HDGE’s second-largest short position, at about 5 percent of the fund, is Chipotle Mexican Grill, Inc. (NYSE:CMG).
Hedge fund manager David Einhorn laid out a short case for Chipotle last October at the Value Investing Conference. Einhorn described it as a great company on its way to being a good company. He mentioned the absence of a moat and the rise of copycats. But he said the main threat comes from Taco Bell’s move upmarket with its Cantina Bell menu to compete with Chipotle’s popular burrito bowl. This comparison prompted me to perform a taste test last fall.
Whatever your view of the relative merits of these menu offerings, the short case for Chipotle begins and ends with valuation. HDGE appears to have increased the size of its short as Chipotle’s P/E has crept back above 35 with the recovery of its stock price from both Einhorn’s presentation and an earnings disappointment last year. At the low last fall, the P/E slipped below 30 and the PEG to 1.49. The P/E is now about 36, the forward P/E about 30 and the PEG is approaching 1.8, meaning the price is about 80 percent ahead of the projected growth rate.
Einhorn and Del Vecchio are not alone in their opinion that Chipotle enjoys a market multiple too rich for its actual prospects. Short interest in mid-January represented 13 percent of the float. As growth slows, multiple contraction seems likely, but the multiple has expanded over the past three months as the market has risen, lifting most boats. HDGE is betting that sooner or later, the contraction is coming.
HDGE’s third-largest short is The Goodyear Tire & Rubber Company (NASDAQ:GT).. Its short case is based largely on Goodyear’s mountain of debt, approaching $6 billion.
“Goodyear may, in fact, implode under the weight of its leverage,” Del Vecchio told The Deal Pipeline last summer. “It could very well go bankrupt in the next two to three years . . . . It’s not a growth stock because there’s no growth. It’s not a momentum stock because the chart looks awful. Some people may see it as a value stock, but I see it as a value trap.”
A combination of high raw material costs, foreign competition and outsized legacy pension obligations contributed to a pattern of negative free cash flow over the past three years. Goodyear expresses confidence that investments in Asia and Latin America will pay off, restoring the balance sheet. The market seems reasonably sanguine, with short interest at just 3.8 percent of the float in mid-January.
Del Vecchio counters that a “combination of increased leverage, worsening cash flow and underfunded pension, combined with pressure on the top line and margins, makes me think they’re in big trouble in a couple of years.”
The article Short Candidates for Contrarians, Part 1 originally appeared on Fool.com and is written by D J Krieger.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
