- Lower financial metrics compared to similar peers.
- Slower rate of new store growth versus private and public gourmet competitors.
- Operating margins that are decreasing while similar peers are increasing.
Following an IPO in January 2015, Shake Shack (NYSE:SHAK) has taken investors on a wild ride. The stock peaked at over $90 in May 2015 and is now trading at ~$35; lower than trading debut (post IPO) price of $47. Even with the recent drop, investors should stay away from Shake Shack stock. The stock is overvalued compared to similar peers and may fall even further.
Before reading the arguments below, remember that Shake Shack's market capitalization today is around $1.25 Billion and the company has 75 stores. Comparing Shake Shack to McDonald's is not relevant. McDonald's has over 32,000 stores with a market capitalization of $115 Billion. To really understand the strength or weakness of Shake Shack's business, the company must be compared to peers of similar size.
When purchasing a share of Shake Shack, a investor is effectively buying part ownership in a network of stores. Shake Shack's US stores are all company owned and some of it's international stores are licensed. To truly gauge the performance of Shake Shack's business, we'll compare it's net income per dollar of market capitalization to public competitors. By using net income per dollar of market capitalization, investors can easily see how much income will be generated by each dollar they invest in Shake Shack stock.
The two public peers used in this comparison are Sonic Burger and Panera Bread (NASDAQ:PNRA). Sonic is of equal size to Shake Shack ($1.45 billion in market cap vs $1.25 billion) and Panera is slightly larger ($4.5 billion in market cap). Net income data will be for the most recently completed quarters multiplied by four. I'll use this to estimate a full year of income. This will account for recent growth from new store openings for Shake Shack.
For every dollar invested in Shake Shack, an investor will likely earn less than $0.01 annually versus nearly $0.03 for Panera Bread and over $0.03 for Sonic Burger. Even with the recent drop in Shake Shack stock price, the stock is still over priced to similar peers Sonic Burger and Panera Bread.
Price to Earnings ratio could have been used here as well, but by dividing net income by market capitalization investors easily see the income generated by each dollar they invest.
Operating Margin Growth
Shake Shack bulls will often mention that the company is young and will increase margins in the future. When this occurs the net income per dollar of market capitalization will increase. While Shack Shake is still relatively young, three years of financial returns are available to judge if this outcome will occur. As Shake Shack opens more stores the company's operating margins should increase. This would indicate scaling benefits exist. Operating margin is defined as revenue divided by operating income.
Comparing Shack Shake again to public peers Panera Bread and Sonic Burger shows that the company is not only failing to increase operating margins but is actually experiencing decreasing margins.
While similar peer Sonic Burger with a similar valuation has increased it's operating margin the past three years, Shake Shack has seen their operating margin fall. Please note that all three companies have different reporting schedules so data from the three most recently completed fiscal years was used.
Shake Shack today competes against fast growing chains Five Guys, Chick Fillet, Sonic Burger and numerous others. The market is very saturated. The company that will gain market share the fastest will likely be the company that is opening new stores at the fastest rate.
Shake Shack currently operates 75 stores throughout the world and opened 12 new locations in fiscal year 2015. Competitor Chick Fillet will be opening an equal number of locations in just two months (February and March 2016) and will likely open 60 in 2016. Five Guys, a direct competitor of Shake Shack, is currently planning to open 50 new locations. Sonic Burger opened 152 stores in 2015.
Only In and Out Burger, a West Coast only burger chain, is opening stores at the same rate as Shake Shack. In and Out Burger has historically opened 10 stores per year but already has 300 versus Shake Shack's 75.
Shake Shack is growing slower than it's peers Five Guys, Chick Fillet and Sonic Burger. Only In and Out Burger, a regional chain, is growing at an equivalent rate. Unless Shake Shack increases it pace of openings, similar peers Five Guys, Chick Fillet, and Sonic will grow market share faster.
When comparing a company to peers, it's important to use similar market and size peers. Comparing Shake Shack to McDonald's or Burger King is not relevant based on the size differential. Comparing Shack Shack to Taco Bell is not relevant due to the difference in market segment.
Though Shake Shack stock price has fallen considerably investors should still stay away from the stock. When comparing the company to similar public peers, Shake Shack earns less income per dollar of market capitalization and has falling operating margins. The company has not shown it can scale. Additionally compared to numerous public and private competitors, Shake Shack is opening new stores at a significantly slower rate.