Meet the "new" lower margin, lower quality CMG $CMG (SHORT idea)
Structural changes in the wake of the multiple disease outbreaks linked to Chipotle $CMG restaurants will force higher costs and lower quality food on a business that was already seeing a massive slowdown in traffic before the latest 2 of 5 major disease outbreaks caught national media attention. Since serving safe food is not something that merits a price premium, CMG's new extensive testing on a very fragmented supply chain is an added cost. Brand perception survey shows major damage while CMG's "fresh" food image will go away as the company is modifying its prep methods (details inside). Please review the attached 74-slide deck.
Ampera Capital LLC
Meet the “new” lower margin, lower quality
Chipotle: some
t
houghts on CMG’s crisis
Short Chipotle Mexican Grill, Inc. (NYSE:CMG)
Prepared by Nick Mazing
Ampera Capital
nick.mazing@amperacapital.com
December 2015
Disclaimer
Duplication and distribution expressly prohibited
Not an offer to buy or sell any securities
Not a recommendation or a suggestion of any kind
This presentation does not create a client relationship
The information presented is fully publicly available and believed to be accurate
but is not guaranteed to be so
Any opinions and estimates presented are subjective by nature, likely to be
inaccurate, and can change at any time
There is no duty to update any statement contained here
Ampera Capital (“Ampera” or “we”/“our”)
currently has a SHORT position
in
Chipotle Mexican Grill (“CMG” or “the Company”) but this can change at any
time
Ampera may have positions in other securities mentioned here for comparative,
contextual or historical purposes
Prepared by Ampera Capital LLC: please read the disclaimer
2
Table of Contents
I. Executive summary
II. Introduction and thesis
III. What happened at CMG?
IV. Meet the new lower margin, lower quality CMG
V. Estimates and multiples contraction for 2016 are likely
VI. Brand perception and traffic are not recovering
VII. CMG’s decline in context
VIII. Risks and uncertainties
IX. Appendix
Prepared by Ampera Capital LLC: please read the disclaimer
3
Executive Summary
Prepared by Ampera Capital LLC: please read the disclaimer
4
Executive summary
The food safety crisis at Chipotle (E. coli and norovirus outbreaks in
2015) are challenging the chain
already suffering
from major same
-
store
sales deceleration
More incidents than nationally publicized
The new safety initiatives outlined by CMG will result in
lower margins
and
lower quality food on an ongoing basis
CMG’s premium multiple over the restaurant industry comps
will contract
with the new, lower margin structure
CMG
brand perception scores have already declined
precipitously
Empty restaurant pictures all over social media
CMG’s problems need to be viewed in the
context
of
Other consumer growth highflyers are crash
-
landing
Food as fashion on a somewhat slower cycle
Ampera estimates that CMG could trade towards $400 in 2016, down
from ~$550 in mid
-
December 2015
Prepared by Ampera Capital LLC: please read the disclaimer
5
Introduction and thesis
Prepared by Ampera Capital LLC: please read the disclaimer
6
Introduction and thesis
Ampera Capital LLC (“Ampera”) is an emerging NY
-
based
Long/Short manager that focuses on consumer equities
Founder is a former consumer banker at Lehman and operator at Aramark
Founder formerly
ServSafe
certified, the gold standard in applied food service safety
Previous restaurant ideas shared publicly on
SumZero
and/or HVST include:
December 2013: Potbelly PBPB (Short), Noodles NDLS (Short)
April 2014: Del Frisco’s DFRG (Short)
July 2014 Papa Murphy’s FRSH (Short), Arco Dorados ARCO (Long)
August 2014: El
Pollo
Loco
LOCO
(Short
)
March 2015: Habit Restaurants HABT (Short)
Ampera
has established a SHORT position in CMG
Ampera sees CMG at ~$400 in 2016, down from ~$550 in mid
-
December 2016
Street estimates too high + multiple contraction
Additional guide
-
down, first dip buyers selling, end of buyback all possible near
-
term catalysts
Prepared by Ampera Capital LLC: please read the disclaimer
7
Introduction and thesis
The food safety crisis at Chipotle (several salmonella, E. coli and
norovirus outbreaks in 2015) are challenging the chain
already suffering
from major traffic deceleration
The new safety initiatives outlined by CMG will result in
lower margins
and
lower quality food on an ongoing basis
CMG’s premium multiple over the restaurant industry comps
will contract
with the new, lower margin structure
CMG
brand perception scores have already declined
precipitously
Empty restaurant pictures all over social media
CMG’s problems need to be viewed in the
context
of
Other consumer growth highflyers crash
-
landing in Q3
-
Q4 2015
Food as fashion on a somewhat slower cycle
Prepared by Ampera Capital LLC: please read the disclaimer
8
What happened at CMG?
Prepared by Ampera Capital LLC: please read the disclaimer
9
What happened at CMG?
While the headlines have focused on the recent E. coli and Boston
norovirus incidents, CMG has been linked to
THREE
OTHER
outbreaks in 2015 which the company does not discuss
July 2015: Seattle, WA, E. coli, 5 known cases
August 2015: Simi Valley, CA, norovirus,
234 known cases
August/September 2015: Minnesota,
salmonella
, 64 known cases
Oct/Nov 2015: multi
-
state, E. coli, 52 known cases
December 2015: Boston, MA, norovirus, 140+ known cases
Key takeaway: the 2015 food safety crisis at CMG is deeper than
nationally reported. It comes as the company was already seeing
challenging traffic trends
Prepared by Ampera Capital LLC: please read the disclaimer
10
Source: http://www.foodsafetynews.com/2015/12/a
-
timeline
-
of
-
chipotles
-
five
-
outbreaks/#.VnYRBhUrIdV,
accessed 12/19/2015
What happened at CMG?
Here is what the company says:
Prepared by Ampera Capital LLC: please read the disclaimer
11
Source:
https://
www.chipotle.com/update
, accessed 12/19/2015
No mention that we
see of the large CA
norovirus outbreak, the
earlier WA E. coli, nor
the MN salmonella
What happened at CMG?
Here is what the company says:
Prepared by Ampera Capital LLC: please read the disclaimer
12
Source:
https://
www.chipotle.com/update
, accessed 12/19/2015
No mention that we
see of the large CA
norovirus outbreak, the
earlier WA E. coli, nor
the MN salmonella
What happened at CMG?
Here is what the Center for Disease Control (CDC) says:
Prepared by Ampera Capital LLC: please read the disclaimer
13
Source:
http://
www.cdc.gov/E. coli/2015/o26
-
11
-
15/index.html
accessed 12/19/2015
What happened at CMG?
Ampera comments
Five
separate
food safety blowups, E. coli (2x), norovirus (2x), salmonella (1x)
The source of the last E. coli is still unknown, something that is relatively rare
Compare to the very recent Costco E. coli cases, linked to chicken salad very quickly
Neither the CDC nor CMG have commented on possible
additional
E. coli
cases in
previously unaffected states
, such as Georgia
Prepared by Ampera Capital LLC: please read the disclaimer
14
Source: http
://www.ajc.com/news/news/local/women
-
say
-
they
-
got
-
sick
-
after
-
eating
-
kennesaw
-
chip/npfGT
/ accessed 12/19/2015
What happened at CMG?
Ampera comments (continued)
The norovirus case linked to a single location in Boston grabbed headlines, as
it affected over 140 students from Boston College alone
Prepared by Ampera Capital LLC: please read the disclaimer
15
Source
:
www.boston.com
and
www.foxsports.com
accessed 12/19/2015
Not the kind of headline you want to see
What happened at CMG?
Ampera comments (continued)
Understanding the gravity of the situation requires reading specialized
publications
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16
Source
:
http://www.foodsafetynews.com/2015/12/a
-
timeline
-
of
-
chipotles
-
five
-
outbreaks/#.
VnYRBhUrIdV
accessed 12/19/2015
Under
-
reported
What happened at CMG?
Ampera comments (continued)
At least one of the Seattle locations that was
closed and reopened during the
multi
-
state E. coli outbreak
has been shut down on or around Dec 10, 2015,
by state health authorities “for repeated violations”
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17
Source
:
http://www.seattletimes.com/seattle
-
news/health/seattle
-
chipotle
-
closed
-
for
-
repeated
-
violations
/
accessed 12/19/2015
What happened at CMG?
Ampera comments (continued)
Food safety is serious business
and CMG’s management is only now starting
to address the problems head
-
on
Sometimes things can go really bad
CMG has affected ~500 people: actual number much higher as only some
seek medical attention, and only some of these get reported up the chain
Prepared by Ampera Capital LLC: please read the disclaimer
18
What happened at CMG?
Ampera comments (continued)
CMG was already seeing decelerating SSS (same store sales) into Q4 when the
latest outbreak became national news (from the Q3 2015 release)
Prepared by Ampera Capital LLC: please read the disclaimer
19
Source
:
http://
ir.chipotle.com/phoenix.zhtml?c=194775&p=irol
-
newsArticle&ID=2098750
accessed 12/19/2015
What happened at CMG?
Ampera comments (continued)
CMG was already seeing decelerating SSS into Q4 when the latest
outrbreak
became national news
CMG had to run a Buy One
-
Get One Free “BOGO” promotion for 6 weeks
in Q3 to get the numbers up (Q3 2015 call transcript)
Q3
2014
transcripts has no mention of BOGOs or the “Friend/Faux” promo
Prepared by Ampera Capital LLC: please read the disclaimer
20
Source
:
http://
seekingalpha.com/article/3587406
-
chipotle
-
mexican
-
grill
-
cmg
-
steve
-
ells
-
on
-
q3
-
2015
-
results
-
earnings
-
call
-
transcript?part=single
accessed
12/19/2015
Side note: CFO doesn’t
know hot much food they
gave away
What happened at CMG?
Ampera comments (continued)
With SSS
already decelerating
from 19.8% to just 2.6% YoY in Q3, it is of no
surprise that CMG issued a rare warning on after the close on Friday, Dec 04,
2015
It is
unlikely that the warning incorporates the impact from the Boston
incident
(early reports on Dec 07) or the 11 am December 04 CDC update
CMG guided Q4 SSS at negative 8
-
negative 11%
CMG November SSS had dropped to negative 20% after the publicized
closure of 43 units, and ended November at negative 16%
In Ampera’s view, CMG will probably issue another update in
January 2016 on SSS trends,
likely surprising to the downside
Prepared by Ampera Capital LLC: please read the disclaimer
21
Source
:
http://
www.sec.gov/Archives/edgar/data/1058090/000105809015000047/cmg
-
20151204x8k.htm
accessed 12/19/2015
What happened at CMG?
Ampera pro
-
tip: when at CMG, do NOT do this; do this instead
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22
Meet the new lower margin, lower quality CMG
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23
Meet the new lower margin, lower quality CMG
Key take
-
away: the changes that CMG is making to address its food
safety crisis will very likely result in a new baseline of l
ower margins
AND lower quality food,
based on our analysis here
Chipotle has been a great concept, in our view
Simple, high throughput assembly: essentially sells one product, burritos (if
you think about it, the salad is a burrito with some ingredients subtracted)
Excellent food cost due to high rice/bean content and a lot of fresh, in
-
store
preparation
Company operated stores, cohesive “restauranteur” culture, beautiful
architecture/open kitchen designs, focus on operations and differentiated
marketing incl. marketing of its supply chain
Industry
-
leading AUVs
Still plenty of runway left domestically
It is possible that the small farm/local supply chain is the real weak
link in the model
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24
Meet the new lower margin, lower quality CMG
The recent incidents (2 publicized/3 less so, despite one being a
norovirus outbreak much larger than Boston) have led to plenty of
criticism of CMG’s marketing and crisis management
Ampera views things like “non
-
GMO” and “local” as ridiculous on a scientific basis but
understands their use in “feel good” marketing by the likes of CMG and WFM
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25
Meet the new lower margin, lower quality CMG
It is critical to understand that CMG is adding additional steps in its
food handling and preparation procedures that will likely result in
more handling (costs) and lower quality food,
in Ampera’s view
Additional testing on top of a fragmented supplier base
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26
Source
: https://www.chipotle.com/food
-
safety
accessed 12/19/2015
Additional testing. Can you charge more for
that? Probably not. New cost of doing business.
Meet the new lower margin, lower quality CMG
It is critical to understand that CMG is adding additional steps in its
food handling and preparation procedures that will likely result in
more handling (costs) and lower quality food,
in Ampera’s view
Additional handling and preparation
Prepared by Ampera Capital LLC: please read the disclaimer
27
Source
: https://www.chipotle.com/food
-
safety
accessed 12/19/2015
Did you get that? Formerly fresh produce will now be submerged in
boiling water. Will they boil the salad lettuce? Additional labor expenses
for sure. Effect on quality?
↓
Scalding risk? Can you charge more? No.
Meet the new lower margin, lower quality CMG
It is critical to understand that CMG is adding additional steps in its
food handling and preparation procedures that will likely result in
more handling (costs) and lower quality food,
in Ampera’s view
Additional handling and preparation
Prepared by Ampera Capital LLC: please read the disclaimer
28
Source
: https://www.chipotle.com/food
-
safety
accessed 12/19/2015
Read this again.
Washing tomatoes,
dicing them, then
washing them
again in a central
production facility.
Only then sending
them to stores.
Effect on quality?
↓
Can you charge
more? No.
Meet the new lower margin, lower quality CMG
It is critical to understand that CMG is adding additional steps in its
food handling and preparation procedures that will likely result in
more handling (costs) and lower quality food,
in Ampera’s view
Additional training and audits
Prepared by Ampera Capital LLC: please read the disclaimer
29
Source
: https://www.chipotle.com/food
-
safety
accessed 12/19/2015
Again, additional
necessary costs
that cannot be
recouped directly,
at least for now,
because of the
food safety crisis
the company is in.
Meet the new lower margin, lower quality CMG
CMG’s
own co
-
CEO’s confirmed our views
on quality and margins
in the recent interview on CNBC’s Mad Money on Dec 16, 2015.
Watch
the interview
, no pricing action plans and could not confirm
that the food will stay the same
=
lower margin, lower quality
Note that no numbers given during the interview; lots of awkward pauses; no
discussions of the large California norovirus outbreak and the MN salmonella
Did not answer Cramer’s question whether the food will be as good
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30
Source http
://video.cnbc.com/gallery/?video=3000466605
accessed 12/19/2015
Meet the new lower margin, lower quality CMG
It is important to understand that “lower margin, lower quality”
“new” CMG is a
directional
call
New lower margin structure is unknown even to CMG as it is work
in process
CMG’s cost of doing business just went up: their cost of serving safe food
just went up, but this is the industry expectation, nothing that a business can
charge more for (at least in the “first” first world)
Actual margin hit can be knowable only in
retrospect
New lower quality food is probably a given: products that used to
be fresh will now be submersed in boiling water; diced tomatoes
will be rinsed after dicing. Peas in the
guac
next? We hope not
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31
Estimates and multiples contraction for 2016 are likely
Prepared by Ampera Capital LLC: please read the disclaimer
32
Estimates and multiples contraction for 2016 are likely
CMG continues to trade at a premium vs. the overall industry
Ampera’s restaurant industry comp list consists of 57 names
Median 2016 EBITDA multiple declined from 10.7x in August 2016 to 9.6x
in mid
-
December 2016
CMG has already seen some contraction, from 18.0x to 16.3x
Only
substantially smaller, high
-
growth US chains trade above CMG: SHAK,
ZOES, WING and HABT
In our view
, “new” lower margin/lower quality CMG will see
continuous reversion to the industry mean multiple just as the
industry mean continues to decline. Not “just another” outbreak
Key take
-
away: CMG could trade materially lower on 2016 unit and
SSS assumptions that are not very different from those of Wall
Street analysts
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33
Source: Bloomberg as of 12/18/2015
Estimates and multiples contraction for 2016 are likely
Working assumptions
2016 average store count: 2,113 units (=Street estimate)
2016 average store revenue: $2.34 mm (3% drop vs. 1.8% SSS drop Street
est.)
2016 revenues: $4.944
bn
(1.2% lower than Street est.)
2016 EBITDA margin: 16.5% (vs. 19.5% Street est. due to negative fixed cost
absorption, unit
-
level inefficiencies, increased baseline marketing, and
structural margin changes described previously)
2016 EBITDA multiple 14.5x (vs. 16.28x on Street estimates now)
Implied EV: $11.830
bn
Implied market cap: $12.790
bn
(company has net
cash+investments
)
Implied share price: $410
(vs. $579.50 Street target, with 15 buys/16 holds/1
sell)
H1 2016 issues: choppy traffic driven by aggressive
marketing/BOGOs vs new cases, ongoing vs. one
-
time costs
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34
Source: Bloomberg as of 12/18/2015 and Ampera estimates
Estimates and multiples contraction for 2016 are likely
Prepared by Ampera Capital LLC: please read the disclaimer
35
Source: Bloomberg as of 12/18/2015 and Ampera estimates
A lot of room
for multiple
compression in
CMG
Brand perception and traffic are not recovering
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36
Brand perception and traffic are not recovering
Key
-
takeaway: CMG’s brand perception and traffic have
absolutely
collapsed
in the aftermath of the food safety crisis into December
Prepared by Ampera Capital LLC: please read the disclaimer
37
Source
:
http://
nrn.com/marketing/survey
-
chipotle
-
s
-
reputation
-
suffers
-
after
-
e
-
coli
-
outbreak
accessed 12/19/2015
Brand perception and traffic are not recovering
Social media flooded with empty CMG restaurant pictures
to this day
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38
Source
:
Twitter Search function, accessed 12/19/2015
Brand perception and traffic are not recovering
Social media flooded with empty CMG restaurant pictures
to this day
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39
Source
:
Twitter Search function, accessed 12/19/2015
Brand perception and traffic are not recovering
Social media flooded with empty CMG restaurant pictures
to this day
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40
Source
:
Twitter Search function, accessed 12/19/2015
CMG’s decline in context
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41
CMG’s decline in context
Key take
-
away: there is
no appetite
for consumer growth stocks in
Q3
-
Q4 2015 as the bull market gets tired
Even if CMG experiences a miraculous traffic recovery, it is very
far from certain that the stock will bounce back
Miracles do happen
: micro
-
cap sandwich chain COSI blamed the Pope visit
for its Q3 results, maybe this can happen in reverse
On a more serious note, we present a number of charts showing
steep declines in consumer growth stocks recently
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42
CMG’s decline in context: growth restaurants
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: SHAK
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43
CMG’s decline in context: growth restaurants
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: HABT
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44
CMG’s decline in context: growth restaurants
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: ZOES
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45
CMG’s decline in context: growth restaurants
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: BWLD
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46
CMG’s decline in context: growth restaurants
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: WING
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47
CMG’s decline in context: growth restaurants
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: FOGO
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48
CMG’s decline in context: growth restaurants
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: TACO
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49
CMG’s decline in context: growth packaged food
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: WWAV
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50
CMG’s decline in context: growth packaged food
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: MJN
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51
CMG’s decline in context: growth packaged food
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: FRPT
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52
CMG’s decline in context: growth packaged food
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: BUFF
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53
CMG’s decline in context: growth packaged food
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: BETR
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54
CMG’s decline in context: growth supermarkets
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: WFM
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55
CMG’s decline in context: growth supermarkets
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: SFM
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56
CMG’s decline in context: growth supermarkets
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: TFM
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57
CMG’s decline in context: growth footwear/apparel
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: UA
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58
CMG’s decline in context: growth footwear/apparel
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: LULU
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59
CMG’s decline in context: growth footwear/apparel
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: SKX
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60
CMG’s decline in context: growth footwear/apparel
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: VFC
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61
CMG’s decline in context: growth footwear/apparel
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: COLM
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62
CMG’s decline in context: growth consumer services
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: PLNT
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63
CMG’s decline in context: growth consumer services
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: FIT
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64
CMG’s decline in context: growth consumer services
N
o appetite for consumer growth stocks in Q3
-
Q4 2015: GPRO
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65
CMG’s decline in context: “food as fashion”
This is very “soft” thinking: there are certain parallels between food
and fashion: both work on cycles as formerly “new” things become
old, and then become new again with a twist
Pizza is a good example: personal sized, assembly
-
line types now “hot”
Mexican is not in a “new” cycle yet, it’s just there. CMG’s success has invited
“new Chipotle” imitators, some are now public
CMG will not have a “new
-
ness” tailwind for a while: it is a bet on a format
(limited choice Mexican)
Plenty of criticisms of the food itself (from Chubby Chipotle)
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66
Risks and uncertainties
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67
Risks and uncertainties: do not try this at home
The standard risks apply, including potentially unlimited losses
from short selling: don’t get “
KBIO’d
”
Some CMG
-
specific risks
Based on our own research, CMG still has a lot of believers: anyone who had
“missed” the stock is looking to get in at this opportunity.
In our view, this is not
“just another” food safety problem
. “New” CMG will be a different business, with
lower profitability, probably lower premium vs. historical, and with less
goodwill
JACK in the 1990s and YUM in 2006 not good comps
Problems at JACK much deeper (several deaths); easy fix (cook longer)
YUM/Taco Bell in 2006: YUM has traded off its China results for a long time, Taco
Bell less relevant at the time; no fundamental business changes required
CMG increased their buyback authorization and co
-
CEOs said in the Cramer
interview (link earlier) that they are buying back “aggressively”
Blackout period starting in January
Management appears contrite now, unlike the earlier reaction
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68
Appendix
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69
Appendix
Ampera’s published restaurant ideas have generally performed as
expected
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70
NDLS Short 12/2013
PBPB Short 12/2013
Appendix
Ampera’s published restaurant ideas have generally performed as
expected
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71
DFRG Short 04/2014
LOCO Short 08/2014
Appendix
Ampera’s published restaurant ideas have generally performed as
expected
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72
HABT Short 03/2015
Appendix
Ampera’s published restaurant ideas have generally performed as
expected
Two painful exceptions:
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73
ARCO Long 07/2014
FRSH Short 07/2014
Thank you for reading.
Ampera Capital is a consumer equities
-
focused long/short manager,
utilizing fully
-
transparent
Separately Managed Accounts (“SMA”) for UHNW individuals and
allocators. For more information on the strategy, please email
nick.mazing@amperacapital.com
Prepared by Ampera Capital LLC: please read the disclaimer
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