Early last summer, I stopped by the corporate offices of Chipotle Mexican Grill (CMG) in downtown Denver and had a great chat with the head of investor relations. I've always been impressed with Chipotle's management, and its food. The company's financials at the time of that meeting were also quite tasty. It was opening dozens of new locations every quarter; its comps had been growing consistently; and its earnings-per-share was up 24 percent in the first quarter of 2013 and almost 30 percent in F2012.
Despite all of these positive numbers, I couldn't convince myself to buy CMG that day. At $372 a share, its PE multiple was pushing 40x trailing earnings. That's way above my comfort level, so I decided to hold off. My cautiousness has saved me a great deal of money over the years, but in the case of CMG, it cost me dearly. The stock rallied in a big way. By the end of the year, it was well over $500. In late-January, after Chipotle announced another 20 percent rise in earnings-per-share for F2013, it shot up another $60 in a single day.
Chipotle was my biggest miss of 2013. Now, I'm worried that if I don't get over my fears about its valuation, it could wind up being my biggest miss of 2014, too. In fact, CMG is starting to bring back unpleasant memories of the biggest miss of my career.
Back in 1992, I visited the headquarters of another budding consumer brand that had turned a unique regional product into a national craze. In that case, the company was located in Seattle instead of Denver and it was selling gourmet coffee instead of healthy Mexican food. I'm talking about Starbucks (SBUX). It had recently come public at the time of my visit. Like Chipotle these days, its stock seemed too "expensive" on a multiple of trailing earnings to buy (I believe its PE was in the high-30s), so I decided to wait until it cooled down a bit. It never did. Since that fateful day 22 years ago, it has gone up 100-fold.
At its current price of $555, CMG's multiple is now north of 50x earnings. That makes me very, very nervous, because it puts a tremendous amount of pressure on the stock. Chipotle has to deliver near-perfect results each and every quarter to avoid a major sell-off (which happened twice in 2012). Nonetheless, I'm doing everything I can to talk myself buying CMG--and not just because it reminds me so much of Starbucks. Three other factors make me believe that the stock will most likely continue to thrive and could even hit $1000 in the not-too-distant future:
Number one: Chipotle does not franchise.
Franchising is the corporate equivalent of steroids. It boosts growth quickly, but the side-effects can be deadly. By keeping all of its locations company-owned, Chipotle will continue to grow steadily while maintaining rigorous quality controls. Chipotle customers know that they can walk into any location and get the same high-quality fare. Thanks to that consistency, more and more customers are doing so, too. Even though food costs went up last year, Chipotle's same-store sales grew every quarter because of increased traffic, with comps rising from one percent YOY in the first quarter to almost 10 percent in the fourth.
Number two: Like Warren Buffett at Berkshire Hathaway, Chipotle's leaders have refused to split the company's stock.
This is an increasingly popular approach. Corporate managements from Google to Priceline to Biglari Holdings have adopted it, and for good reason. While it's terrible for brokerages and investment banks because it reduces a stock's trading volume (and their commissions), it lessens volatility by pricing out bottom feeders and fickle, short-term investors.
Number three: With exactly zero debt on its balance sheets and free cash flow of close to $300 million, Chipotle's visionary founder and co-CEO Steve Ells is investing in new opportunities.
First, he launched the Asian fusion concept ShopHouse. Then, in December, news broke that Chipotle had bought into the Pizzeria Locale chain. I ate at the Pizzeria Locale in Denver this past Friday and it is a potential homerun. The food not only came out quickly, it was delicious--far better than the pizza at Texas' "Pie Five," the fastest growing player in the hot fast-casual pizza category. I'm sure Steve Ells will bring the same focus on quality, consistency and prudent growth to ShopHouse and Pizzeria Locale that he brought to Chipotle--and I fully expect both of these ventures to feed healthy revenue streams into Chipotle's bottom line.
I don't question Ell's ability, or his business acumen. I do, however, question my own intestinal fortitude when it comes to buying his company's stock. Will I finally get over my nervousness about Chipotle's valuation and get on board? Even after outlining all the great things about it, and reliving my costly failure to buy Starbucks in the 1990s, I'm still not sure...