Chipotle - Feeling a Little Indigestion
Note: this post was
carried this morning on Wallstrip
Overview
The indigestion is not from my burrito. I feel
about Chipotle kind of like I feel about my Blackberry - it is an
essential element of my daily life. Some black beans, some rice, some
Neiman Ranch shredded pork, some spicy salsa, a little guac, all
wrapped up in a fresh tortilla, and I am one happy (and full) dude. I
get into the whole organic thing - I’m the sucker who is willing to pay
extra for that Neiman Ranch meat, Hawthorne Valley Farms vegetables or
whatever other organic purveyor happens to be in my line of sight. That
said, I have to separate out my personal feelings about the product
from my empirical beliefs about the prospects for the stock (what would
Peter Lynch have done in this situation?). As usual, I will let the
internet do the talking, but my distillation of the information is that
this is a well-managed company with a great product, but they’re
heading straight into a strong headwind. See if you agree.
The Point - Best Practices + Food that’s Healthy - This is Good
So what is the #1 issue impacting the food and beverage industry today? You got it - health. This was elegantly discussed on the Nerac website:
Nerac: What is the number one trend in the food and beverage industry today?
Karen: Health, in general, is the top trend. Consumers are paying
more and more attention to their diets and discovering a link between
nutrition and wellness. They want to be educated on nutrition more now
than ever before. Organic food producers are benefiting from this
emphasis on health. The market for organics has been growing at a rate
of about 20% per year. The major players in grocery, like Wal-mart, are
getting on-board with organic foods and beverages. The market for
functional foods is growing, too, but at a slower rate as compared to
organics. This could be due to the fact that consumers need convincing
that the health claims, attached to functional products, are truthful.
Besides [this we’re] also seeing a lot of functional ingredients being
added to traditional foods. Fiber is probably the most popular one
right now with both producers and consumers.
The trend towards organics and healthier fast food offerings are
playing right into Chipotle’s power alley. As an investor, I like
tailwinds, and the organic boom certainly represents a tailwind for
Chipotle relative to traditional fast food offerings like McD’s, the BK
Lounge and the rest of them. Further, the Company has also positioned
themselves as being a caring and concerned citizen, and embedding these
values in their corporate culture. The blog Green Rising, adding some
additional color to a piece that ran in Fortune, had a nice post on this point:
Chipotle Mexican Grill is leading what I hope will
become a strong movement in the U.S. The company, which serves Mexican
fast food, is model for other fast food restaurants in terms of
health-conscious and sustainable products. This article on Fortune even
likens Chipotle to “the fast-food equivalent of yuppie supermarket
chain Whole Foods Markets”.The key take-away from the article is that deviation from the norm
is being driven by the producer, not the consumer. Chipotle could serve
junk food like most fast food chains but it doesn’t. The average
consumer is too occupied by his daily grind to seek out or create
alternatives - they must be presented to him. That is why it is vital
businesses grow a conscience. Steve Ells, the founder and chief
executive of Chipotle says:“As I toured confinement operations and looked at how the animals
were treated and what the workers were subjected to and the effect on
the environment, I knew that I didn’t want my success to be based on
that kind of exploitation,” Ells says. (In response, Cindy Cunningham
of the National Pork Board says: “Farmers live on the farm. They
breathe the air. They drink the water. It’s in their best interest to
protect the environment, and they do. The same goes for animal care -
an animal that is not well cared-for is not going to produce well.”)From an economic stand point, liberals and conservatives have always
been on opposite ends of supporting big business. Personally, the
hardest part about supporting big business is accepting their ignorance
of social and environmental issues. If business was about making money,
but not at any cost, more people would be able to see eye to eye on
many policy issues society currently finds divisive.By e-mail, Lederhausen, a Chipotle director, told me that that he
thinks the company’s values are vital to its success. Chipotle, he
says, is “one of the best examples in the marketplace of a business
with deeper values, deeper meaning and ultimately deeper connections
with their customer base, WITHOUT being pretentious, boring or finger
pointing. Any business that can define a purpose bigger than their
product,” he says, “will outperform businesses that are just selling
product.” It’s tough to argue with that.Tough indeed.
Ok, ok, I get it. Calm down. Starting to sound like iPod groupies, huh?
The Counterpoint - Lots of Competition, Love for Organics Fading, Valuation Priced for Perfection - this Sucks
Check out these little ditties from the web:
Qdoba is an exact copy of Chipotle but the management is not quite as strong.
2) Hilary on Stocks:
Despite the encouraging news of increased transactions
and CMG’s plans to keep growing, there are also some reasons to be
cautious. Chipotle’s profit margins are roughly half of the industry
average.
3) Phil Town:
Many other establishments offer healthy alternatives in
fast food, and Chipotle is competing along with them. Now that they are
independent from McDonald’s, Chipotle may be in a weaker position as
they need to compete by themselves, without the support and leverage
previously provided by McDonalds.
4) Ad Age:
The article contends that that the once sensational market growth of organic foods is starting to fade.
5) Judy’s Book:
Chipotle should give out a survey form to it’s customers
to collect feedback to improve their products and services. Customers
prefer Baja Fresh or Salsaritas or Qdobas to Chipotle’s current
offering.
Whew - that’s rough stuff. Bottom line: people investing in a
company whose margins are less than half of the industry average and
trades at a P/E of 53 are banking on massive future expansion,
increased market share, and accelerating consumption of their products.
That’s called perfection, my friends. Is this a perfect picture? Well…
A few things to consider. Chipotle is riding the wave of
health/organic foods (think Whole Foods). They’ve successfully
associated their brand with quality, using phrases like “ingredients of
integrity.” Despite packing 1,000 calories a pop, people believe they
are eating healthy. Is this true brand loyalty or are they merely
riding the wave of a fad? The majority of people “addicted” to Chipotle
are simply people who have never considered a burrito as a legitimate
lunch/dinner outing. People who dislike Chipotle always cite the same
reason: they’re just not that good, comparatively. It’s not “real”
Mexican food (it’s actually a San Francisco invention) and seems to not
be as good as other burrito franchises such as Baja Fresh or Qdobas.
Their limited menu means they can be easily substituted by chains such
as Panera. Also, the organic craze could potentially be as short-lived
similar to the Atkins fad. Another point that’s been given only limited
exposure is how the loss of McDonalds will effect the company’s
bargaining power with suppliers (2), (6). Having a massive conglomerate
behind you when dealing with the likes of Coca-cola can be pretty
helpful.
I gotta go now, sorry. I love those burritos, but I’m cynical on the stock.
Chipotle: Buyer Beware.
Thanks to Rick Calmon for assistance with this post.
The author does not have a position in the securities of Chipotle.
