very different customer bases. The most interesting comparison is that Mr. Johnson didn't want to move to Plano, TX and instead commuted from California. Sound familiar?

Maybe moving headquarters to a new location is more preferable to clashing with existing employees that aren't viewed as "top talent", but paying a premium price for a stock making such as drastic move doesn't seem logical. By the way, the move didn't work out for J.C. Penny as the stock has plunged from over $40 on the excitement of his hiring in early 2012 to a meager $2 now.

New Strategy

Since the health scare, my thesis on Chipotle has constantly hammered home that the company didn't need a new strategy. The Mexican restaurant chain only needed to hammer home the healthy aspects of eating at Chipotle and naturally assure that another major health issue didn't pop up.

Instead, the company went on an apology tour, changed the process for getting fresh food to stores and lost their message in the shuffle. Anybody looking at the below 10-year chart on revenues and the stock price would likely conclude that Chipotle has top talent. The health scare in late 2015 is starting to look like a blip on the radar.

CMG data by YCharts

The reality remains that Chipotle produced phenomenal results unlikely to be duplicated. The company generated restaurants-level margins in the 27% range prior to the health scare and just about the only restaurant duplicating those numbers now is Shake Shack (SHAK). In Q1, Shake Shack was up at 28.5% while Chipotle was down at 19.5%.

In essence, Chipotle found lighting in a bottle once and it's virtually impossible to repeat. Completely changing the corporate culture and replacing all of those employees that likely include people with deep knowledge of the business isn't a way to achieve these results.

Ron Johnson looked to change J.C. Penny stores into affordable chic similar to his work at Target (TGT) and expound on the high-end work at Apple (AAPL) stores. Customers wanted discounted merchandise and not an upgraded shopping experience.

New CEO Brian Niccol stayed on topic with the "food with integrity" historical concept of Chipotle, but he has routinely talked about innovation, altering the menu, changing the dayparts with a possible shift to breakfast and expanding marketing spend.

All of these moves pull the company away from the actual mission of the company to serve people with quality fresh food via a simple menu. Interestingly, the simple menu and focus is a shared attribute of Shake Shack and the new CEO is moving Chipotle farther away from the one issue that mattered.

No longer does the company discuss obtaining freshly raised food and no longer does the restaurant concept have a cult following.

The company plans a special investor call on June 27 to review the organizational changes. The meeting will have to outline additional costs and factor in disruptions in the business with the end impact being lowered EPS targets. A whole new corporate workforce must be hired to implement these new initiatives.

The below EPS targets will no doubt collapse. The company will be lucky hit $10 per share in 2019 making the stock extremely expensive at $435.

CMG EPS Estimates for Current Fiscal Year data by YCharts

With only 28 million shares outstanding, a few million dollars of additional expenses will have a huge hit on EPS. The company is making a shifty move to reduce the costs of being in Newport Beach by moving 150 jobs to low cost Columbus. Off course, the ideal solution was moving employees to Columbus from high costs areas like New York and Denver to cut costs versus shutting complete locations.

The involved cities have the following cost of living scores per Expatistan:

New York City - 241 Los Angeles - 192 Denver - 169 Columbus - 129 Takeaway

The key investor takeaway is that new CEO Brian Niccol wants to implement a new strategy, but most of 2018 will involve shifting office locations and hiring new employees at a high cost to business. Any business model can't possibly accurately estimate the impact to customers and employee morale including store employees not impacted by the shift. What one can derive is that any costly disruption is not good for a stock in the short run and hence a stock like Chipotle must be avoided trading at over 40x reasonable 2019 EPS estimates below $10.

Disclosure: I am/we are long AAPL.

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 information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.