Chipotle Mexican Grill (NYSE:CMG) is a great story stock: Guy (Steve Ells) starts a small burrito shop in 1993 focused on quality, ethically sourced food. It's such a big hit that it grows like wildfire. Over two decades later, same guy is running the place, and it has over 2,100 locations. In the interim, Chipotle stock runs up over 1,600%.
But investing in a story can be a dangerous proposition. That's because there's usually a significant gap between the stories we tell ourselves about our investments and the reality that the underlying companies operate in. I believe that's the case with Chipotle today, and it's why I've decided to sell my shares -- once Motley Fool trading rules allow.
Food poisoning is a catalyst, not a cause
Much has been made about the food-safety crisis at Chipotle, and for good reason: Starting in July 2015 and continuing to the end of the year, the company had several bouts of food-borne illness among its customers, including E. coli, salmonella, and norovirus. Hundreds of people became sick either because of problems with food sourcing, or because sick employees were allowed to work when they should have been sent home.
The effect on Chipotle's comparable-store sales -- a key metric to measure how business is faring in the restaurant industry -- was marked.
But here's my somewhat controversial belief: For long-term investors, the food-borne illnesses are largely a noisy catalyst. The real "signal" is the fact that Chipotle's moat -- or sustainable competitive advantage -- is being eroded.
The company was visionary to pioneer a simple menu that touted its ethically sourced food and generous treatment of employees. However, other companies -- seeing the success of this approach -- are free to copy it. For customers and employees of other companies and the public in general, that's a great thing. For shareholders, however, it could spell trouble.
A canary in the mine
To get a better idea for what I'm talking about, let's examine the case of Whole Foods (NASDAQ:WFM). Another founder-led outfit that was the first major player in its industry to focus on the ethics of where its food came from, Whole Foods flourished for over two decades.
The Great Recession actually helped the company, as it allowed Whole Foods to remain the only player in natural and organic goods; bigger players pared their organic offerings to match tightened budgets nationwide. Shareholders were major beneficiaries: Between going public in 1992 and October 2013, shares returned 4,400%.
But then, the bottom appeared to fall out. Since then, comps have either stalled or shrunk. The company's stock has lost over half of its value. While there were some controversies the company was linked to during this time, the real reason for the fall was simple: The competition had caught up. Between Kroger, Costco, Trader Joe's, and even Wal-Mart, people had far more convenient locations to get their organic goods than trying to schlep to one of Whole Foods' roughly 400 locations.
Again, this is great for us consumers: We have more healthy options for our families, but it hasn't been good for Whole Foods' shareholders. The same -- I believe -- will happen to Chipotle. While it remains a leader in the field, companies are popping up all over that have a similar focus, and more entrenched players are even tweaking their offerings to compete.
Far too pricey
To be honest, I think Chipotle the company will be OK. Try as they might, the likes of McDonald's and Taco Bell won't be able to displace Chipotle in the hearts and minds of customers. The bigger problem is simply the price tag. Currently, Chipotle is trading for 61 times trailing earnings and 63 times trailing free cash flow.
Even if the company hits analyst estimates for 2017 of $9.90 per share, the company will still be trading for over 40 times earnings. I simply don't believe that Chipotle will be able to grow that fast in today's competitive market. Though I'll surely be frequenting its locations for a long time, the combination of the loss of its moat and its expensive price tag are forcing me to sell my shares when The Motley Fool trading rules allow.
I suggest fellow shareholders consider these factors as well before deciding to continue holding.