Could Activist Trigger McDonald's (MCD) to Repurchase Chipotle (CMG)? - Buckingham Research

September 7, 2016 8:02 AM EDT
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Price: $411.94 +1.69%

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Buckingham Research analyst John Zolidis weighed in on Chipotle Mexican Grill (NYSE: CMG) following news activist investor Bill Ackman has amassed a near 10% stake in the company with the 13D having fairly standard language.

Zolidis highlighted the following key points amid the disclosure:

Is there a more specific activist story/investment thesis out there? During our discussions with investors we have heard criticism and complaints around the following topics: management compensation and structure, the slow roll-out of apps and technology, a weak and slow response to food safety and supply chain issues, an overcapitalized balance sheet (leverage is currently 1.6x lease-adjusted EV/ EBITDAR vs. an average of 2.9x for the group), unnecessary distraction incubating growth concepts, and slow progress internationally. However, none of this appears to come together into a coherent, specific course of action that would unlock shareholder value, similar to what we are currently witnessing with Buffalo Wild Wings, Inc. (BWLD, NEUTRAL). See our note published yesterday (Refranchising Math Points to Upside for Equity Value) on a recent BWLD 13D activist proposal.

Could McDonald’s (MCD; Not Covered) repurchase Chipotle? This idea has been mentioned to us more than once. The idea is that CMG would provide MCD with a growth vehicle. Further, MCD has the infrastructure and expertise in place to convert CMG to a franchised model which perhaps could unlock further value. CMG currently operates 100% of its locations thus making it more difficult (or at least more time consuming) to pursue a franchising strategy as an independent company. MCD could also leverage its international reach to accelerate CMG expansion overseas. Lastly, assuming MCD paid a 50% premium to yesterday’s close, it would equate to an ~$18B deal vs. MCD’s $102B market cap. If this was entirely debt financed it would move MCD’s lease-adjusted debt to EBITDAR ratio to 4.9x from 3.3x. This level of leverage would be similar to that of other highly franchised restaurant companies including QSR, (5.2x) DPZ (5.0x), or WEN (5.5x). Frankly, we believe a McDonald's-Chipotle transaction has peu de chance. Rather, we mention it in an effort to be comprehensive as we speculate on a possible activist angle for this investment.

The real issue remains regaining customer trust, in our opinion. It’s easy to make up strategies to unlock value at CMG. However, what is really required is the return of the customer following the food safety issues from the last year. Little seems to be making this happen although we are hopeful that time heals all wounds. In addition, we note that CMG has added incremental promotions in the last week (free soda for students and free kids’ meals on Sundays) on top of the frequency program Chiptopia which is ongoing through the end of September. Our view on these promotions is that sacrificing margins for traffic is acceptable in order to get customers to return to the stores and get comfortable again with the concept. It’s unlikely that any activist effort can accelerate the process of regaining consumer trust but we imagine the company is open to additional ideas on this front.

The firm maintained a Buy rating and price target of $547 on CMG.

For an analyst ratings summary and ratings history on Chipotle Mexican Grill click here. For more ratings news on Chipotle Mexican Grill click here.

Shares of Chipotle Mexican Grill closed at $414.07 yesterday.

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