Shares of Shake Shack (NYSE:SHAK) have embarked on an impressive rally in recent months, achieving a year-to-date gain of approximately 88%. The stock’s surge can be attributed to various factors, including the strong rebound of QSR (quick-service restaurant) stocks during this period and Shake Shack’s continuous expansion into new markets, which must have contributed to its overall upward momentum.
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While Shake Shack’s recent gains are certainly impressive, it is prudent to approach its investment case cautiously. Specifically, concerns arise when considering the company’s ongoing struggle to deliver sustainable profits. Despite management’s admirable efforts to moderate the company’s operational expenses, Shake Shack continues to grapple with the challenge of attaining substantial profit margins and, consequently, a positive bottom line. Accordingly, I am neutral on the stock.
Expansion Phase Delivers Fruitful Top-Line Results
Shake Shack numbered 456 locations by the time it reported its Q1 results, but the company is still in its growth phase, aiming to continuously expand its top-line numbers. Management’s efforts have been quite fruitful, as the combination of a growing restaurant footprint along with strong demand for their delicious burgers has resulted in rapidly-growing sales.
Notably, Shake Shack’s system-wide sales experienced a tremendous year-over-year increase of 27.5%, amounting to nearly $395 million, with the company’s licensed business achieving its strongest quarter to date. This growth was driven by the successful establishment of new restaurants as well as the performance of existing ones.
Specifically, during the quarter, Shake Shack opened 13 new Shacks, consisting of six company-operated locations and seven operated by licensed partners. By the end of March, the total number of locations stood at 449, marking a remarkable 17.5% year-over-year growth. Also, as mentioned earlier, by the time the report was released in April, this number had further increased to 456.
Furthermore, the company experienced significant growth due to sales at its existing locations. In fact, same-Shack sales witnessed a notable year-over-year increase of 10.3%, propelled by a 4.8% increase in foot traffic and a 5.5% rise in pricing.
It is commendable that Shake Shack managed to drive consumer spending on its burgers despite higher pricing, considering it is already recognized as one of the most expensive fast-food chains globally. For context, in a survey conducted by Stifel, Shake Shack ranked first in the “Worst Bang for Your Buck” list, indicating customer dissatisfaction regarding its pricing. However, the actual results achieved by Shake Shack demonstrate the brand’s resilience and its enduring appeal – a great intangible asset!
Margins Remain Soft Despite Improvement Efforts
Despite Shake’s noteworthy expansion of locations, same-store sales, and overall system-wide sales, the company’s margins remain quite thin. Management’s efforts are commendable, and while there are some improvements in moderating costs, they are hardly sufficient to result in a fruitful bottom line.
To give you some context about this, Shake Shack’s management has been trying to improve the company’s margins through three key routes.
The first route is through driving sales and prioritizing the channels where each individual Shack is most profitable. In addition, the company is directing more business into its own channels by offering the lowest menu price there as well as value-added day-part promotions. This could help the company capture more of the consumers’ total spend than having an app like DoorDash (NYSE:DASH), for example, charge their hefty fee.
Secondly, the company is targeting labor efficiencies and growing throughput. Management is so far seeing great benefits in this area from recruiting and retention tactics, while better staffing is helping to extend operating hours and be more efficient. Kiosks are an important tool to help drive profitability, in that regard, as they are higher-margin locations with lower costs than the big Shacks.
Thirdly, the company is attempting to improve its off-premise profitability and lower controllable expenses. Such examples include reducing packaging and increasing pricing further on third-party apps (despite efforts to drive sales to direct channels as well) to boost margins.
Fortunately, management’s efforts to improve margins have been indeed productive. Notably, the percentage of food and paper costs in relation to total revenues decreased from 30.4% in the prior year period to an impressive 29.4%.
Additionally, labor and related expenses saw a decline from 30.7% in Q1-2022 to a more efficient 30.4%. As a result of these efforts, the company achieved a significant enhancement in restaurant margins, which increased by 310 basis points to 18.3% compared to the previous year.
Outside of the Shack-level economics, the company also reduced its general & administrative expenses from 15.4% to 12.4%. Despite these notable improvements, profitability remains a challenge as the total expenses amounted to $256.5 million, surpassing Shake Shack’s total revenues of $253.3 million.
Sure, the loss attributable to Shake Shack shareholders improved from last year’s $10.2 million to a more modest $1.5 million. However, the core issue remains — despite implementing economies of scale and persistent efforts to enhance margin, the company doesn’t seem to be able to free enough room to record meaningful profits.
Is SHAK Stock a Buy, According to Analysts?
Regarding Wall Street’s sentiment, Shake Shack features a Hold consensus rating based on four Buys, seven Holds, and one Sell assigned in the past three months. At $69.92, the average Shake Shack stock price target implies 11.2% downside potential.
If you’re wondering which analyst you should follow if you want to buy and sell SHAK stock, the most accurate analyst covering the stock (on a one-year timeframe) is Jake Bartlett from Truist Financial, with an average return of 25.75% per rating and an 82% success rate.
The Takeaway
Shake Shack’s expansion efforts and the resilient demand its strong brand attracts continue to deliver notable top-line results. However, the company continues to struggle with profitability, as its margins remain thin despite improvement efforts.
While management’s initiatives to control expenses have shown promise, Shake Shack has yet to achieve substantial profits. Hence, I suggest investors approach Shake Shack’s investment case cautiously, especially following the stock’s extended rally year-to-date.
