Customers have come to know Chipotle Mexican Grill's (NYSE:CMG) food for two things above all else: it is both satisfying and consistent.
You could easily say the same about the company's stock performance. Its shares have walloped the market in four of the past five years, providing a return of more than 650% during that stretch.
But every once in a while a Chipotle burrito can bust, be too soggy, or just prove underwhelming. This could also be the case for investors, particularly for those with a short-term perspective.
Here are three key reasons why Chipotle's stock could drop from its recent record high:
1. The market has great expectations
Many competitors have jumped into the fast-casual restaurant scene over the years, but Chipotle remains in a league of its own when it comes to stock price. And, for investors, price always matters.
Investors don't care how savory your barbacoa burrito is, they're going to whet their appetite elsewhere if your stock's too pricey. Right now, Chipotle looks expensive from almost every angle. Relative to its industry, the overall market, and its five-year historical average, Chipotle's stock is in the stratosphere.
To be sure, Chipotle is posting some hearty growth rates, and it's important to assess whether this blazing-fast burrito maker can measure up to the hype. To this end, let's look at the company's price/earnings-to-growth, or PEG, ratio.
The PEG divides a simple P/E ratio by a company's annual earnings-per-share growth to arrive at a readily comparable metric. Typically, a PEG ratio below one is desirable. As of now, Chipotle's PEG ratio stands at roughly two, whether we use past earnings growth of 25% or analysts' growth projection of 24% over the next five years.
Trading at twice the desired PEG ratio leaves little wiggle room for Chipotle going forward. Earnings results have proven a bit lumpy in the past, and there's reason to believe this stock could take a hit if that's the case in the near future.
2. Chipotle faces a branding dilemma
In recent years, Chipotle's management has walked a fine line with the "Food With Integrity" branding. On one hand, leadership sets high standards when it comes to sourcing its meats and vegetables. For example, Chipotle strives to purchase beef that is free of antibiotics and added hormones.
On the other, these high standards place the company in a bind when suitable suppliers are scarce. Last year, Chipotle only found naturally raised beef for 80% to 85% of its sourcing needs, compared to 100% in the year prior.
In the most recent quarter, co-CEO Steve Ells noted that this struggle to find antibiotic-free cows continues. He pointed out that the U.S. is experiencing a "60-year low" in overall beef supply, which is making matters even worse.
This supply demand imbalance forces the company to raise beef prices more than those of its other products. It could also lead to supply disruptions at certain restaurants or undermine its "Food With Integrity" philosophy, a key component of the overall brand.
Management claims that a temporary solution has been found in recent months via sourcing grass-fed beef from Australia. But you have to wonder how well that will resonate with customers who appreciate Chipotle's "local food" cred.
All things considered, Chipotle is stuck between a rock and a hard place right now. If beef supplies continue to plunge, Chipotle's supply chain could take a hit. If Chipotle sacrifices quality, though, its brand -- and consequently, its stock -- could, too.
3. Unhappy workers could make for sloppy burritos
Chipotle frequently touts its "special people culture" as one of its key differentiators, but occasionally there are signs that its people don't feel so special.
Just last week, in fact, workers collectively shut down a Chipotle in Pennsylvania because they felt they were "forced to work in borderline sweatshop conditions." That was the explanation given in a letter posted on the front door of the building. It also contained the words "People > Profits" typed below.
This is not the first negative human resources incident that Chipotle has faced in recent years. A few years back, multiple government agencies investigated the restaurant chain for its improper hiring of undocumented immigrant workers. The investigation by Immigrations and Customs Enforcement led Chipotle to fire 450 unverified workers in Minnesota alone.
These incidents undermine Chipotle's people-centric messaging, and they could increase employee turnover, one of the largest costs in the restaurant industry.
Around the country, fast-food workers are feeling the pinch and making their voices heard. Further walkouts or similar incidents could hurt the company's bottom line and its otherwise admirable reputation in the industry.
The takeaway for investors
At this point, what could take a bite out of Chipotle's stock? Well, Chipotle's shares are trading at a significant premium to its peers' stock, so even a minor quarterly hiccup could curb investors' enthusiasm in the near term. Second, supply chain imbalances are forcing management to walk a tightrope between touting holier-than-thou ingredients and not-so-holy suppliers.
Finally, a people culture that fails to exceed the standards set in the fast-food world is bound to cause unease for all stakeholders. If Chipotle can navigate around these pitfalls, its success story will continue. If not, investors will head for the exits.
Isaac Pino, CPA owns shares of Chipotle Mexican Grill. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. 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.