In April 2015, I warned investors of Shake Shack (SHAK, Financial) being a poor purchase for now. At the time, the stock was trading around $70 per share. Of course, short term it kept going up, breaching $90 before making a long descent back to the $30 range, which is where it’s been for the last couple of years.
Shake Shack is an incredible growth story and investors are still willing to pay up for future sales and earnings. That doesn’t make them wrong. What matters is that the company continues to grow profits, earnings and book value, which it will.
While McDonald’s (MCD) has close to 37,000 locations, Shake Shack has 143 stores - 79 company owned and 64 licensed, with 32 to 35 looking to open next year, along with 16 to 18 new licensed stores. To be clear, if Shake Shack could open up just 10% of the total locations that McDonald's has now, the stock at this price would be a no brainer.
Shake Shack's third quarter sales grew 26.9% to $94.6 million, including licensing revenue up 30% to $3.5 million. Since Shake Shack doesn’t franchise (it uses licensing agreements) the company should be able to keep the standard for quality consistent across all locations for years to come. While the company gets about $220,000 a year from licenses, its company owned stores generate north of $5 million.
See the latest financial results here.
The more important factor here is that the Shack still has raving fans. Every time I go to the one at Union Station or Chinatown here in Washington, D.C., it’s busy -- very busy. And it’s fast -- very fast.
However, guru investors have stayed away from Shake Shack with Paul Tudor Jones (Trades, Portfolio) and Steve Cohen both buying and then selling out within a fairly short amount of time. To me this is a long-term trade where the investor is betting on the company getting to its 450 store mark faster than originally anticipated in the IPO documents.
If it’s able to open 30 to 35 locations a year, which it looks like management wants to do, then by 2027 it could have almost 450 stores. At that point, consumers will be paying around 20% more for the meal, and the chain could be generating over $6 million per store. That would put the sales in the $2.7 billion range before adding in any licensed stores, which could be another 400, adding $100 million more to that number. If that happens, the increase on net income would be $125 million to $130 million.
That’s where the current valuation gets fuzzy. The profit on licensed stores is higher, and Shake Shack could decide to open more of those for even greater profit long term. Additionally, the bottom line could be boosted even more through further automation like Manhattan's Astor Place Shake Shack, where the cashiers were replaced with iPads.
Granted, Shack will never grow like a technology company, but its profits are likely to be much more stable and consistent. As long as the company doesn’t make a massive Chipotle (CMG)-like blunder, investors shouldn’t lose money by owning the stock at these levels.
60 Minutes interviewed the founder, Danny Meyer in August, and he had this to say: “We are as sometimes as mystified as anybody as to what the magic of Shake Shack is. I think we know that this is fine-casual. This is a new way of dining…”
Let’s not take too big of a drink of the SHAK Kool-Aid, because the company will still need a lot more growth to justify its valuation. Yet, when the company is generating $100 million a year, even in line with other fast casual multiples, the value would be over $3 billion, maybe even close to $4 billion.
Disclosure: I have no positions in any stocks mentioned in this artice.