Barron's Streetwise - Chipotle's Back. Also, Who Needs REITs?

Episode Date: July 3, 2020

The burrito chain's CEO on culinary changes, the pandemic response, and growth potential. Also, Jack takes on real estate. Learn more about your ad choices. Visit megaphone.fm/adchoices

With record levels of dry powder available for investment, find out what's in store for private markets in 2025 and beyond. Listen to Crafting Capital in partnership with UBS at partners.wsj.com slash UBS, Spotify and Apple Podcasts. You know, and the next thing you know, we're pivoting to closing dining rooms, closing restaurants, some are digital only, some are takeout only, and it just became real time.

And kind of in that moment, I also realized, holy smokes, I think our digital business is going to become the business over the foreseeable future. And thank God, you know, we had invested the way we had. Welcome to the Barron Streetwise podcast. I'm Jack Howe. The voice you just heard, that's Brian Nickel. He's the CEO of Chipotle Mexican Grill, and I recently grilled him until he spilled all of the beans about his turnaround efforts at Chipotle, including a mobile ordering makeover that has kept the burritos flying during the pandemic. We'll also say a few words about REITs. Those are real estate investment trusts, a way for investors. Those are real estate investment trusts. A way for investors to gain some real estate exposure without buying entire buildings.

Chipotle and REITs coming up. With me as always, our audio producer, Metta. Hi, Metta. Hi. Metta, I ate a very important donut this past week. Okay, do tell. important donut this past week. Okay, do tell. I was out with my daughter and she talked me into stopping at the local bake shop for some sweets. It wasn't really a hard sell if I'm being honest. I got the brownie for her and a donut for myself. It was a pumpkin-y, glazy type of thing and they

put them in a bag. I was walking back out of the car and there were some outdoor tables at the bake shop and a couple of them were filled but it wasn't too packed and I've noticed lately that restaurants near us are reopening not just for takeaway but people sitting on the inside and I thought you know what this looks kind of pleasant out here so I got my daughter we sat at the table and we ate our sweets was the first time we dined in I guess you could say since the shutdowns in March. It might not sound that important, but I view it as a milestone donut on the road back to recovery. It's heartening to see some signs of recovery at nearby restaurants because I've been seeing mixed signals from Wall Street on sit-down restaurant chains. Around the third week of June, an analyst at

Wedbush Securities raised his revenue estimates for a handful of chains for both the second quarter of this year and all of next year. He wrote in a report that he's bullish on a brew house chain called BJ's Restaurants. The ticker there is BJRI. Also Chewy's Holdings for Tex-Mex. That's C-H-U-Y. And Darden Restaurant. That's the owner of Olive Garden.. That's C-H-U-Y. And Darden Restaurant. That's the owner of Olive Garden.

The ticker there is D-R-I. But he says those are only for investors who can stomach some likely near-term volatility. He also warns that a lot depends on things like whether increased unemployment benefits are extended and whether the virus gets worse. Around the same time, an analyst at UBS wrote that conversations with management teams and franchisees pointed to continued optimism around reopenings. But then a week later, right around the end of June, the research arm of Bank of America called B of A Global Research put out an analysis of Saturday night wait times at several hundred Olive Garden locations. It used Olive Garden as a proxy

for the group because it's such a big mature restaurant chain. The analysis showed that wait times were getting longer during June but that suddenly they've fallen again and lots of tables are available. The report also cited data from OpenTable, the reservation service. It said that reservation growth has slowed in general and gone into reverse in some states like Texas, Arizona, and Florida. The report attributes this to COVID-19 increases in those states. I want to see restaurant chains rebound because they're such an important source of jobs. And because when publicly reported numbers for the big chains get better,

it will probably mean that all those independent restaurants our friends and neighbors own are seeing some relief too. I had an opportunity recently to speak with the chief of a big restaurant chain that has done better than most during the shutdown. Hey Brian, it's Jack Howe from Barron's. How are you? I'm doing well. How about yourself? I was gathering a couple notes on you and I immediately became hungry for a burrito. I didn't have any way to get my hands on one, so the closest I had at the house was some chili. So I had some chili earlier in your honor. Hopefully now I can focus without getting too hungry. There you go. There you go.

I must admit, I think a burrito would have been better, but I understand. I bet. Brian Nickel became CEO of Chipotle in 2018. And before that, he ran Taco Bell. He presided over the introduction of the Nacho Cheese Doritos Locos Tacos. It's a taco supreme in a shell made of real nacho cheese Doritos. If you're still thinking about trying it, you're overthinking it. You know, Meta, that taco is a young person's game.

I feel like I need an edgier delivery. Hang on. He presided over the introduction of the Nacho Cheese Doritos Kick-Ass Locos Tacos. You know what, I might have overshot the mark there. Now Brian does not have plans to bring Doritos dusting to Chipotle. And by the way, those Doritos Tacos were a huge hit for Taco Bell and for that reason and many others, the chain sales grew nicely under Brian. Meanwhile, Chipotle sales had slumped.

Here's a 30-second history of Chipotle starting in 1993. Chipotle was founded by a classically trained chef named Steve Ells in Denver using an $85,000 loan from his father. The two of them calculated that the store needed to sell 107 burritos a day to be profitable, but after a month it was selling more than 1,000 burritos a day. Ells turned that restaurant into a new take on the fast food chain, with a focus on local sourcing of ingredients and plenty of on-premises cooking. Chipotle went public in 2006 and has become one of the greatest growth stories in restaurant

history with a recent stock market value of $29 billion. But in the few years before Ells stepped down and Brian Nickel came on board, Chipotle hit a rough patch. There were some food safety mishaps, including E. coli outbreaks in 2015. An E. coli scare causing Chipotle to temporarily close dozens of stores. A lot of damage has been done, Mr. Ells. Stock prices dropped double digits since this began in early November. That's a big loss on the bottom line. Federal prosecutors said more than 1,000 customers got sick during a series of outbreaks between 2015 and 2018.

Sales hadn't been the same since. There was also a confidence issue. A year before Brian got the Chipotle, I wrote a cover story for Barron saying that the company can grow from here, but that its food safety problems raise the question of whether some of its commendable practices like small farm sourcing and on-site cooking made food safety more difficult. When Brian arrived, he found a few things missing. When I got to Chipotle, what I found was it was a company full of ideas, just it lacked, I would call it, discipline and focus to figure out

what are the few things you want to do really well. And then I think they had lost some focus on executing the basics of running a great restaurant. So Brian began modernizing the way Chipotle prepares food and deals with its suppliers. Look, if you're going to take care of making the guac, you're not the person that preps the meats. If you're a person that works the grill, you work the grill. There's no reason why we cannot do local, wholesome, nutritious produce and meats and do it in a safe way. The good news is we've made a lot of progress and we're using what I would say are industry-leading food safety practices. And we've also educated the farmers and the suppliers on, hey, this is how you make sure that the rice gets to our restaurant in a safe fashion so that, you know, we don't have to throw it away when we get it in the event it's not right.

Brian didn't just focus on safety. He says he got back to basics on consistency and taste also. We just went back to following the original program on culinary of how to make great chicken, how to make great guacamole. And our food is terrific when it's done correctly. It's amazing when all the culinary is truly executed in all the food, meaning you get just the right char on the chicken and, you know, you get just the right amount of lemon, just the right amount of jalapenos chopped. In retail, including restaurants, Wall Street watches a measure called same-store sales. You ignore the effect of newly opened and recently closed stores to see how sales are trending at long-standing locations.

A few percentage points of same-store sales growth is generally considered a healthy result. Chipotle's same-store sales grew 11% for all of 2019 and more than 14% this year through February. The company was back to form, but then came COVID-19. What happens if we have to close all our restaurants? What's our burn rate? You know, I knew we were a special organization from the standpoint of we owned all our restaurants, you know, I had $900 million of cash, but you know, I'd never taken the time to say, well, shoot, if I have to close all my restaurants, how's our liquidity hold up? That was a theoretical exercise until it wasn't.

You know, and the next thing you know, we're pivoting to closing dining rooms, closing restaurants. Some are digital only, some are takeout only. And it just became real time. And kind of in that moment, I also realized, holy smokes, I think our digital business is going to become the business over the foreseeable future. And thank God, you know, we had invested the way we had. over the foreseeable future. And thank God, you know, we had invested the way we had.

That investment included getting mobile ordering right and rolling out a reward system. For young customers especially, digital is a must. The key is to process mobile orders without slowing down the line for customers who are ordering at the restaurants. Brian says he took a secondary food preparation line at restaurants that had been used for big catering orders and converted it to a system for fulfilling digital orders by the end of 2019. And that was good timing. Over the last four months, we've probably seen what I would have guessed would have taken us another four or five years to build as far as a database and adoption of our digital system happened in like four months. The digital business became the business. You know, it went from 20% of our business to 70, 80% of our business. Brian told me that 30% to 40% of his restaurants are open for dining in, but that most customers are still taking food out. He says he expects companies to

pay closer attention to their balance sheets long after the pandemic is gone. Chipotle had a strong enough financial position to honor first quarter bonuses for its workers, even though March shutdowns hurt quarterly growth. Barron's magazine included Brian in its recent top CEOs issue for his management during the pandemic. So what do Chipotle's growth prospects look like from here? The barriers to entry for making burritos seem low. I asked what sets Chipotle apart. Now, where else can you get a chicken burrito where it definitely can fill you up for a meal? And for most people, I think you can cut it in half and get two meals out of it for, you know, call it eight to ten dollars. And then when you stop and think you can cut it in half and get two meals out of it for, you know, call it $8 to $10.

And then when you stop and think about it, it's like, well, geez, you know, these guys take a different approach to animal welfare. We take a different approach to regenerative farming. We take a different approach to dairy. And we do what we believe are the things in a way where you're going to end up with better food, more wholesome, nutritious food, and done in a way that's sustainable. Chipotle stock is up nicely this year and was trading recently near all-time highs. It's valued at more than 70 times last year's earnings, which seems ambitious, even considering that earnings per share are expected to reach double last year's level within four years. So how big can the chain get? Here's Brian.

four years. So how big can the chain get? Here's Brian. Today we're 2,700 restaurants. I think we could easily be 6,000 plus restaurants just in the United States. And we're just getting started with Canada and we've got a few restaurants in Europe. And if you think about our average store unit volumes, you know, we're north of 2 million. I think we will definitely get back to 2.5 million. And, you know, look, I think our digital business helps us get, you know, close to 3 million. So lots of organic growth within the existing restaurants still to be had. And then just, you know, huge runway of growth to build new restaurants over the next, you know, five to seven years, next decade, call it. Meta, a couple of days after I spoke with Brian, I did a deep cover investigation of his digital delivery execution. So you ordered a burrito online?

Precisely. I downloaded the app. I chose 1245 as the pickup time, and I went to my nearby drive-thru at precisely 12.45. Hi, is this where you pick up a mobile order? And the guy had the bag sitting right next to him. Thank you. And it was piping hot. That was easy.

So were you wearing, like, sunglasses and a hat and, like, a long trench coat? I was wearing a surgical mask and a fake mustache on the outside of it. I was still feeling peckish for a little more restaurant analysis, so I reached out to Nicole Miller-Reagan. Hi, Nicole. It's Jack Howe from Barron's. Hi, how are you? Nicole covers more than 20 restaurant stocks for Piper Sandler and calls Chipotle a top pick. At this stage, they're getting near completion of what we call the recovery, and that is a return to what is record level or industry high, average unit volumes, margins, etc. And then the next phase is going to be accelerated development,

and that should be in the form of really unit growth and then an ability to utilize their balance sheet in a normal environment. Nicole agrees that the management change at Chipotle has been healthy. You don't often see the founder running the company for that long. And then again, the people were fantastic. They were separated. You had finance operations, et cetera, in Denver and you had marketing in New York. So they were siloed. And then again, the company outgrew a talent. And again, they're very talented people, but it was now a national brand. And so bringing in the new team is not about Chipotle returning to what it was, but capitalizing and leveraging on Chipotle as the next global growth brand.

capitalizing and leveraging on Chipotle as the next global growth brand. I asked what kinds of restaurants will succeed in this environment and be best positioned for an industry recovery. Bigger is better, says Nicole. Scale is going to absolutely dominate in this market. From a fundamental perspective, that just means a footprint. And that means proactive versus reactive. That means a balance sheet loaded with cash instead of debt. And from an equity capital markets perspective, that's going to mean large cap turning into mega cap stocks. Another favorite of Nicole's is Wingstop Restaurants. The ticker there is WING. It has a strong takeout business.

And there's something related to gender. Maybe I should let her explain. There's a gender divide as there's the reopening process. So the males have been less anxious. And within that category, the dads want to get out more than, let's say, individual households. I know my husband's sitting next to me. He's like, duh, like no kidding. Whatever do you mean? Yeah, that's been established in some survey work that we've been provided through a partnership. And I found that very interesting.

It does explain, you know, Wingstop's 30% plus comps. So is Wingstop the manliest of the restaurants then? Well, and I do want to be very careful because they're very, very broad demographic profile. But let's say you're talking about skewing 55%, 60% male, not like 90%. But just even that little bit is just going to give the nudge in the direction. They're the ones basically willing, saying, I'll get in the car, I'll go out. Mom's saying, no, I'm going to stay home. I'm going to have Chipotle delivered while I'm in my Lululemon pants, while I'm using Instacart, right, to have my groceries delivered, right? That's what's happening for mom.

Dad's out buying a rifle, an RV, and chicken wings. Madda, it's listener question time. I'm excited. I know you're excited. You're excited, right? Totally. Who do we have? We've got a question from Josh from Pittsburgh. Let's hear it. I'm one of those Robinhood retail investors you've been hearing so much about lately in the news. My question has to do with adding REITs to my portfolio.

Are REITs a good way for me as a retail investor to get real estate into my diversified portfolio, or should I leave that to my retirement savings account? Thank you, and I really enjoyed listening to the show. Thanks, Josh from Pittsburgh. I think your question is, should you buy REITs in your regular account or your retirement account? Let me answer that in two parts. Not really, and I don't think so. I'll preface this by saying, I have plenty of opinions that don't match up with orthodox Wall Street thought. Most of them involve stuff investment companies say you need in your portfolio, but that I think you don't need. For example, we talked about gold in an earlier

episode. REITs, for people who don't know, are real estate investment trusts. The trust buys real estate, it collects rents from tenants, it passes the income on to investors as dividends. The case for REITs is summed up nicely by a customer brochure I looked at recently. It was put out in 2013 by one of the big U.S. brokerage firms, and it says that REITs have had a low correlation with stocks and that they've also had handsome long-term returns. Low correlation means two investments don't behave the same way. If one tanks in a given year, the other might hold its value. And that could reduce the overall risk of a portfolio. The brochure points out that over the prior 25 years, both

U.S. stocks and U.S. REITs had returned an average of around 10% a year. That's a great deal. Reduce your risk without sacrificing returns. The problem is that was 2013. If we look now over the past five years, that same broker's REIT index fund has returned only 2% and change per year versus over 10% for its U.S. stock index fund. Now, maybe we're just catching REITs at a bad moment, but that's kind of the whole point. Stocks have bounced back this year, but the S&P 500 is still down a few percent year to date. The REIT component of the S&P 500, however, is down more than twice as much, 8% and change. S&P 500, however, is down more than twice as much, 8% of change. REITs are supposed to help offset weak periods for stocks, but lately they've amplified the downturn and parts of the REIT world

have had atrocious performance. Morgan Stanley pointed out recently that office and strip mall REITs were down more than 30% year to date. Hotel and enclosed mall REITs were down more than 30% year-to-date. Hotel and enclosed mall REITs were both down closer to 50%. That doesn't sound like a safe haven to me. What's happening, of course, is that the pandemic has worsened the challenges of malls, shut down hotels, and shifted millions of office workers to their homes. And that's causing investors to wonder whether office occupancy will return to normal or whether the shift is permanent. But let's put returns aside. The main reason for my REIT skepticism is the question of why I need them. I own a house. Isn't that real estate exposure?

That 2013 brokerage brochure says no because I don't collect rent. That's true. Not only do my kids pay me nothing for the bedding and meals, but I have to help the older one with her math homework and give the little one baths. It's a terrible deal. But then again, my house has an implied rent in the form of money I don't have to pay for rent because I own a house. Also, I have exposure to house prices changing over the long term, hopefully rising. We'll see. Anyhow, I also own an S&P 500 fund and that has about three percent exposure to REITs not only that but all those non-REIT companies in the S&P 500 they own commercial real estate I mean they don't rent it out

they work in it and try to make profits think of all those Amazon warehouses I think I'm pretty well stocked up on real estate without REITs. Now, Josh, you might one day find individual specialty REITs that appeal to you for their growth prospects, and that's fine. In recent years, REITs that own data centers and cell phone towers have looked more like tech companies than landlords. I'm sure we'll have new categories of growthy REITs in the future. new categories of growthy REITs in the future. But should you buy REITs? I'll refer you to another 2013 document, that year's letter to Berkshire Hathaway shareholders written by Warren Buffett. In the letter, he writes about his will. His Berkshire shares will go to charity, and there's cash that will go to a trustee to manage for his wife's benefit. Now, in the letter, Buffett discloses his instructions for

the trustee. Put 90% of the money in a low-cost S&P 500 fund and 10% in short-term government bonds. There's no mention of REITs or commodities or fancy pants asset classes you've never heard of. Some older investors might say they need REITs to be able to spend the income, but there's nothing to say they can't just buy a stock index fund and occasionally sell some shares. Anyhow, if you're very young or worth billions, feel free to put 90% of your money in the S&P 500 like Buffett's will says. The rest of us might want to dial down the risk a bit, but consider doing that by shifting the mix, not by adding more packaged investments promising stock-like returns without the stock-like risk. Thank you, Josh from Pittsburgh, for sending in your question. And everyone,

please keep the questions coming. Just tape on your phone, use the voice memo app, and send an email to jack.how, that's H-O-U-G-H, at barons.com. Also send comments. Am I wrong about REITs? Tell me why. Are you offended by a generalization you heard about who likes Lululemon or rifles or RVs or chicken wings? Don't yell at me for that. That was Nicole from Piper Sandler. Go ahead and yell at me. I'll just cry myself to sleep in the RV tonight with a face full of wing sauce. Thank you for listening. Meta Lootsoft is our producer. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts.

And if you listen on Apple, please write us a review. It helps other people find the podcast. Follow me on Twitter to find out about stories and new podcast episodes. That's at Jack Howe, H-O-U-G-H. See you next week.