Chipolte (CMG) – Burrito Loco

by riskreversal September 27, 2016 3:12 pm • Trade Ideas

The last time I took a look at Chipolte (CMG) was late December (here) as the company’s e.coli / norovirus crisis was emerging. The stock had declined from its all time highs made in August 2015 at $760 to $500, and even after the stock’s 35% decline I had the following to say:

No matter how much you like this company, its product and or its management, given the stock’s quick decline, you have to weigh the potential for the news flow to turn quickly and the stock’s potential to reverse vs the continued uncertainty. No one knows how and when this is going to shakeout, but one thing is for sure, the bloom is off the rose, and it may take years for the company to gain back the trust of consumers, and shareholders.


The point here is simple, the fundamentals are in a fairly rare situation, they are un-quantifiable, which really only leaves us with sentiment and technicals. I suspect both have more to go on the downside, as there are few obvious quick fixes.

Valuation: For the time being it appears that despite not knowing what was the cause of the e-coli / norovirus cases that were ongoing until this past Spring, they have stopped now, and might have been totally random.  The company has made tremendous efforts to win back customers as eps is expected to fall 75% in 2016 on a 10% sales drop. For the time being most efforts appear to be failing as same store sales have not budged in the right way. EPS is expected to fall from a peak in 2015 of $15.43 a share to $3.71 this year with sales expected to drop from $4.5 billion to $4 billion this year.  Assuming that consensus estimates are close to correct with eps rebounding to $10 a share in 2017, the stock is trading at about 41x those earnings, near a 5 year high.

Activist: We are not exactly sure what the impetus was, but last month infamous activist hedge fund investor Bill Ackman of Pershing Square took a 10% stake in the stock. As Barron’s noted on Sept 7th, Pershing’s filing with the SEC suggested that they see CMG as “undervalued,” applauding “a strong brand, differentiated offering, enormous growth opportunity and visionary leadership.

Technichals: The stock has spent the better part of 2016 trading between $400 and $500, with the average price about $440.  CMG has found some technical support between $390 and $400:

[caption id="attachment_66649" align="aligncenter" width="600"]CMG 1yr chart from Bloomberg CMG 1yr chart from Bloomberg[/caption]

Taking a 5 year view and you can see just how important the $400 support level is. That was where the stock was in mid 2012 before a massive 21% one day post earnings decline. That decline ultimately carried on for months until the stock bottomed at $235 representing a nearly a 50% peak to trough decline from its then all time highs from April 2012:

[caption id="attachment_66650" align="aligncenter" width="600"]CMG 5 year chart from Bloomberg CMG 5 year chart from Bloomberg[/caption]

Options Snapshot: short dated implied volatility has shot up in the last couple weeks as investors look to the next identifiable catalyst, Q3 earnings which should fall in the third week of October.  30 day at the money implied volatility has shot up from about 25% (the price of options -blue line below) vs 30 day realized volatility (how much the stock is moving-white line below) barely budging as the stock trades in a tight range:

[caption id="attachment_66651" align="aligncenter" width="600"]From Bloomberg From Bloomberg[/caption]

So What’s the Trade?

For those who may be considering a long entry, thinking that $400 may be the floor and the next piece of good news may establish a new range above $450, a level the stock has been below since early June, we want to lay out a long stock alternative. The following strategy sets some parameters where the week to week gyrations within a recent range aren’t to be worried about as much, but if the stock moves higher you can participate. For example:

CMG ($420) Sell the Jan 380 put vs Buying 450/520 call spread total package costs $1.00
  • Sell to open 1 Jan 380 put at 12.00
  • Buy to open 1 Jan 450 call for 16.00
  • Sell to open 1 Jan 520 call at 3.00

Rationale – This trade uses the recent low to sell a put that almost entirely finances a $70 wide call spread in January with a break-even not too far above where the stock is currently trading (break-even 451). If the stock is between 380 and 450 this trade will expire worthless and the dollar is lost. Below 380 it’s like being long stock (and has a margin profile of being willing to buy stock there). Above 451 it has potential profits of up to 69 dollars if CMG is at or above 520 on January expiration. Between now and then there will be mark to market profits and losses based on the deltas (about 50 deltas here), but as long as the stock is above 380 on January expiration the most that can be lost is $1.