How Chipotle's Leadership Disappointed on Its Earnings Call

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In this this Market Foolery segment, host Chris Hill and Motley Fool Funds' Bill Barker digest Chipotle Mexican Grill's (NYSE: CMG) report -- which was fine -- and its conference call, which had Hill (a shareholder) feeling a bit irked. How should Steve Ells have responded to its latest health safety issue? Is it even that big a deal? Do the real facts even matter once the PR issues take hold? And why, oh why, hasn't Chipotle started serving breakfast?

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A full transcript follows the video.

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This video was recorded on July 26, 2017.

Chris Hill: Chipotle's second-quarter results came out last night. They were, obviously, not taking into account the recent norovirus outbreak at the location in Virginia. The numbers were fine. As a shareholder of Chipotle, I went into this quarter bracing myself for a slashing of guidance. That did not happen. I was also crossing my fingers hoping that management, and in particular CEO Steve Ells, was going to be saying all the right things. And I can't say I'm thrilled with what he had to say on the conference call. In a nutshell, it seems like there was still a decent amount of denial going on. If not denial, defensiveness on the part of Steve Ells and his management team, because they keep talking about the health protocols that they have in place. They're like, "We've got this. We're the only major restaurant that has this particular type of safety protocol." And I just want to kind of scream, shut up. [laughs] Don't tell me how great your health protocols are when over 100 people are reportedly getting sick and you have to shut down the store!

Bill Barker: All right, what would you have preferred? The question is going to get asked on the call. If they don't address it first, then it looks like they're hiding. So your preference would be what? That they say nothing about it in the presentation, and then the question comes, "People are getting sick again; what's up with that?"

Hill: Here's what I would have preferred. I would have preferred, and we talk about emotion in investing, and books have been written about Warren Buffett and taking the emotion out of investing, and all of that makes perfect sense to me. Every once in a while, when something is going wrong, and in the case of Chipotle, we're talking about something that has gone wrong more than once, what I want to see is anger. Frankly, I would have been perfectly happy if Steve Ells had addressed the health issues with a level of anger in his voice, and drawing lines in the sand and saying, "This isn't acceptable. We blew it again, and heads are going to roll if XYZ."

Barker: His own head?

Hill: You know what? If I'm on the board of directors, I'm seriously considering that. He's the founder-CEO, he's the visionary, and I know he's not necessarily the operational guy. That's fine. Get someone in there who is the operational guy or gal. You see these reports were Chipotle is saying, "We figured out where the problem is, and it has to do with our management at the local level." In the case of Chipotle, they're saying, "It's not a problem with our food supply. This was an isolated incident at one location." OK, fine, what was the problem at that one location? "Well, management wasn't really upholding the safety standards and the health standards that we have put in place." 

As a shareholder and someone who has watched this company for a long time, my question for that would be, how is that possible? Since one of the things I hear and have heard for years about Chipotle, in reference to why they don't roll out more locations more quickly -- they have this concept that people like; why aren't they opening more locations more quickly? And the response is always, well, they really take their time picking the location, training the staff, they have to get everybody on board, and it makes it sound like it's the greatest staff in the world, the best-trained staff in the world. We talked the other day about McDonald's. Do you know what McDonald's doesn't have? They don't have these types of problems with their food supply.

Barker: No, but everybody does at some point. I think one of the problems for Chipotle is, when a perfectly commonplace thing happens, it's a national story. Last year I was on the road, I was in Indianapolis, and I had one day outside of Indianapolis. I went to a local restaurant and got sick the next day. And I went on to Yelp or something and found that two other people had gotten sick at this restaurant, same day. But it's not a national story. That's three people that I know of, and presumably it was a one-time thing. That happens in restaurants. Chipotle, unfortunately for itself, is in a position where the thing which happens somewhere in the country, I don't know, the CDC's got records on this, norovirus outbreaks in restaurants. It's a national story every single time it happens. 

So you've gpt your conspiracy theorists out there who are measuring how often it's happening in Chipotle compared to how often you would expect to see it in a restaurant chain of this size and all that, and it's 4x -- E. coli is one thing, the norovirus is another. The norovirus is showing up often enough that those who are prone to looking for conspiracies or are mad that they are losing money in this investment and therefore want to blame something other than bad luck or paying too much for an investment, or any other number of things that you could attribute this to, are looking for conspiracies. I think sometimes, bad luck does accumulate at a certain place. Really, Chipotle is running out of the number of times when you can hold that theory in your mind without dismissing it as, "No, it's Chipotle."

Hill: Right. And that's one more thing, I think, on the communications side of things, that Chipotle continues to get wrong. Again, this defensiveness. One of the things they talked about on the call is this executive director of food safety that they've hired, James Marsden, who put in place, I'll just read from this news article. "Marsden introduced Chipotle to the concept of HACCP, hazard analysis and critical control points." Again, Ells, during the conference call, "We're the only major restaurant to have HACCP."

Barker: That's not a great endorsement.

Hill: [laughs] Yeah, I was going to say ...

Barker: I'm not sure everybody else is lining up --

Hill: It doesn't appear to be working.

Barker: -- to buy shares of HACCP. Could we get a better acronym there, too?

Hill: They really do need one. But to go back to the communications piece, someone close to Ells needs to make it very clear to him that, fairly or unfairly, we're going to get tagged with this for the next, I'm going to say minimum three years, in a way that McDonald's, any other fast-food chain, any other fast-casual chain, is not going to get tagged. As you said, the restaurant you ate at in Indiana, that's not a national story. Chipotle is on the clock. And maybe it's not fair, but that's the way it is. So they need to react accordingly. And continuing to talk about how great their safety protocols are doesn't fill me with confidence.

Barker: What about all the people who went there and didn't get sick last quarter? There were hundreds, possibly thousands of people who didn't get sick.

Hill: Possibly.

Barker: We'll never know. [laughs] 

Hill: That would be great, if Ells decided to be completely tone-deaf and play that up. "We're estimating how many people, and sure, you can focus on the 135 reported people in Virginia who got sick. But, ball-park, we have 99.98% of our customers not getting sick. We're going to focus on the positive."

Barker: [laughs] So if we're griping about Chipotle, the other thing that we were talking about, where's the breakfast?

Hill: Where is the breakfast?

Barker: Where's the breakfast?

Hill: I don't know. That's another question that has come up before. Again, McDonald's seemed to figure out a way to make not just breakfast, but breakfast all day. And I guess your colleague, Charly Travers, pointed out that what has been the explanation in the past from the company is, "We can't offer breakfast burritos and breakfast tacos and that sort of thing because it would disrupt the food-prep system that we have in place for the lunchtime crowd," and all that kind of thing. And your response was ...

Barker: My response was, I'm happy to eat what they serve for lunch for breakfast anyway. But also, this is a problem that everybody else has figured out.

Hill: Yeah, I don't know why, somehow, Chipotle can't figure this out. Or, on the flip side, I don't know what's so special about their food-prep system that they can't disrupt it so I can get a breakfast taco.

Barker: No. I think opening up at 11:00 rather than 7:00 or 8:00, and serving breakfast, seems to be an opportunity that they could take advantage of, and I imagine someday they will.

Hill: That's the thing. If, for whatever reason, Steve Ells decides in a year from now that, "I'm out, I'm not going to be the CEO anymore" -- if a new CEO comes in, isn't one of the first things that he or she does is taking a good, long, hard look at breakfast?

Barker: Yes. It's an open opportunity. I think they have the ingredients there to combine into a breakfast menu of some sort. They're forced to serve breakfast at Dulles Airport.

Hill: They don't serve what we consider breakfast. They don't serve eggs. They serve their basic food --

Barker: They could serve Rice Krispies. You know? Mexican grilled Rice Krispies.

Hill: Chorizo-infused Rice Krispies?

Barker: Go wild.

Hill: You know what? Someone at Mondelez just got an idea for the next brand of Oreos. [laughs] 

Barker: No, they serve, more or less, their standard menu, don't they?

Hill: Yes, it's their standard menu.

Barker: And you can have it for breakfast. But there's a rule at Dulles that if you're operating there as a restaurant, you must serve breakfast, because a lot of people need breakfast. I've had Chipotle for breakfast at Dulles. Have you?

Hill: I have not, no. I don't fly into Dulles that much. I'm not a world traveler like you are. 

Barker: You just traveled the world. What are you talking about? You more recently were traveling internationally than me.

Hill: But I'm saying in the aggregate, not as often.

Bill Barker has no position in any stocks mentioned. Chris Hill owns shares of Chipotle Mexican Grill. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. The Motley Fool recommends Yelp. The Motley Fool has a disclosure policy.