The West Coast is suffering through a drought so bad that California Governor Jerry Brown has declared a drought emergency. California is a key U.S. supplier of avocados and other vegetables. If the water shortage pushes the price of these food stuffs too high Chipotle Mexican Grill (NYSE:CMG) says it will pull guacamole and even salsa off the menu... But what's Mexican food without salsa and guacamole?
Where's the Rain?
According to the National Oceanic and Atmospheric Administration, nearly two-thirds of California is experiencing extreme or exceptional drought conditions. Another 25% or so of the state is facing severe drought. In fact, every portion of the state is dealing with some level of drought. That's bad considering that in 2012 Cali earned more from agriculture than any other state in the Union.
One crop is avocados. This tasty green treat is a staple in Mexican fare, an increasingly popular food choice domestically. Demand for Mexican flavors has helped Calavo Growers (NASDAQ:CVGW) more than double its sales over the past decade—avocados account for about 60% of its business. Calavo estimates that it handles around 30% of all of the avocados grown in California. If the drought hurts that avocado crop, Calavo's business will feel a direct pinch.
Worse, the company has been expanding into tomatoes. That's another big crop in California and a key ingredient in Mexican food. But Calavo is just the first in line for the pain. Imagine what would happen to ingredient costs for a Mexican-themed restaurant like Chipotle.
Obviously, if prices go up for avocados and tomatoes Chipotle will be facing higher costs. In the company's 10k it warned, "in the event of cost increases with respect to one or more of our raw ingredients, we may choose to temporarily suspend serving menu items, such as guacamole or one or more of our salsas, rather than paying the increased cost for the ingredients." What?
The company openly admits that such a decision might "negatively impact our restaurant traffic and comparable restaurant sales, and could also have an adverse impact on our brand." When it comes to Mexican food, salsa (tomatoes) and guacamole (avocados) are key flavors. Killing either would be like McDonald's (NYSE:MCD) deciding to get rid of its "special sauce." A Big Mac is just a burger without the special sauce, and a burrito bowl lacks any flare without salsa and guacamole.
But, before you get too fired up about this one, that warning in the 10k has been included, pretty much unchanged, since 2008. The difference is that the drought in typically dry California is pretty serious this time around. Is Chipotle really willing to play this game of Russian roulette with its customers?
Don't count on it...
My guess is that Chipotle refuses to pull the trigger and that warning is just a case of cover your you know what. In fact, there are at least two other options for dealing with higher ingredient prices: raise burrito prices or let margins shrink. Either would be better than the public nightmare of a national Mexican chain without salsa and/or guacamole on its menu.
What this drought scare and Chipotle's warning really speak to is the long-term risk we face from changing weather patterns. Luckily, human ingenuity is already on the case. Cavalo and Chipotle can thank their lucky stars that companies like Consolidated Water (NASDAQ:CWCO) are already working to get California more water.
Consolidated's main line of business is operating 13 water desalination facilities in the Caribbean. But, it has a project in the works in Rosarito, Mexico. That desalination plant could provide water to Tijuana and San Diego. This, in turn, could help sate California's water needs.
Perhaps more important, however, Rosarito would get this Caribbean-focused company a toehold outside of its dominant market. While Consolidated will never be a growth story like Chipotle, such expansion could make it a pretty interesting player in the water utility space. That, in turn, might help Chipotle fulfill its customers' guacamole desires as the restaurant chain continues to aggressively build out its store base.
Always dig deeper than the headline...
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Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and McDonald's. The Motley Fool owns shares of Chipotle Mexican Grill and McDonald's. 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.