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What do Videos of Exploding Cows have to do with Chipotle?

By Johnny Chen – Feb 15, 2014 at 7:00AM

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Better known for its burritos, why is Chipotle releasing satirical videos covering industrial-scale farming?

This month, Chipotle (CMG 4.78%) will release "Farmed and Dangerous," a four-part comedy series on Hulu. The series, which involves mad scientists and exploding cows, takes a satirical look at industrial-scale farming. While the hero is named Chip, there are hardly any scenes that directly tie Chipotle into the series. So why is the burrito-maker getting involved with a TV-streamed series that mentions the company's name only once?

It's about the mission
Chipotle's CEO Steven Ells has been direct about his feelings in regards to industrial-scale farming. In the last earnings call Ells emphasized the company's mission, "Food with Integrity," which focuses on sustainably raised ingredients. Ells notes that while there is uncertainty about whether the "Food with Integrity" mission will drive foot traffic, he notes that where food comes from and how it becomes part of meals have become increasingly important to Chipotle's customers. The social buzz created by the "Food with Integrity" mission coupled with Chipotle's food will strengthen the company's bond with its customers.

Chipotle has taken several steps to further the "Food with Integrity" mission. By the end of 2014, the restaurant chain expects to be entirely GMO-free. The burrito maker is looking to expand the availability of Sofritas, a new vegan tofu menu item, which has shown to be popular even with people who eat meat. In 2013, the company rolled out a Scarecrow marketing program which included a three-minute video and a game for Apple iPads and iPhones. The Scarecrow program covered issues in industrial food production that included the overuse of antibiotics in livestock farming.

The "Farmed and Dangerous" series is an extension of that culture system. The culture is more important to Chipotle than just getting people in the door. Ells noted, "All of these things that we're focused on, our food culture, our people culture, the unique way in which we market Chipotle, demonstrate how we are changing the way people think about fast food. But we also know that to change food culture and to reach even more people is going to require that we serve more than burritos and tacos."

Every mission comes with a cost
Becoming GMO-free has come at a cost for Chipotle. Food cost in 2013 rose to 34% of operating cost from 33.5% in 2012. The increased food cost affected Chipotle's operating margin, which fell to 26.6% in 2013 from 27.1% in 2012. The operating margin drop would have been worse if it was not offset by favorable sales leverage from higher restaurant sales. According to CFO John Hartung, the increased food cost may lead to an increase in menu prices in the third quarter of 2014. While nothing is definite yet, will its growing menu prices keep customers away?

The stock also rises
Chipotle's stock has been resilient to past menu-price changes. In 2012, investors remained bullish on Chipotle's stock partly because of positive foot traffic even as the burrito maker raised menu prices because of its push toward using organic food.  However, the past price increase caught many customers as an unwelcome surprise.  

Chipolte has learned from its experience, marketing its "Food with Integrity" message to customers to partially offset the blow of menu price increases. For Chipotle's desired customer, a slightly more-expensive burrito isn't so bad if the extra cost goes toward properly sourced foods. These customers may even want to order more often from Chipotle because of its non-GMO foods.

Many investors think this scenario will play a part in Chipotle's future growth, as evidenced by its recent P/E ratio of over 50, compared to the industry average P/E of 22.30. I believe that Chipotle will maintain its P/E premium. Why? Consider this: Chipotle is already promising low-to-mid single-digit comparable-restaurant sales growth in 2014, before before factoring in higher menu prices.  But if Chipotle can keep customers coming in the door, and also raise the prices it charges them, then this would boost the value of its sales even past the promised "low-to-single digit" range. That would obviously please investors, and probably make them more than happy to pay the premium P/E. And this time, the image of exploding cows will remind customers that a slightly more expensive Chipotle burrito is worth it.

Johnny Chen has no position in any stocks mentioned. The Motley Fool recommends Apple and Chipotle Mexican Grill. The Motley Fool owns shares of Apple and Chipotle Mexican Grill. 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.

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