- Shake Shack stock gained incredible momentum following the IPO, taking the stock past $90 per share.
- Shake Shack stock has now been on the decline reaching closer to its initial pricing.
- Trading at extremely premium valuations, how much growth is necessary to justify Shake Shack's current valuation?
There is no question that Shake Shack (NYSE:SHAK) has been a roller coaster ride since their IPO. Being priced at $21 per share and then rocketing past $90 is as exciting as it is dangerous for investors. So when you face a company that is so small, so volatile, and yet has so much investor interest, how do you value it?
Most multiple valuation methods would scare off investors from Shake Shack. They are trading at 109x their EBITDA and 7x sales. But these numbers don’t necessarily scream overvaluation as much as they scream big growth on the horizon. I’m projecting Shake Shack to close 2015 at $190 million in sales; a 60% increase from the year prior. This should excite investors because in 2014 Shake Shack increased revenue by 45%, and in 2013 increased revenue by 43%. So, Shake Shack is actually increasing revenue year over year by a large margin. If this trend continues, Shake Shack could grow at an incredibly fast pace and hit a billion in sales rather quickly.
But let’s pretend that Shake Shack has peaked in terms of YOY revenue growth. Let’s say that they increase revenue by only 50% next year and then continue down a slower growth path. Below I’ve outlined a 10 year DCF that uses that growth and applies a 10% discount rate. The operating margin finishes at 14% which is the average for the restaurant industry.
As you can see, one of the most attractive things about Shake Shack is that they produce positive operating cash flow. Sure, FCF is negative due to capital expenditures, which is to be expected for a growing company, however they are still operating with positive OCF. Now the DCF model above assumes that Shake Shack’s revenue is on a slow downward spiral, and yet it still leaves Shake Shack with a valuation that mirrors their current market capitalization.
I believe Shake Shack’s stock price is going to be tied exclusively to their growth for the next few years. The last quarter of 2015 and first quarter of 2016 will give a lot of insight into where Shake Shack is headed. If revenue for Q4 of 2015 is greater than $60 million and/or revenue for Q1 2016 comes in greater than $61 million, then this company is likely on track to grow their sales past the projections in my DCF and make it much more reasonable to buy Shake Shack stock at its current valuation. However, if Shake Shack starts to slip or become stagnant on topline growth, then I would be looking to pull back. The Shake Shack story is all about growth and a high double digit revenue growth rate will need to continue for shareholders to really cash in big on this one.