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This article is part of our Rising Star Portfolio series.
I've been coveting shares of Chipotle Mexican Grill (NYSE: CMG ) to buy for the real-money Rising Star portfolio I'm managing for Fool.com for quite some time now. I kept waiting for a more reasonable price.
Sometimes waiting is how investors miss out on stellar returns; when will some of the greatest stocks our marketplace has to offer finally look "cheap"? It may take a really long time. So, I'm throwing over-caution to the wind and finally taking a bite of Chipotle.
Formed in 1993, Denver-based Chipotle provides delicious burritos and other Mexican fare at a fast-food pace.
Oddly enough, in 1999 Chipotle became a subsidiary of fast-food giant McDonald's (NYSE: MCD ) . Mickey D's divested Chipotle and it went public in 2006. One thing Chipotle has in common with its former parent is serious speed. In some locations, Chipotle has been able to serve more than 300 customers in an hour. Chipotle also allows customers to place orders by fax, online, and even though an iPhone app.
With the exception of the quick-serve element, Chipotle and its former parent McDonald's have little in common. Part of Chipotle's secret salsa has been its "Food With Integrity" mission. This mission goes far beyond fresh ingredients and burritos made before customers' eyes. Chipotle has committed to turning the traditional fast-food model on its ear, "serving customers the very best ingredients, all raised with respect for the animals, the environment and the farmers."
Chipotle does its best to source naturally raised meats, and a good percentage of its beans are organically grown. Chipotle also tries to serve locally grown produce when possible and when in season. Part of its mission is to seek out sustainable ingredients as well as ingredients that are free of pesticides, hormones, and antibiotics.
Why I'm buying
Chipotle is a well-run company that exemplifies purpose over profit, which is why it's a perfect addition to this portfolio.
Granted, I was hoping its most recent quarter would deliver a disappointment (and a relatively bargain price), but unfortunately for bargain hunters, Chipotle just delivered the same kind of amazing quarterly results it always does.
Chipotle still looks like one heck of a pricy stock. It's trading at 38 times forward earnings, and sports a PEG ratio of 2.13. This looks pretty insane compared to McDonald's, which trades at 15 times forward earnings (granted, Mickey D's PEG ratio is currently 1.70). Panera Bread (Nasdaq: PNRA ) (which my colleague Jason Moser bought for his Rising Star portfolio) also commands a premium-looking price but looks cheaper than Chipotle, trading at 24 times forward earnings and a PEG ratio of 1.48.
Then again, who wants to buy fast-food purveyor Wendy's (NYSE: WEN ) , another quick-serve rival? It may be in slightly better shape after ditching Arby's, but still trades at 21 times forward earnings and a PEG ratio of 1.29. I'd take Chipotle any day.
Chipotle's got plenty of solid reasons to command a premium price. Take room for growth. There are currently about 1,230 Chipotle restaurants. Compare that to McDonald's (33,510 restaurants, mostly franchised) or Wendy's (6,594 restaurants, again, mostly franchised). Panera is a bit ahead of Chipotle in terms of store count, with 1,541 restaurants (franchised and company owned).
In addition, as Sara Wright wrote recently on Fool.com, Chipotle is testing a promising ancillary concept, ShopHouse Southeast Asian Kitchen; there's already one in Washington, D.C., and Chipotle plans to open another in 2012. There's plenty of potential in Chipotle taking its operational expertise at wrapping quick, wholesome burritos and extending it to other fare, thereby giving it far more growth possibilities than Mexican burrito-peddling alone.
Chipotle's incredible growth over time gives us another reason to understand its high multiples. Check out compound annual growth rates for Chipotle versus the aforementioned quick-serve peers.
Revenue, 5-Year CAGR (LTM)
Net Income, 5-Year CAGR (LTM)
Gross Profit, 5-Year CAGR (LTM)
Source: S&P Capital IQ. LTM = last 12 months. NM = not meaningful.
Granted, in investing we're really focused on future returns, but given Chipotle's relatively modest store count, room for growth here and internationally, and the idea that it can translate its expertise to other concepts and cuisines, there's good reason to believe Chipotle can continue to deliver spicy growth for some time to come.
And now, the risks
I repeat: Chipotle's a highflier with a premium valuation; there's no doubt about that. Any investor who's been around the block a couple of times knows that a whiff of disappointment can send shares of such stocks plunging. (Should that occur, unless there's a severe problem with the business, it would make a perfect opportunity to buy more.)
Although Chipotle's Food With Integrity mission is a major reason I'm buying, it also spells out a particular challenge for the company. In its most recent 10-K, Chipotle warned that it is running up against shortages of naturally raised chicken and steak. In some of its restaurants, it has had to switch back to conventionally raised beef due to supply constraints early this year.
Rising food costs are an issue for all restaurants, and many of the ingredients Chipotle has sworn to include on its menu when feasible are often more expensive and in shorter supply. In addition, some competitors have caught on to increasing consumer attention to food issues like the ones Chipotle has addressed, and have begun offering similar ingredients. Emulation is flattery, but if enough rivals make these moves, Chipotle won't be as well differentiated.
Labor issues can hit Chipotle, too, and not just in the form of higher worker salaries. In 2010, the Department of Homeland Security conducted an audit at Chipotle's Minnesota stores, and the company lost 450 employees who happened to be unauthorized immigrants. Although Chipotle said it requires all workers to provide the correct documentation to ensure its employees are eligible to work in the U.S., clearly this issue has cropped up and could impact Chipotle. It's also undergoing current audits in Virginia and Washington, D.C.
Foolish bottom line
Overall, the future is bright for Chipotle, and I've long believed it's one of the truly great, innovative companies out there. Anchoring too much on valuation can cause investors to miss out. I'm taking a helping of the burrito stock for this portfolio, and looking forward to the future for the company and Food With Integrity.
I mentioned Chipotle's international potential as one of the biggest growth drivers in the future, but if you'd rather buy shares of companies that are already operating abroad with aplomb, I invite you to read "3 American Companies Set to Dominate the World." It's a free report our analysts have penned, and you can read all about it by clicking here.