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How Bad Are Things for Chipotle? Just Listen to Management

In this episode of Market Foolery, Chris Hill is joined by Bill Barker from Motley Fool Funds as they consider the road ahead for Auto Zone (NYSE: AZO), Amazon's (NASDAQ: AMZN) experiment with revolutionizing supermarkets, and the stunning lack of success that Chipotle (NYSE: CMG) has been having recovering from its food safety issues. 

A transcript follows the video.

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This podcast was recorded on Dec. 6, 2016.

Chris Hill: It's Tuesday December 6th, welcome to Market Foolery. I'm Chris Hill, we are back from New York city back in the studio, and joining me today from Motley Fool Funds, Bill Barker. Thanks for being here.

Bill Barker: Thanks for having me.

Hill: You're on your way to New York City.

Barker: Yes, day after tomorrow.

Hill: Tournament, tennis tournament?

Barker: Yes.

Hill: How you feeling? If I'm at a sports book in Vegas, I'm not saying that gambling is legal, but if I'm at a sports book in Vegas and I can put some money on this court tennis tournament, how much should I be wagering on Bill Barker?

Barker: And the DC team?

Hill: And the DC team, yeah.

Barker: You might want to save some of your money. The number one and two seeds in this draw.

Hill: Go elsewhere in the casino, maybe find something else to bet on.

Barker: This is going to be a fairy-tale story, if DC comes through.

Hill: If your court tennis team comes through and wins this tournament, you're saying, "Let's call up the people at Disney, because if you liked Remember the Titans, if you liked all the other sports movies, come-from-behind, we've got no chance to win, have we got a story for you."

Barker: It's like Miracle on Ice times twelve.

Hill: We got some news today. It's not just court tennis that we're talking about. We have some actual news in the grocery industry, in the restaurant industry. Let's start with some earnings. First-quarter profits for AutoZone came in higher than expected, although same-store sales up 1.6%. That, I don't think that number is blowing anybody away.

Barker: Nah, it's about the level of inflation, that's about all that you've got there, is people buying about the same amount of stuff per store, and paying 1.6% more for the opportunity to do so. And so that's fine, that's sort of middling. Still, better than losing same-store sales, which we'll get to in another form later on in this episode.

Hill: Yeah, we will.

Barker: And what does it actually amount to? They had a 3.4% net sales increase for the quarter, because they opened some more stores, and they've improved their margins so net income was up almost 8%, and then what they continue to specialize in is buying back their own shares, and they bought back enough of them that they have earned 13% more year-over-year per share, off that 8% net income growth. So once again spending more than all the money they earned for the quarter on buying back their own shares.

Hill: Why do you think more businesses, particularly when it comes to retail, why do you think more businesses don't follow this blueprint? Because, as we've talked about before, AutoZone buying back their own shares has been an absolute winner for investors over the last 20 years.

Barker: Yeah, I think that more and more companies are buying back their own shares, and AutoZone has specialized in it to its credit, and to the benefit of its shareholders, and I think to a large extent managements in many cases are more interested in empire building, in having enough money to buy another company. To grow operations by expanding into different lines, and AutoZone has stuck to what it does, and it hasn't really been an acquirer, except of its own shares and that's turned out very well.

A lot of management incentives are about growing a business, rather than growing shareholder returns.

Hill: Where do you think this stock is in, say three years? I mean is this as, because I know the past is no indication of the future, but it really does seem like a very likely outcome over the next three years is that we just see this playing out over and over.

Barker: Yeah, I think this is the business plan, is to open a few more stores every quarter to improve margins. It's still an industry where there are plenty of mom and pop shops to further pressure by opening more stores. They've already got more than five thousand in the US, several hundred in Mexico, a handful, I think eight in Brazil, so I think that the expansion will continue where it is right now. They'll continue to buy back shares.

The fleet, US fleet of cars is continuing to age, it just set a record again this year, the average age of cars on the road. Did you know?

Hill: I don't know, and I'm surprised that the age has increased because it, well, go ahead and give me the number.

Barker: I was going to make you guess the number.

Hill: I'm going to guess.

Barker: Wrong.

Hill: 43. The average car on the road is 43 years old.

Barker: What is this, Cuba?

Hill: It is not Cuba. No, I'll say 10. Nice round number, 10.

Barker: Pretty close. 11.6, and that's been going up because cars are better made. Cars stay on the road longer and longer and longer as they are better made all the time, and that's good news for AutoZone which is largely supplying parts to used cars, cars which have aged and the whole car isn't done, but you replace a lot of things over 11 years, and that's only to the average age. So you got a lot of cars older than average of course, and that is the expansion opportunity that they've enjoyed in, especially over the last seven years, there was a bit of a jump in the age of cars, when new car sales declined around '08, '09, so you saw a rather rapid expansion and a lot of cars being kept on the road longer then, even though new cars are selling very well.

Hill: That's why I'm surprised, because the last couple of years, the automakers have had phenomenal sales. We have literally tens of millions of cars over the last two years, where the average life of that vehicle is zero to two, so that's bringing the average down. That's why I'm surprised that it's 11.6.

Barker: And there aren't that many cars that just get junked. They just keep staying in service, so you've got all the ones that are already on the road sticking around for another year, even though you've got a bunch of new ones coming on. So, maybe the real opportunity for them is Cuba, where possibly some business opportunity is opening up. So the story was, and I didn't see this myself, but I heard somebody else talking about that Fidel Castro's hearse broke down during the parade or ...

Hill: During the funeral procession?

Barker: Funeral procession.

Hill: Really?

Barker: Which indicates many things, one of which is AutoZone could be selling parts in Cuba, because I got to believe that that hearse was probably one of the top line cars they had available.

Hill: Yeah, I would think so.

Barker: You would hope, right?

Hill: Well yeah, he was in charge of that country for a long time, so yeah, you would think he'd be able to get some good wheels.

Barker: Yeah.

Hill: It's all on a relative basis I guess. You had indicated that we would be talking about same-store sales on another story, so let's get to that story. Shares of Chipotle are down 7% this morning on some pretty heavy trading [inaudible 00:07:35]. Steve Ells, who's the founder of Chipotle and one of the co-CEOs, spoke at an investor conference and pretty much everything he said was negative. It was truthful. He didn't appear to be holding anything back, but he was talking about things, he said, "We took our eye off the ball on customer service." That's a direct quote.

Half of their restaurants, on their own rating system of guest experience, half of their restaurants get a C, D, or an F. This, among other things does not bode well for anyone who is a shareholder or a potential shareholder, looking at this company and thinking, "Well once the calendar flips to 2017, they're going to have 12 straight months of easy comps to jump over, and they're going to get this thing behind them."

That may still be the case, but I would feel a lot more confident in that scenario playing out if they had spent the last 12 months on things like making sure that the guest experience, which includes things like, how clean are the bathrooms, what does the soda fountain area look like? All that sort of thing, so this is, Steve Ells is basically saying, "Yeah, we've got a lot of challenges right now."

Barker: Yeah they do and I would love to read the transcript of, or be able to listen to an audio clip of that presentation, because it just sounds like it was thoroughly a downer and the market is responding as one might expect, down 7% on Chipotle shares today. There really hasn't been any piece of good news coming out of the company for, I don't know, 15 months, something like that. And they had really remarkable comp growth going into all these episodes, they had too many of them for people to dismiss one or two, and they continue to be perceived by the public as a place to avoid, and despite some aggressive offers that they've done to get people in and buy more, and give specials on return visitors and loyalty cards and things like that, it's not sticking yet and people's attitudes are hard to shift when it comes to food safety.

Hill: One of the rumors that's going around this morning, and it is just a rumor at this point, although the way rumors work, maybe it is contributing to some of the drop, is that Monty Moran who's the other CEO, other co-CEO, is that his job is in trouble and that he maybe the one to have to walk the plank on this one. Steve Ells is the food guy, Monty Moran is the operational guy, and I'm not saying that idea is unwarranted, but it does remind me of sort of, in the world of sports talk radio, where someone says they got to fire the coach, and they never really, or they rarely get around to it, and here's who the next coach should be.

It's like, you know what, if you want to fire Monty Moran you can do that, but you better make sure you've got a top notch operational person coming in to take his place, because Steve Ells ain't that guy. He was never that guy, he was the founder, he was always the food guy, and you want him to do that, so ...

Barker: Well, the one piece of news that's out there, and there's now rumors that Chipotle has got some new members coming on to its Board by their declaration and that that will be done shortly. And I imagine they would have some input, this is most likely in response to the pressure from Ackman and his money.

Hill: I was going to say, is this Bill Ackman's doing?

Barker: Believe so, he's been activist on this one and trying to force some changes, and this sounds like the kind of change that as you say, it's a rumor, and that might be something that is out there, either with sources or not, and a change is seemed to be afoot at the very least at the Board level. And you would expect that one of the things that Ackman is likely to be pressuring for is for franchising, which the company doesn't do, and which is one of the plays in his playbook, Ackman's playbook, and that that may not sit well with the one or another of the co-CEOs. A co-CEO is not a traditionally useful way to run a company, so maybe there is room for some changes at the senior level.

Hill: All right, before we get to our next story, got to say a word about Rocket Mortgage by Quicken Loans. If you've ever bought a home, you already know how time-consuming and frustrating getting a mortgage can be. Rocket Mortgage brings that whole process into the 21st century by taking the complicated, time-consuming parts of applying for a mortgage out of the equation. You can easily share your bank statements and pay stubs at the touch of a button, and get approved in minutes for a custom mortgage solution that's been tailored to your own financial situation. And the best part is you can do it all on your phone or tablet.

So, if you're looking to buy a home, if you're looking to refinance your mortgage, which makes an unexpectedly wonderful gift at the holidays for that special someone in your life. Hey, I know it doesn't necessarily seem like it on the surface, but you go under the tree and you unwrap something and it's like, what is it, look what I got you! I refinanced our mortgage!

Barker: Look, I think everybody appreciates all of the advertisers, your ability to individualize and personalize their products. I don't know that you're going to win on this one. On the Christmas gift of a refinancing.

Hill: You never know until you try.

Barker: So, if you try it, how are you going to do? "Honey, I got you that new mortgage you've been hoping for."

Hill: I'm not saying that's your only gift that you give that special someone in your life, but it's ...

Barker: "Kids, kids! Check out your stockings! New mortgages for everybody!"

Hill: It's not the kids, the kids don't own the house. You haven't used that line on your kids before, where it's just like, "Hey, this isn't your house, this is my house. I just let you live here."

Barker: I've used variants, yes.

Hill: Anyway, if you're looking to refinance your mortgage just in time for the holidays, check out Rocket Mortgage today at quickenloans.com/fool. Equal housing lender, licensed in all 50 states, nmlsconsumeraccess.org number 3030.

Barker: You ever use that on the friends of your kids? "Hey, this isn't your house!" That's mean old Mr. Hill entering the living room to disrupt and harass the friends of his kids.

Hill: I don't think I've used that exact line.

Barker: Try it. Try it this weekend.

Hill: You know what, I just might. I'll see. Amazon has unveiled a format for grocery stores, and Amazon getting into the grocery business is no secret but this is pretty intriguing. It's called Amazon Go, and it's essentially the grab and go method of shopping that they have unveiled at a new store in Seattle. No lines, no cash registers.

You and I, and your colleague at Motley Fool Funds, Charlie Travers, we were talking about it this morning when we were getting coffee. If Amazon can do for grocery shopping what Panera has done for, what they've done across the street from Fool HQ in terms of just, I can order online or in the case, there is a short video that Amazon produced where it looks even easier, it's not like, "Oh, I'm going to order online, spend time on my computer," it's like no. It's all near-field technology with your smartphone. This could make grocery shopping a hell of a lot more enjoyable.

Barker: Yeah, I think it is a concept certainly given the success that Panera is seeing, and others, Panera's not the only one doing this, but it makes a lot of sense. If you can pull it off, and I guess the one store that Amazon has right now is only open to employees but will be open later in the year, and you use your app to get in and then the secret monitors just follow you around and see what you're taking off the shelves and charge you for it, and that as long you don't care about privacy in any way, I think it's awesome.

Hill: Yeah. Yeah, no question. This is a grocery store concept that is not going to appeal to everyone, because that is exactly how they're tracking what you're buying, and you could make a pretty decent case that if you shop at Safeway or Giant or anywhere else that has, you know, Harris Teeter, anywhere else that has a rewards card, well they're tracking what you're doing as well.

Barker: Yep. No, Amazon's just going to track everything you touch, everything you look at, and your thoughts, sooner or later.

Hill: Not your thoughts, but that's one of the things in the video, is just you can take something off the shelf, and then if you decide, "Nah, I don't really want to buy this," you put it back on the shelf, it removes it from your cart.

Barker: Oh, they'll be tracking your thoughts. I mean, that's what artificial intelligence is getting at right, is getting at your thought patterns based upon your previous purchasing history, and they're not embedding anything in your brain, but they are going to ...

Hill: Not yet.

Barker: That they'll tell us about. But I expect this will be a very interesting and likely profitable thing. Well, I don't know profitable, Amazon's never been in it for the money, right?

Hill: No, not so much. But, grocery stores historically don't have phenomenal margins, they have pretty thin margins, and if Amazon can ...

Barker: Get rid of all the employees.

Hill: Or certainly most of them, because at some point you probably have to have people on hand, just as Panera does, just in case something goes wrong, and obviously they're preparing the food back there. I also have to imagine there's going to be security on hand. And by the way, that to me, that's the story I'm the most interested in right now. Who is the first joker who's in Seattle, who's going to try and rob this place? Someone's going to try and rob it. Don't you think? Or maybe not, because conceivably there's no cash on hand or anything like that, it's like no, it's all electronic so there's nothing really to steal except for food.

Barker: I don't know, because if you're using your app right, and then they sort of track what happens to you, I guess you have to have your phone on you or something like that, and then it just, if you leave your phone on the floor, you grab some stuff and run out. How are you robbing this place? What's your strategy? You've watched the video.

Hill: I'm going to have to think more about this.

Barker: What's the hole?

Hill: It would definitely involve getting rid of your phone for a while, and you would need someone else to go in and pick up your phone afterwards and bring it out. So you'd need a accomplice, like any great robbery, you need an accomplice. Yes, we're talking about how to rob Amazon's brand new grocery store. We're going to need, a couple of our dozens of listeners are in the Seattle area, we're going to need someone to check this out and report back to us. Not on the robbing.

Barker: Any of them thieves?

Hill: No, I want to be very clear.

Barker: To the best of your knowledge?

Hill: We're not advocating that they try and rob the place. We would love it if someone could shop there and report back.

Barker: All we're saying is, if you were the writer of a TV show, Law & Order, and it featured people robbing this store ...

Hill: Yes.

Barker: What would be in that episode?

Hill: Exactly.

Barker: That's what you're saying. You're not advocating that people do this, just ...

Hill: We're not advocating that at all. Particularly [Allison 19:59] who's one of our listeners in Seattle who posted this story in our Facebook group, which now has a thousand people in it by the way, so if you're on the Facebook and you want to join the conversation on Motley Fool podcast, you can just join that group.

Barker: In no way are you saying that the police should be following her around, because she might be a thief.

Hill: No.

Barker: That is not what you're saying.

Hill: No, nobody's saying that. [Allison 20:19]? No. [Allison 20:20] is an upstanding person. There's, no. We're not talking about her, we're talking about at least one other listener in Seattle.

Barker: She could probably throw a Law & Order script together pretty quickly though.

Hill: I would think so. Couple of housekeeping notes before we wrap up. It was something I meant to mention on yesterday's episode when we were up in New York City. You know who else is banning the Samsung Galaxy 7 phone? Amtrak. When we were on the train riding up to New York City and I was accessing the Wi-Fi, of course the first thing that pops up is the Amtrak website and banner across the top saying, "Oh by the way, if you have a Galaxy Samsung phone get off this train right now because these things are terrible and they're going to blow up, and we don't want our train blowing up."

From Ryan, one of our listeners who Dan Boyd, producer Dan Boyd posted some photos yesterday on Twitter of the scene at Shake Shack when we were in a booth taping yesterday's podcast. And Ryan wrote, "I would of loved to see some of the stares you guys must have received." Now let me paint the picture, because we're going to bring Dan in a second to share his perspective.

Where I was sitting in the booth, I was sitting on one side of the booth, Dan and Jason Moser were on the other side. My field of vision was maybe 10% of the restaurant, and so I saw people who were eating their meals, and occasionally, particularly in the booth right behind where Dan and Jason were sitting, and the tables in my purview, they were looking back and clearly with quizzical looks on their face, trying to figure out, who are these people and what are they doing. They're not eating. They're sitting in a booth and they're holding microphones. And the microphones did not have any sort of identifying Motley Fool logo or anything like that, so even someone familiar with the Motley Fool wouldn't have necessarily known who we were and what we were doing there.

So the stares that I got were stares that were quizzical in nature.

Barker: Hostile?

Hill: Dan, what kind of stares were you getting?

Boyd: I'd say that the most common stare was exasperated.

Hill: Not hostile?

Boyd: Somewhat, I'm sure, yeah there were some hostile stares. So like you said, we were just sitting there, he had already eaten.

Hill: Yeah, we got there, we sat at different tables, we ate, had a wonderful meal, and then a booth opened up and we're like, "Oh, that's where we'll sit to tape the podcast."

Boyd: Well in New York City as many of our listeners probably know is a pretty busy place, and we were at a Shake Shack taping around 12:45, 1:00 yesterday afternoon, which some people might call lunchtime. So a lot of people came in, and there were looks first of like, what's going on over there, and then wait a second, those guys aren't eating, with some furrowed brows and some frowns.

Hill: Again, Dan was getting the looks of, will you please just stop whatever it is you're doing, because we want to eat.

Barker: So I'd like to credit myself for this idea, I think we, maybe a year and a half ago had talked about whether you could do a show outside of the studio, and the necessity if you were to do so, of having people that could back you up in a fight.

Hill: Yes.

Barker: And you went immediately to Dan being your first choice, and rightly so. And now that you've done this, is it the case that when you go out of the studio, you're going to make sure that you've got a posse that can help you out, because things might go wrong. Especially in New York, challenge New Yorkers regarding their food, that's not quite like getting between a dog and his food, but it's still, you're asking for it, I say.

I say you're lucky you got out of there.

Hill: As long as I've got Dan by my side, I'm relaxed, I'm feeling good. I'm not worried about any sort of issue from [crosstalk 00:24:26].

Barker: All right, say you didn't have Dan. Do you think that they were going to go after you? "Hey buddy, that's our booth! You with the microphone!"

Hill: We talked about this ...

Barker: "Take that microphone and get out of here!"

Hill: We talked about this afterwards, both Dan and I had the same thought which was, "Boy, it was really great," when we got done taping it was like, "Wow, it's really great no one came up and actually started talking to us while we were," and they would of been completely forgiven if they ...

Boyde: Yeah, but like five seconds after we were done taping, someone was like, "Hey, are you guys using that booth?"

Hill: Yeah.

Boyde: And I was like, "Yeah, yeah, go for it man." But it was five seconds after we were done.

Hill: They were happy we were gone. Last item, I think the last time you were on, the last couple times we talked about holiday TV specials, and you pointed out something this morning which, I think we may need to contact someone at TV Guide's website, whoever does their web operations. Tvguide.com has very helpfully, very helpfully put together a single page calendar for anyone interested in holiday television specials, and also holiday movies, hey it's a holiday themed movie like Elf, or Scrooge, or Jingle All the Way, all that sort of thing, and it's hey, all in one list. In chronological order, here are all the holiday specials you could possibly want to watch. And you can very quickly figure out where and when is my holiday special going to air.

Barker: Last night for instance, Jingle All the Way.

Hill: Yes.

Barker: Scrooged.

Hill: Yes.

Barker: Was that it? Were those the only specials airing yesterday?

Hill: There's a third item for Monday December 5th, and it is Victoria's Secret Fashion Show.

Barker: What says Christmas more than Victoria's Secret lingerie.

Hill: And it's interesting, if they had just added the word Christmas, it would make ...

Barker: You'd give it a pass?

Hill: I'd give it more of a pass.

Barker: Oh, well it's a Christmas fashion show.

Hill: The fact that it's simply Victoria's Secret Fashion Show, I'm wondering if someone at TV Guide's website maybe fell down and hit their head on something hard.

Barker: It must be the only Christmas special which only airs at 10 o'clock or later, which it did last night apparently, and we were unaware of this. I also questioned programming it up against Monday night football, but I guess for those that don't have cable, that works.

Hill: Again, Victoria ...

Barker: Is it a part of you're annual family holiday traditions? Gather round ...

Hill: Kids gather round, dad lit a fire and we're going to watch the Victoria's Secret Fashion Show.

Barker: Get the popcorn and the hot chocolate.

Hill: No, no.

Barker: No?

Hill: Elf, yes. Rudolph the Red Nosed Reindeer, yes.

Barker: According to TV Guide, you're missing out.

Hill: Apparently I missed out last night, and that time is gone. But, hey it's just another 364 days until we get to it again.

Barker: Any of the other ones on this list, reminders or things you didn't know about that you feel you need to add to your annual traditions?

Hill: Not really. I mean, I think if there's one main takeaway for me, it's that wow, there sure are a lot of holiday specials. Way beyond what we grew up with.

Barker: Yeah, and now a lot of them I think are on either Lifetime or Hallmark or whatever, because there seem to be a lot of young couples that find each other at the holiday season, these movies.

Hill: Sure, and that's fine, but the original Willy Wonka and the Chocolate Factory with Gene Wilder? As much as that is a beloved movie.

Barker: Is that on this list?

Hill: That's on this list, I just, I was scrolling through.

Barker: That is a stretch.

Hill: I think that's actually going to be in the email that I send to tvguide.com. I have two questions for you. One, what's with Willy Wonka? Two, what's with the Victoria's Secret Fashion Show? Like, come on.

Thanks for being here.

Barker: Thanks for having me.

Hill: As always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy yourself stocks based solely on what you hear. That's going to do it for this edition of Market Foolery, this show is mixed by Dan Boyd. I'm Chris Hill, thanks for listening. We'll see you tomorrow.

Bill Barker has no position in any stocks mentioned. Chris Hill owns shares of Amazon.com and Chipotle Mexican Grill. The Motley Fool owns shares of and recommends Amazon.com, Chipotle Mexican Grill, Panera Bread, and Twitter. The Motley Fool is short Shake Shack. The Motley Fool recommends AutoZone. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.