New Report On Chipotle Food Safety, Staffing, Threatens Margins And Profits – Chipotle Mexican Grill, Inc. (NYSE:CMG)

NEW YORK (February 19) – A new report alleges ongoing food safety, training, staff, and management issues at Chipotle Mexican Grill (CMG) that could affect prime costs by increasing total labor costs and benefits as well as headquarters operating costs that will affect net profit margins.

Our Prior Reporting

We’ve reported on Chipotle since December 2015 since its Norovirus issues centered around Boston College and all through their problems with food safety. Our criticism of the founder/CEO and his management was harsh and unrelenting. Our commentaries and criticisms were cited by national media and pirated, often verbatim, in other websites.

We watched the stock crater, and rightfully so, we believed, because, in our view, CMG management put the safety and well-being of its customers behind the company stock price, an unforgivable sin in any business but particularly so in a business that can make people sick and even kill them.

We also found CMG’s use of pretentious, feel-good, but nebulous terms like “responsibly raised”, “clean food”, and “food with integrity” as marketing ploys generally disrespectful to, and exploitive of, a public that is mostly ignorant of USDA terminology. (Even today, Chipotle still references one of its meat offerings as “steak”, which has no USDA definition, versus merely “beef”; we presume because the former term sounds like it should command a higher price.)

But Chipotle management also seemed to repeatedly downplay food safety concerns, which we found to be unfathomable and indicative of extraordinarily poor judgement by senior management. Overall, we found CMG’s marketing terminology and tactics, to be too clever by half; a ploy to move what we view as basically “fast food” into higher cost, higher margin, “casual dining” fare. As we asked in the Summer of 2017:

“how long will customers continue to pay premium fast-casual prices for what is essentially a fast food (and beans, rice, salad and around (about) a quarter cup of protein) dining experience where “quality” amounts to a heavy helping of corporate PR with a side order of nebulous “Responsibly Raised” corporate propaganda?”

But in October 2017, we recognized that the brand was valuable, notwithstanding the management, and urged investors to “leg-in” to CMG once some of the main actors in the Chipotle C-suite had exited. We believed change was coming and that it was inevitable that the then-management team would soon leave day-to-day management. We called what we then believed would be the virtual bottom of the stock at the end of that month, although a bit too soon.

We suggested a buy-in at a price below $250. But events moved faster than we anticipated, and Chipotle took to the upside slightly over a month after our article printed here on Seeking Alpha. That was because on November 27, 2017, it was announced that the CEO would be stepping down as soon as a new boss could be found.

On February 9, 2018, Chipotle reached its bottom at $255, about $5 above our “less than $250 per share” buy-in price and, less than a week later, on February 13, the company announced that Brian Niccol of Taco Bell would become the company’s next CEO. We had presumed the Chipotle C-suite would stay intact through at least the 2017 Q4 earnings report and the price would move lower; below our $250 target. But that was not to be.

We have happily watched CMG’s turnaround ever since and even saw the company adopt some of the recommendations in our articles, like closing lower margin restaurants in over-saturated markets and diversifying its menu. The stock has appreciated considerably and the company was doing well, important to us, as it meant Chipotle’s workers – some 40,000 when last we checked – and investors (particularly those who bought in at the pre-food crisis high end) would be absolved of their losses.

A New Assessment

We had hoped that all the issues we reported on a few years ago had been resolved with the new management. We “stuck our heads” into Chipotle from time-to-time, but never much; certainly not enough to compile an article about it for Seeking Alpha. Things seemed fine, except for some routine regulatory issues with New York City’s strict hours of work law and a consistent single-digit to low-double digit weekly summary of illness reported on the IWasPoisoned.com crowd-sourced, self-reporting food safety blog website whenever we checked in. Aside from a little-reported Chipotle food safety issue in 2018, we barely noticed, the burrito slinger has been largely off our radar.

But now, it appears it should not be, at least not here in New York. And there are indications on social media that it is a wider problem that will affect prime costs and net margins.

A Damning New Report

Earlier this month, a new, little reported, 36-page report by progressive consumer group National Consumers’ League (NCL) and a powerful New York City workers’ union, 32BJ SEIU, alleged multiple instances of Chipotle restaurant managers circumventing the company’s highly-touted food safety measures, including pressuring employees to work even when sick (which was possibly the wellspring of the Boston College Norovirus outbreak); under-staffing to reduce prime costs; insufficient training; and instances where local restaurant managers appeared to know in advance that Chipotle’s EcoSure independent food safety inspector would be evaluating their location.

Other allegations included restaurant managers’ strictly adhering to budgeted restaurant metrics with concomitant pressures on subordinate staff, such as pressure to speed up work, not to come to work, deliberate and inappropriate under-staffing, sending workers home early from a shift; focusing on “throughput” (the number of customers put through the line in a given time), so that hand-washing and other food safety protocols are ignored; and foregoing necessary equipment repairs and equipment purchases.

Source: Reddit, as mentioned in our article from June 2017, where we quoted a purported Chipotle worker who said the company was not washing food according to procedure unless inspector was about.

Several of the complaints in the report echoed concerns we had raised in the past, such as from the picture we referenced in June 2017, above, about workers and even managers acting one way when CMG’s independent food safety inspectors were around and another when they were not.

While it is clear that Chipotle has one of the strictest protocols for food safety in the restaurant industry (even in New York City, CMG locations overwhelmingly earn an “A” ratings from the New York City Department of Health and Mental Hygiene), two other points need to be considered with that:

  • First, those protocols are absolutely necessary in a business model that requires on-site cooking with fresh produce and raw meats
  • second, that those protocols are alleged by people purporting to be CMG workers are at least occasionally being ignored

Among the worst worker allegations by people who purport to be current or former employees, who are made anonymous for the report – but presumably identifiable by the report authors – was a violation of what the report claims are Chipotle’s protocol for workers who have vomited. According to the report, under Chipotle’s protocols workers who vomit are supposed to be off for three consecutive days:

Worker 3 (Restaurant B) says he has “never heard of anyone” being kept from work for the full three days and gave the example that his GM asked him to work in April of 2019 even though the GM knew he had vomited two days earlier. Worker 3 asked if he was OK to work and “[the GM] said yes, I should come in. Generally managers [make] you work if you feel fine, even if you should be technically excluded.”

A year ago, a commenter on Reddit, purporting to be a Chipotle worker, and multiple replies, made clear that the mandatory three-day sick leave policy for workers who have vomited or had diarrhea, as described in the report, is unclear or mismanaged among a number of people who purport to be Chipotle workers.

Another worker “…a service manager at Restaurant U, says that his GM recently called a manager meeting where she instructed everyone “to make the lives of people who call out [sick] as hard as possible.” The GM also told all managers to mark workers as a “no-call, no-show” if they call out sick the day of their shift.

Duly Circumspect

To be clear, the report was written in conjunction with a New York City service union that would very much like to organize Chipotle workers and improve their working conditions; ordinarily, one might take such a report with a grain-of-salt, given the perspective of its authors, and parts of it might even be viewed as alarmist.

But the report echoes some of the reportage we cited about Chipotle back during its food safety crisis and cites reporting we see in social media by people who purport to be Chipotle workers, so we find it more credible than not. We are not alone. According to a local New York City media outlet:

(t)he report prompted Council Member Mark Levine, who chairs the legislature’s (sic) Health Committee, to call for a public hearing about fast food safety in New York City, according to a press release.”

We reached out to Chipotle for comment about the report since they had issued no news release on the report as of the date of our inquiry with them. Their entire reply, from Chipotle’s chief reputation officer, is shown below:

We are proud of our industry leading food safety practices and we are committed to a culture of food safety in our restaurants where employees are supported and heard.

Chipotle’s engaged and hard-working employees are what makes (sic) us great, and we encourage our employees to contact us immediately, including through an anonymous 800 number, with any concerns so we can investigate and respond quickly to make things right.

We will follow up on every allegation once we have access to the information.

Chipotle offers a quarterly bonus for ALL employees, which includes managers and hourly crew members, with up to a month’s worth of pay per year. Following proper food safety procedures is a requirement to achieve this bonus so it actually reinforces our best practices with everyone in the restaurant.

Chipotle is committed to creating a safe and engaging work environment for its employees by offering industry-leading benefits such as debt-free degrees, tuition reimbursement up to $5,250 per year, competitive health benefits and quarterly bonuses for all employees.

Chipotle does business in a number of jurisdictions where fair work week laws are in effect and a number of other states where progressive interests hold sway over the legislature and the executives are likely to consider them in the near future.

The Economic Policy Institute describes fair work week laws as

…laws (that) provide workers with greater stability, predictability, and flexibility in their work schedules; in many cases, they also require employers to give part-time staff opportunities to increase their hours before adding new staff. These comprehensive laws primarily apply to retail and fast-food workers-who are more likely than other workers to be subject to volatile work hours. The nearly 740,000 workers protected by these comprehensive fair workweek laws include an estimated 327,000 workers in New York City; 175,000 in San José; 172,000 in the state of Oregon; 40,000 in Seattle; 23,000 in San Francisco; and 2,500 in Emeryville, California.

Summary

Samuel Johnson, the 18th Century British essayist and critic is said to have written to the effect of, “Nothing concentrates the mind like an imminent hanging.”

Johnson’s quote is apropos to CMG’s circumstances as the distance between the Chipotle’s food crisis gets smaller in the rear-view mirror of time. Those food safety scares of the last decade dominated food safety news reporting, and for weeks at a time. The message many consumers took was clear: “If you eat at Chipotle, there’s an above average risk of getting sick.”

That narrative has changed more recently given a long stretch without a major incident and well-publicized food safety standards. But just as “eternal vigilance is the price of liberty”, eternal vigilance is the price of maintaining Chipotle’s fresh-never-frozen, prepared-on-site, business model. If the “Unsavory Side” report is to be believed, “Eternal vigilance” at Chipotle seemingly requires more than the company is currently doing.

In our view, vigilance will require extensive, paid training, continuing “refresher” training over a worker’s employment, better scheduling, higher pay to retain workers and far more random – and frequent – inspections.

Having food safety inspectors “parachute in” to a territory to carry out inspections is an automatic “tell” to other restaurants in the territory to heighten their food safety vigilance.

When Chipotle restaurants serve hundreds of diners per day, and Chipotle’s reputational risk is extraordinarily high should there be another widespread food safety crisis at even a single restaurant, extraordinary and constant vigilance are required. All that – training, scheduling, additional sick days, inspections, and more to protect the company reputation all require higher costs. Those costs, together with the possibility Chipotle workers will organize, given the obvious union pressure evidenced by the report, will likely trim margins for an already higher cost dining option with limited price elasticity.

We urge investors to hold, but hedge, their Chipotle holdings and regularly update their stop loss orders on the stock, but anticipate lower profits if the company takes the findings of the report and elsewhere to heart. If it doesn’t, we think investors should be prepared to take a hit if and when the next widespread food safety failure hits the stock.

And we would not count on it recovering this time.

Note: Our commentaries most often tend to be event-driven. They are mostly written from a public policy, economic, or political/geopolitical perspective. Some are written from a management consulting perspective for companies that we believe to be under-performing and include strategies that we would recommend were the companies our clients. Others discuss new management strategies we believe will fail. This approach lends special value to contrarian investors to uncover potential opportunities in companies that are otherwise in a downturn. (Opinions with respect to such companies here, however, assume the company will not change).

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The views expressed, including the outcome of future events, are the opinions of the firm and its management only as of today, February 19, 2020, and will not be revised for events after this document was submitted to Seeking Alpha editors for publication. Statements herein do not represent, and should not be considered to be, investment advice. You should not use this article for that purpose. This article includes forward-looking statements as to future events that may or may not develop as the writer opines. Before making any investment decision you should consult your own investment, business, legal, tax, and financial advisers.

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