How Chipotle's Comeback Attracted Big Data Robots And Value Investors Alike

By Antoine Gara and Maggie McGrath

When William Ackman's ailing hedge fund Pershing Square Capital Management bet $1 billion on shares in Chipotle Mexican Grill beginning in July 2016, the stakes couldn’t have been higher. Pershing Square was reeling from what would eventually be a near $4 billion loss in drugmaker Valeant Pharmaceuticals , which caused the high-flying hedge fund to post two straight years of heavy losses and its assets under management to fall by nearly half.

An e-coli and norovirus outbreak at Chipotle stores on both coasts of the United States, which hospitalized dozens of customers nationwide, meant Chipotle wasn’t faring any better. Once a stock market darling with a seemingly-addicted base of millennial-aged customers, Chipotle’s traffic plummeted, sales plunged as much as 30% and the once-high flying stock was nearly halved.

To invest $1 billion in Chipotle at stock prices hovering around $400 a share, Pershing Square and its lead partners on the investment, Ali Namvar and Anthony Massaro, had to believe success would one day return to the restaurant. Yet as Namvar and Massaro used Pershing Square’s value and activist-driven investment approach in the run-up to their burrito bet, a new class of investment experts -- data-driven research firms like Orbital Insights and M Science -- have also drawn investors to Chipotle shares, spotting what looks like a recovery. This new form of analysis, less about lasting business fundamentals and geared towards short-term insights on performance relative to expectations, reveals dramatically shifting tides in the world of investing that could imperil funds like Pershing Square.

With Chipotle’s stock in free-fall in the first half of 2016, Namvar and Massaro began to kick the tires on an investment, but their approach was increasingly at odds with the money that drives price fluctuations on Wall Street these days. Though a bottoming in Chipotle’s sales plunge and recovery would cause the stock to skyrocket, Namvar and Massaro spent little time trying to predict when such a plateau would occur.

Instead, they started with a big-picture assessment of the business and came to believe Chipotle was unique in the restaurant sector: Its menu boasted simple and artificial free ingredients - grilled and simmered in stores - prepared right in front of customers’ eyes. Steve Ells, Chipotle’s founder and CEO, was a classically trained chef who’d had ambitions of opening the next Michelin-rated eatery until he realized there was an opportunity to one-up fast food in American diets. The strategy had been a wild success -- until the norovirus outbreak.

Namvar and Massaro had a hunch that, despite the double-digit same-store sales declines hitting the company in the wake of the food safety scandal, Chipotle’s underlying business remained unparalleled. The company once boasted a $22 billion market cap due to its sky high store-level profits, driven by a quick turnover of customers spending nearly double what they’d shell out at McDonald’s, Wendy’s or Taco Bell. Pershing Square was confident growth would one day return. Continued domestic expansion and the beginning of an international push offered a margin of safety, they judged, as did opportunities for increased efficiency, mobile ordering and catering.

In July 2016, with the stock changing hands below $400 a share (an enterprise value of about $11 billion), Pershing began aggressively buying shares. By mid-October, Pershing Square built a 10% stake in Chipotle, making the hedge fund the company’s second largest shareholder to Fidelity.

Now, with Chipotle shares up about 15% from Pershing Square purchase price, the fund isn’t alone on its billion dollar burrito bet. A new breed of investor is increasingly nibbling on Chipotle stock armed with a completely different investment calculus. If these investors put their dollars to work, it’s because complex algorithms and reams of big data analysis -- not carefully honed instincts or long-term analysis -- says the security may soon pop in value. Forget Chipotle’s antibiotic-free menu or its standing with college-aged eaters; these investors are scanning satellite images, repositories of credit card data, email receipts and web traffic to confirm whether an opportunity exists.

In the past month, Chipotle’s once-dormant stock began to appeal investors whose eyes are open to these sorts of alternative data. On March 21, a highly-followed data research firm called M Science published a report that forecast Chipotle’s same store sales in February were tracking higher by about 20%, far more than the consensus of 15% growth among the Wall Street analysts who cover the restaurant.

Citing an analysis of their proprietary data inputs of traffic trends, M Science noted to its scores of hedge fund subscribers, “We now think Q1 ’17 same-store-sales will easily beat consensus expectations of +14.9% by about 300 basis points should the company just be able to maintain its February two-year growth rate in March.” In an April 21 follow up, M Science pegged Chipotle’s March sale-store-sales growth at 16%, still above consensus and showing continued positive momentum on a one-year basis -- albeit at a decelerating rate.

Since M Science published its report to subscribers in March, the stock has risen nearly 20%.

Separately, Orbital Insight, a big data research firm using artificial intelligence to scan satellite images provided by vendors like Digital Globe to count cars in Chipotle parking lots also forecast a recovery. In a March 27 post, Orbital Insight’s John Han published data that shows a bottoming of year-over-year car declines at the end of 2016 and a modest recovery in the first quarter. In an interesting twist, Orbital’s data also tested conventional wisdom about norovirus as the downfall of Chipotle's stock. Traffic, the firm found, had begun to peak several months before the outbreak emerged.

“People talk about how e-coli was the issue that caused stock to fall. That’s part of it, but we saw things already peaking a few months ahead of that,” Han told Forbes in a phone interview earlier this month.

In theory, Pershing could benefit enormously from using these types of insights; the minutia could help them time an investment (or, in the case of the peaking traffic, a short) to maximize its value. But it’s not clear if the old guard will ever jump on the Big Data train. Neither M Science nor Orbital Insight could confirm if they are working or will work with the likes of Ackman and other hedge funds; Pershing Square, too, declined to comment.

Part of the disconnect seems to stem from the time horizon on the investment. A.B. Mendez, a portfolio manager at Frost Investment Advisors, says he’s less focused on calling a plateau in traffic and more concentrated on getting value out of something that has become unloved by the market. And, besides, he still thinks old school stock analysts have a pretty good grip on Chipotle.

“We get research from so many brokers and many of them, especially the larger brokers that publish sell side research, do a lot of their own checks,” Mendez said, noting that self-respecting sell-side analysts have their own data sources.

Mendez bought into Chipotle in 2016 for many of the same reasons as Pershing Square: it was an opportunistic bet on a business that, essentially, started the whole fast-casual dining craze. He’s still holding onto the stock, and sees growth ahead. “They could increase their store count by 30% or more and not risk oversaturation,” he said.

In July, value investment firm Ruane, Cunniff & Goldfarb disclosed a new investment in Chipotle. "We contacted a number of food safety experts to verify that Chipotle management had established industry leading food safety practices in all of its stores. We reviewed the history of outbreaks at public and private restaurant chains and tallied the long term impact each outbreak had on each chain’s franchise value. Most importantly, we held conversations with dozens of industry veterans to develop a timeline for Chipotle’s recovery," the firm said of its diligence. "While we expect Chipotle to suffer through a slow and bumpy recovery, we believe the company has an opportunity to more than double its U.S. store base over time at terrific unit economics." Incidentally, like Ackman, the fund had also been handed crippling losses from its confidence in Valeant.

The optimism, whether it's from big data firms or shoe leather value investors, is a welcome projection for Chipotle, which in recent months has been going into overdrive to make sure the food safety scandal is firmly in its rear view mirror.

In December, the company got rid of its co-CEO structure and made founder Ells its sole chief executive (Ells had shared CEO duties with Monty Moran since 2009). It’s also changed its mission statement, launched a new advertising campaign and reached a settlement with Pershing, adding four Ackman-approved directors to its board. One of those four directors, incidentally, is Namvar.

Legacy equity analysts appear equally unconcerned with the potential threat that Orbital, M Science and their satellite-wielding, receipt-viewing ilk possess. Take, for instance, the latest Chipotle commentary out of Morgan Stanley.

“While momentum and sentiment may be near term drivers of the stock, in the long run, earnings are still what matter,” analyst John Glass wrote in a research note Monday.

“Following a 20% move in Chipotle’s share price since mid March,” he said, “we're left wondering what investors are seeing that we don’t.”