October 25, 2017 / 3:57 PM / a year ago

Short-sellers taste profits as Chipotle shares plunge

NEW YORK (Reuters) - Short-sellers who had targeted Chipotle Mexican Grill Inc (CMG.N) logged a nearly quarter billion dollar paper profit on Wednesday, a day after the burrito chain reported weaker-than-expected sales that sent its shares into a swoon.

Chipotle shares were last down 14.9 percent to $276.09, near a five-year low. Short-sellers had made a paper profit of about $242 million, financial analytics firm S3 Partners said on Wednesday morning.

Short-sellers aim to profit by selling borrowed shares with the hope of buying them back later at a lower price.

Chipotle short-sellers are now up $334 million for the year, and the stock remains easy to borrow for shorting purposes, S3 Partners estimated.

Chipotle has been struggling to recover from a bruising string of food safety lapses that started in late 2015, including a recent norovirus outbreak at a Virginia restaurant.

The company on Tuesday said it will open fewer restaurants and posted lower-than-expected quarterly sales and earnings.

The overall short interest in Chipotle is at about $1.76 billion, according to S3 Partners data.

With nearly 20 percent of the company’s outstanding shares sold short, Chipotle is the most-shorted stock in the U.S. restaurant sector, followed by Starbucks Corp (SBUX.O), McDonald’s Corp (MCD.N), Domino’s Pizza (DPZ.N) and Darden Restaurants (DRI.N), according to S3 data.

On Wednesday, shorting activity was muted, as traders appeared in no rush to close out bearish bets.

“The rule is to let your profits run and cut your losses. I can’t see these shorts covering. This is what they have been hoping for,” said Ihor Dusaniwsky, head of research at S3 Partners.

While shorts were having a good day, the sharp drop came at a bad time for billionaire William Ackman, whose $10 billion hedge fund Pershing Square Capital Management is Chipotle’s biggest investor.

The value of Pershing Square’s roughly 10 percent stake in Chipotle fell to low as $789 million, down about $145 million from Tuesday.

The loss came as Ackman’s funds’ returns were on the cusp of turning positive after two years of double-digit losses and weeks before the investor was due to face off against Automatic Data Processing (ADP.O) in a bitter proxy contest.

Trading in Chipotle’s options also leaned towards bearish bets on Wednesday.

To be sure, the high short interest might give pause to investors looking to bet against the stock, according to Brad Lamensdorf, co-manager of the AdvisorShares Ranger Equity Bear ETF, which had a short position in Chipotle until last year.

Lamensdorf was referring to a situation where even a modest gain in a heavily shorted stock gets blown into a sharp upward spike, as an increasing number of short-sellers rush to close bearish positions.

“When you have over 20 percent of your float short that should be a concern for any short-seller because if (Chipotle) were to turn things around and come out with good news, it would be like trying to get an elephant through a mouse hole,” he said.

Reporting by Saqib Iqbal Ahmed and Tanya Agrawal in Bengaluru, Svea Herbst-Bayliss in Boston and Noel Randewich in San Francisco; Editing by Meredith Mazzilli

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