All posts by Roger Lipton


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I attended the well attended ICR Conference in Orlando last week and listened to restaurant companies, public and private, present their stories over the course of three days. Some reports have been positive but I read the tone as subdued. While customers are feeling more job security than in the recent past, translating to “gains” in same store sales, and operators are more constructive in terms of operating initiatives and expansion possibilities, I call the improved attitude a “relief rally”. As a country western tune put it “Down so far, down looks like up to me.” My view, probably in the minority right now, may  well prove to be overly cautious, but here are a few supporting facts.

Just because the economy has demonstrated real GDP growth of 3% or so over the last six months of ’17, it does not necessarily follow that this strength will continue. Q2 through Q4 of 2010 averaged 3.0%, Q3 and Q4 of 2013 were 3.1% and 4.0%, and Q2 and Q3 of 2014 were 4.6% and 5.2%, none of which lasted. However, I’ve said many times that the restaurant industry has proven to be a leading indicator for the economy as a whole, so perhaps November and December restaurant industry “strength” is a forerunner of continued economic growth.

Here’s the problem, and these statistics have been provided by David Rosenberg, the highly respected economist and stock market strategist. Over the last several months, the consumer savings rate has been drawn back down to 2.9%, a decade long low, from 3.7% a year ago and 6.1% only two years ago. At the same time, consumer credit balances soared at a 10.4% annual rate (up $8.3B) in October and a  14.1% annual rate ($11.2B) in November. Over the last four months, $30B of consumer spending has been financed by credit card debt (up 9.3% annualized), as Rosenberg puts it: “a binge we last saw a decade ago, and we know how that turned out”. Rosenberg also points out (1) that household debt service and rent payments now absorb close to 16% of household after tax income, which would be a six year high. (2) the delinquency rate for motor vehicle loans has climbed to their highest level since October 1011 (3) The average interest rate on over $1T of credit card debt is up 50 basis points in the last month, a $50B hit to consumers, the latest rate above 19% for the first time in five years (4) the delinquency rate on all personal loans is almost at 2%, a four year high, and a significant rise from 1.5% just six months ago. All of this supports the view that while the unemployment rate is down to 4%, lots of jobs are part time, wage rates are stagnant, and consumers are financially stretched out.

The question then becomes, how strong are the restaurant sales, and can they continue if consumers are financially strapped? The answer is: restaurant sales are only “strong” relative to the even worse trends of the last couple of years.  The sales, up 1.8% and 1.9% in November and December, do not account for the price increases that have negated the sales increases. Traffic and Transactions have in turn been flat, or worse, at almost all reporting chains. Add to the equation that 95% of restaurant chains are leaning heavily on value oriented promotions. Led by McDonald’s with their $1 through $5 specials, Burger King with 2 Whopper’s for $6.00, Wendy’s with 4 for $4, the various boxes or buckets for $5.00, Taco Bell’s $1.00 offerings, anybody selling lunch for more than $5.00  or dinner entrees for more than $10.00 has a real challenge.

We don’t know whether real GDP growth can be sustained at 3% (or better) or not. We do know, however that the “better” (but NOT MUCH) restaurant spending trend has been financed by consumers running down their saving rate and running up their credit card debt (with higher interest and default rates). The restaurant sales and traffic trends will likely continue to look firm, but the comparisons continue to be very easy versus the negative trends in the Q1 OF ’17. The average ticket at restaurant chains will be under pressure with the myriad of “value” offerings. Store level margins will be almost impossible to improve, with higher labor, higher rent, flat to higher cost of goods, and sluggish traffic. Sustainably better sales (and  traffic) trends may establish themselves over time, but we doubt that it will be over the next several months.

Roger Lipton

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Economics seems like such a complex subject, as represented by PHDs and pundits. Some of you may remember Martin Zweig, a very successful money manager who made his name by predicting the 1987 crash. More than that, his investment mantra, “Don’t Fight the Fed” has proven to be one of the simplest, but most durable, tools in capital management. While everyone seems to be celebrating two quarters of 3% GDP growth (not “great”, but better than 2%), and debating whether the economy will continue to strengthen or weaken once again, everyone seems to be forgetting that Central Banks around the world have enlarged their collective balance sheet by something like TEN TRILLION DOLLARS since the financial crisis of ’07–08. In an effort to stave off a deflationary collapse, the Fed, the European Central Bank, the Bank of Japan, the Swiss National Bank, and the Peoples Bank of China have created new currency (something like “cryptocurrency”), and bought all kinds of fixed income securities as well as equities. This has, as designed, inflated the bond and stock markets, keeping interest rates very low (still negative on trillions of fixed income securities) and elevated the stock markets to record highs. Janet Yellen and other economists are mystified as to why all this newly created capital has not stimulated inflation in wages and groceries, ignoring the fact that inflation has been huge in the capital markets, real estate, art and other asset classes with the notable exception of gold (so far). The “wealth effect” for the upper class at least, has allowed the for the purchase of a Van Gogh painting for a cool $450M and apartments in the Big Apple for $60-100M. Grocery and apparel prices have not inflated, but the creation of $10 trillion of fresh capital has had its intended inflationary consequences in the form of asset prices.

Now comes the test, as the Central Banks begin to “normalize”, reduce their balance sheets, and pull back the Keynesian accommodation that helped to avoid an even larger financial crisis back in ’08. Our SIMPLE point here: If Central Banks provided $10 trillion dollars of freshly printed currency, which no doubt was a major contributor to the steady (though anemic) economic growth of the last seven years and the straight line upward in the stock and bond markets, it seems reasonably predictable that the removal of that “accommodation” will reverse a lot of that economic progress and asset inflation.

Do not despair, however. In our view, the stock and bond markets will not collapse, and THE REASON IS SIMPLE. THE CENTRAL BANKS WILL CAPITULATE, and back off their intended “normalization”. Within a matter of months, the sale of securities by our Fed, and the reduction of purchases in Europe, Japan, China, and Switzerland, will create a year to year reversal of something like a trillion dollars, annualized, of buying power, and that will weaken the worldwide economy. At that point, the politicians will scream “do something”, and the Central Banks will back off their QT (Quantitative Tightening). The result will be the “can kicked down the road” once again. Unfortunately, though, each financial “heroin hit” has to be bigger than the last to maintain the economic “high” (anemic though it may be), so the accommodation will need to be even bigger. Of course the long term downside consequences will be even more dramatic but that is a story for another day. The bond market, with the ten year note still at a historically low 2.6%, (“disbelieving” the strengthening economy), and the gold market which has been firming over the last month or so (anticipating the next round of accommodation), may well be signaling exactly this scenario.

Regarding Bitcoin: Now down about 50% from its peak (about the time we last wrote about it, on 12/19 at the high), we stand by our analysis (from 8/1 and 9/5 at much lower prices, and again on 12/19) The search function on our Home Page will bring up those articles for you). The youtube link below humorously summarizes the situation.  Blockchain technology no doubt will have its applications, but Bitcoin and its 1300 brothers and sisters, amounting to hundreds of billions of dollars of newly “mined” currency, is not going to have material staying power. Watch this video, more truth than fiction.






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I remember Christmas of 2007 very well. I had been very cautious (bearish) in my partnership’s portfolio early in 2007, but got more fully invested in mid-year as the general stock market acted well while restaurants and retail stocks came down to historically attractive prices. By the fall, I was “long and wrong”,  probably 85-90% invested, and my holdings were getting even cheaper.  I figured, however, that Santa Claus always comes, the holiday season would generate retail optimism, and I could lighten up on my holdings either just before or just after December 25th.  Within days just after Christmas, I realized that “something had changed” and enthusiastic holiday spending had not materialized. I spent the next month liquidating my portfolio (even with the losses) and by March 1st I was “net short”. I could tell you that I saw the financial crisis of ’08 coming, and my genius allowed me to make money in ’08 while most money managers lost 30-50%, but it was really the absence of holiday spending in ’07 that got me out of the market and put me in a position to watch the financial carnage of ’08 unfold.

The bottom line is that there hasn’t been a robust holiday season since 2006. Every year since then has been very reserved, up a bit, invariably driven by promotional offers, longer hours open at retail locations, and the increasing influence of on-line spending (also at bargain promotional levels). Some years in the last decade have been better than others, for earnings, depending on inventory levels (for retailers) and cost controls (for restaurants). Sales and traffic trends, especially for brick and mortar retailers, and dine-in restaurants, have been continuously lackluster over the last decade.

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This is a very big ship, forced to navigate a continuing turbulent, competitive consumer spending environment. Growth in sales and earnings has slowed, and we doubt that EPS growth can be re-ignited, in large part due to the law of large numbers. To some extent, SBUX has become a “cash cow”, very profitable, generating still very high returns on capital, even if the base is growing more slowly. The shareholder base is transitioning to include long term value, and dividend, oriented, investors. In fact, SBUX has been in a trading range from the mid-50s to the low 60s over the last two years, with the stock’s valuation mirroring the slowdown in earnings (and EPS) growth. The corporate initiatives described below, further described by management on their conference call, are all necessary for further progress. Collectively, they can maintain corporate progress, and even move the growth rate by a few points, but we suspect that the days of high single digit comps (in the US) and 20% or better EPS gains are in the rear view mirror. There are now a large number of operational moving parts, not all of which will proceed smoothly. Furthermore, the business model is evolving, with possible unintended consequences, as discussed in our report of 8/22/17. Earnings reports in 2018, as predicted by management, will be muddied by one time transactions, so “adjusted earnings” will be a feature of their reports. Analysts and investors may not care much, if the current forgiving stock market environment continues, but tolerance for lots of adjustments will not be as high if the general market runs out of steam. A revised food menu is in the works but, even if food sales increase, non-coffee margins are lower, so earnings may not “leverage”. Starbucks is a great company, and will remain so, admirable in many ways, a great brand building example. The Company is one thing, the stock another. Investors can, and will, decide for themselves, what valuation is appropriate.


Starbucks is the premier roaster, marketer and retailer of specialty coffee in the world, operating and licensing over 27,339 locations in 75 countries. They employ over 300,000 employees generating $22,386 billion in sales.

In addition to selling products under the flagship Starbucks Coffee brand, they sell goods and services under the following brands: Teavana, Tazo, Seattle’s Best Coffee, Evolution Fresh, La Boulange, Ethos and Princi (an Italian bakery concept recently added to their portfolio).

Starbucks purchases and roasts high quality coffees that they sell along with hand crafted coffees, teas and other beverages, and a variety of high quality food items including snack offerings through company owned stores. Starbucks also sells a variety of coffee and tea products and license their trademarks through other channels such as licensed stores, grocery and food service accounts.

Starbucks is considered the main representative of “second move coffee”, initially distinguishing itself from other coffees – serving venues in the U.S. by taste, quality and customer experiences while popularizing darkly roasted coffee.

The first Starbucks opened in Seattle, WA March 1971. Originally the company only sold whole coffee beans and did not brew to sell. In 1987 the original owners sold Starbucks chain to Howard Schultz. It was under Mr. Schultz’s leadership the company developed into today’s concept.


The company operations are organized into four principle segments.

  1. Americas which is inclusive of the U.S., Canada and Latin America;
  2. China / Asia Pacific (CAP);
  3. Europe, Middle East and Africa (EMEA); and
  4. Channel Development which functions primarily as a wholesaler of branded Consumer Packaged Goods (CPG). Such products as single-serve Starbucks Coffee K-Cups, ready to drink bottled coffee, etc. to grocers, warehouse clubs, specialty retailers, convenience stores and U.S. food accounts. The remaining operations are grouped together under the heading – all other segments which include the retail operations of their smaller brands: Teavana, Seattle’s Best Coffee, Evolution Fresh, Reserve Roastery Tasting Rooms.


Starbucks utilizes a wide variety of sites, types and sizes to meet its market penetration objectives. Depending on urban vs. suburban location, types and sizes include traditional and nontraditional mall locations, inside big box retailers, college campuses, hospitals, airports, hotels, resorts, etc. A typical Starbucks free standing unit ranges from 1900-2100 square feet.

Starbucks does not franchise; however, it does grant licenses to operate a Starbucks under certain restrictions to select retail or hospitality operators – such as Marriott hotels, Target Retail Stores and airports to name a few. Average costs to open a license location is $315,000.

One of Starbucks essential attributes is its Return On Investment Capital (ROIC) at the store level performance. See table which reflects unit level economics as disclosed by the company for 3 of its principal markets at its 2016 analyst day in December 2016. While the performance of all stores in each country are industry leading, the returns of the stores opened in FY16 are especially impressive as they are even more profitable than their country-wide averages though they have lower or the same AUV’s. It is also notable that in the 2 years since the last investor day, year 1unit level EBITDA margins and cash ROI’s were up 1400 bps and 3300 bps, respectively, in the U.S. and up 900 bps and 1100 bps, respectively in China. In Japan year 1 metrics were down in the two-year period (EBITDA% -200 bps, ROI% – 1700 bps), likely transitional effects resulting from the buyout of the company’s JV partner in Japan. Still, though the Japanese metrics compare unfavorably with their counterparts in the U.S. and China, their unit level economics surpass most peers.

An equally important attribute of the company’s performance (but less quantifiable) is the culture instilled throughout the organization by Howard Schultz.

Starbucks Culture:

  • Employees are partners
  • Commitment to the environment
  • Provide great work environment
  • Create a third place
  • Never compromise the quality of the coffee
  • Complete guest experience: focus on details, people oriented, team gratification, aggressiveness and stability.

Mr. Schultz handed off leadership to Kevin Johnson in April 2017. This is the second time he will have stepped away. The first time (he remained non-executive chairman) it is worth remembering how the “romance and theater” of coffee preparation and service was lost in pursuit of speeding service and increasing efficiency. This led to “watering down the Starbucks experience” and “commoditizing the brand” per the diagnosis of SBUX’s underperformance sent to top management by Howard Schultz in February 2007. It is also worth remembering that the turn around and the renewed growth and margin expansion noted above dates from his return to the CEO role a year later in 2008 with the initiatives summarized in this letter. Clearly, Mr. Schultz has put a great deal of effort in selecting and grooming Kevin Johnson, his new successor, so relinquishing his executive role will hopefully be more successful this time. Mr. Schultz will remain as non-executive chairman and will supervise the development of the Roastery and Reserve concepts. Mr. Johnson first came to SBUX as a board member in 2009 when he was a top executive with Microsoft and later with Jupiter Networks. Mr. Schultz convinced him to join management in 2015 where he became steeped in the operations and led the development of the digital flywheel which Mr. Schultz determined several years ago would be instrumental in the next phase of SBUX’s corporate life.

LONG-TERM BUSINESS STRATEGIES (Biennial Investor Conference 12/7/16):

  • Transforming the Premium Coffee Experience

 Since opening two years ago, the Starbucks Reserve® Roastery in Seattle has become recognized as the most dynamic and immersive coffee forward retail experience in the world, delivering an unprecedented level of premiumization to the coffee category and fueling the next wave of transformation that is elevating the Starbucks Experience globally.

Each Roastery will serve as the foundation for Starbucks Reserve® stores – a new retail format that will integrate the theatre and romance of the Roastery with the unique culinary experience of the company’s new Italian food partner, Princi.

  • Premiumization Strategy to Drive Innovative New Customer Experiences

Starbucks Reserve® Roasteries will serve as an innovation pipeline that will elevate the brand and contribute a “halo” to the entire Starbucks Experience. This includes new product breakthroughs that will contribute to the growth of the company’s ecosystem, segmented strategically across all Starbucks® stores.

Starbucks is simultaneously innovating and expanding its food menu with products customers have been looking for convenient breakfast; the spring launch of a Certified Gluten-Free Breakfast Sandwich; the expansion of the successful Bistro Box platform; as well as a regional rollout of delicious organic soups. Relevant innovation has become fundamental to unlocking the lunch daypart and building on existing breakfast daypart momentum, giving the company the ability to realize additional profitability and incremental sales.

  • Extending the Digital Flywheel

Starbucks offers the largest and most robust mobile ecosystem of any retailer in the world, with more than 12 million Starbucks Rewards™ members (up 18 percent year on year). Today, Starbucks will unveil an innovative conversational ordering system, My Starbucks® Barista, powered by groundbreaking Artificial Intelligence (AI) for the Starbucks® Mobile App.

Starbucks digital flywheel has also continued to gain momentum with the launch of true one-to-one personalization. While still early in the evolution of this service, Starbucks hyper-personalized email reward offerings – with more than 400,000 variations – have more than doubled customer response rates over previous segmented email campaigns, translating into increased customer engagement and, importantly, accelerated spend. Starbucks has delivered personalized offers to customers directly on the front screen of the mobile app. By early 2017.

  • Unlocking High-Value Opportunities in China

Customers in China have continued to embrace the Starbucks brand, with some of the company’s most innovative, efficient and profitable stores producing record revenue and strong same-store sales growth in FY16. Starbucks newest class of stores in China are delivering the highest AUVs, ROI and profitability of any store class in the company’s 17-year history in the market. Starbucks now operates approximately 2,500 stores in 118 cities in China and employs more than 30,000 partners (employees), opening over a store a day – a growth rate that will continue to accelerate well into the future.

  • Expanding Global Leadership Position in At-Home Coffee and Ready-to-Drink

Over the next five years, Starbucks expects its Channel Development segment, which includes its Consumer Packaged Goods (CPG) portfolio, Branded Solutions (licensed stores and foodservice), and Ready-to-Drink (RTD) segments, will generate an incremental $1 billion in revenue, grow operating income by 75 percent, and double its RTD business outside of the U.S. The company is the industry leader in premium single serve, premium packaged roast and ground coffee, and Ready-to-Drink products, and is well positioned to grow its share of these markets both in the U.S. and globally. The company’s more than 20-year partnership with PepsiCo to create the North America Coffee Partnership (NACP) is a more than $2 billion business and has approximately 97 percent share of the RTD coffee category. The NACP continues to bring to the market highly relevant, new and innovative coffee and energy products to meet the needs of customers looking for premium, on-the-go coffee offerings.

  • Creating Long-Term Opportunities for Partners

From being among the first to offer comprehensive health benefits and equity in the form of stock for partners who work 20 hours or more a week, to providing them with the opportunity for full tuition reimbursement for a bachelor’s degree from Arizona State University through the innovative Starbucks College Achievement Plan, Starbucks has continued to invest in and innovate around the partner experience while balancing the needs of its customers, shareholders and the marketplace. Starbucks has now matched $78 million in 401K savings in the U.S. with a total fund balance of $1.3 billion as of FY16. The company also recently announced it will add an enhancement to the program in 2017.

Starbucks is finding that these incremental investments in both wages and benefits have helped support and elevate its partners, attract and retain the best talent, provide measured improvement in service to customers and deliver outsized returns to shareholders.

  • Shareholder Returns

Starbucks has returned $10 billion of cash to shareholders in the last five years, through dividends and share repurchase. $15 billion more is scheduled over the next three years, indicated to be modestly front loaded to early 2018 . The dividend was recently increased 20% to $0.30 quarterly, so the stock now yields a little over 2%. As noted above, the stock has been in a relatively narrow trading range in the last two years. It is worth noting that Starbucks also invested, in 2016, for operating “partners”, $322 million in healthcare and other benefits, $15M in the Starbucks College Achievement Plan, and $221.6 million in Bean Stock. No doubt, these benefits have been an important contributor to the Starbucks operating “culture”, the best we have ever seen for a food service company of this size.

Source = Starbucks Annual Meeting March 2017

Recent Developments, Per Q4’17 Press Release, Per Q4 Conf. Call Transcript

The fourth quarter was relatively strong, especially in terms of sales, for SBUX, especially considering the challenges within the restaurant landscape. As Indicated above, US comp sales were up 2%, with a 1% increase in traffic, excluding the impact of Hurricanes Harvey and Irma. Comp sales in China were especially impressive, up 8% with transactions up 7%.

Q4’17 had 12 weeks, versus 13 in Q4’16, obviously affecting the YTY earnings comparisons. GAAP results were also affected materially by  “strategic actions….as it focuses on accelerating growth in high-returning businesses and streamlining its operations”. From a revenue standpoint, the consolidated flat revenues would have been 8% higher with the extra week, as indicated in the Q4 release. Be that as it may, Q4 GAAP operating income was down 16.7%, and non-GAAP operating income was up 2.8%. GAAP operating margin declined 360 bp to 17.9%, non-GAAP operating margin declined 90 bp to 20.0%. GAAP EPS was flat at $0.54, non-GAAP EPS grew 10.0% to $0.55 per share.

More details are available within the Q4 release, but it seems noteworthy to us that while consolidated operating margin was down 360 bp, this consisted of a decline of 470 bp in the Americas segment, a decline of 410 bp in the EMEA segment, offset only nominally by 80 bp of improvement in Channel Development and 60 bp improvement in China/Asia. “All Other Segments”, including Teavana stores, Seattle’s Best, and Starbucks’ Reserve lost $46.1M vs. a $10.1M loss QTQ, primarily due to closing Teavana retail stores.

Other Q4 highlights included 603 new store openings globally, Starbucks Rewards’ growth up 11% to 13.3M active members in the US, representing 36% of US sales, and Mobile Order & Pay reaching 10% of US transactions. Long term financial targets were provided, with global comp sales of 3-5%, annual consolidated revenue growth in high single digits, annual EPS growth of 12% or better, and annual ROIC of at least 25%. The dividend was increased by 20% to $0.30 quarterly, 15.1M shares were bought back, and a new commitment was announced to “return $15B to shareholders” over the next 3 years through dividends and share repurchases.

Further highlights of the year and quarter were discussed on the call. 550 new stores were added in fiscal ’17, bringing the total there to nearly 3,000 locations, heading for 10,000 within 10 years. Starbucks Rewards and Mobile Order & Pay platforms continue to be enhanced, drawing more revenues per customer and more participants. New financial products will be offered, in partnership with Chase bank, using Starbucks “currency” at other retailers. (A lot better than Bitcoin, in our opinion, though harder to launder a lot of money one cup of coffee at a time. Starbucks Roastery is a continued focus, and a new Princi Italian Bakery has opened within the Seattle location.

Management pointed out on the conference call that GAAP EPS growth will be above 40% in 2018, with over $0.50 of the gain from the purchase of ownership interest in East China and the sale of TAZO. These transactions, as well as the exit from Teavana stores, licensing Taiwan and Singapore, will affect non-GAAP EPS modestly, if at all (“flat to slightly accretive”) in 2018, then become more meaningfully accretive to EPS growth in late fiscal 2018 and into 2019. It was also indicated that the 12-13% non-GAAP EPS growth will be “back loaded” in fiscal 2018, aided by stock buybacks as well as operational improvements.

There are numerous ongoing growth opportunities for this premier worldwide consumer brand, many of them discussed on the conference call, and we encourage our readers who are interested to read the entire transcript. For our purposes, most of the “needle moving” initiatives have  been discussed above.

Conclusion: Stated at the Beginning of this Corporate Writeup

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On September 5th of this year I wrote an article about Bitcoin, which you can access below: After you have read the previous article, you can return here for my new conclusion. Good luck, and HAPPY HOLIDAYS !!


The price of bitcoin is several times higher now, but I stand by this article. The FLAW in the whole cryptocurrency “bubble” is as follows. While the number of bitcoins that can be created is presumably limited, which would therefore provide the long term value as a currency ( just as with gold over the last four thousand years) the number of competing cryptocurrencies is not limited. Three months ago there were something like 800 competitors to bitcoin, combining to create a total worth of about $125 billion. Now there are more like 1100 “bitcoin like” alternatives, in total worth perhaps $400 billion. In the 1920s, during the Weimar inflation in Germany and Austria,  when a loaf of bread cost 1,000,000 German marks, a mark was therefore worth one millionth of a loaf of bread. If a Bitcoin is worth $20,000., for example, that means the dollar is worth one twenty thousandth of a Bitcoin. That doesn’t sound to me like the US Dollar is worth much, especially if a computer can issue thousands of similar currencies that dilute the Dollar even further.

When the books are written five or ten or twenty years from now about the financial follies of the early twenty first century, the Bitcoin (and competing cryptocurrency) mania will be viewed as one of the “ringing bells” before the bubble burst. One man’s opinion, FWIW.

Roger Lipton


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SHAK came public at $21 a little less than 3 years ago, ran to a high above $90 in June of 2015, and has been in a trading range between $30 and $50 during 2016 and  2017. The stock was “fully valued”, to say the least, at $90.00 compared to the $0.32 per share reported in 2015 and $0.46 in 2016. It is obviously more rationally valued in the high 40s versus the Street estimate of $0.52/share in 2017 and $0.54 in ’18, which could turn out to be $0.65-.66 with the new tax bill. This leaves SHAK valued at about 70x a “tax adjusted” estimate of EPS in ’18. We hasten to point out that, in our mind, there is no other publicly held restaurant company that has more well regarded management, a better store operating model, and a virtually unlimited runway for future expansion. However, a number of the operating parameters (such as AUVs, store level margins, and EPS growth rate) are “coming down to earth” Furthermore, the very aggressive growth of company units (35-40% on the base) has its own set of risks. In fact, we can think of no other restaurant company, in the last thirty or forty years that has expanded from 90 to 125 or so high volume company operated stores, in diverse geographical markets, without a noteworthy degree of inefficiency (to say least). As admirable as this operating team is, we suspect that the Street estimates going forward will prove to be overly optimistic, that same store sales, AUVs, and correlating store level margins will be at least modestly disappointing. It therefore becomes a question of what the stock is worth, in terms of the current P/E relative to the expected, and the actual, growth rate of EPS and EBITDA over the next several years. The last time we opined, early in ’17,  with SHAK in the low 30s, it was on our “watch list” as a potential buy. In the high 40s, with EPS growth in ’18 lower than it was, and what we perceive as continued operational risk from the unprecedented rapid expansion of company units, we consider SHAK fully valued. 70x expected ’18 (“tax  reform adjusted”) EPS more than adequately values this fine management team, and the ongoing value of the Shake Shack brand.

SHAK: Company Overview    (2016 10-K)) Q3’17 Release, Q3’17 Conf.Call

Shake Shack Inc. is a New York City-based chain begun as a hot dog cart in 2001,  to raise funds to renovate a city park,  by founder Danny Meyer, the legendary restauranteur and chairman of the Union Square Hospitality Group.  At the end of 2016, SHAK (which came public in early 2015) operated and licensed 114 units in 16 states including Washington, D.C. and 13 countries generating system-wide sales of $403M. The company bills itself as a fine casual operator with a core menu featuring premium hormone- and antibiotic-free burgers, chicken and hot dogs, crinkle-cut fries and handmade shakes, frozen custard & specialty beverages.  It also serves beer and wine.

SHAK devotes significant resources in the creation (including collaborating with top chefs) and testing of items to supplement its core menu with LTO’s and enhancements derived from seasonal and local products to provide novelty, drive return visits and also for brand awareness.  For example, in April 2016, to promote the brand in the Washington DC, Maryland and Virginia area, the company teamed up with a celebrated chef of Chinese cuisine to offer “Crispy Peking Chicken” (crispy chicken breast, on a n LTO basis only in area stores. The company is also investing heavily in technology to provide customers with state of the art mobile conveniences.

Given the company’s commitment to all-natural proteins that are hormone- and antibiotic-free as well as vegetarian fed and humanely raised, which inherently has some of the same supply chain risks as Chipotle, the company stipulates it has established rigorous quality assurance and food safety protocols throughout its supply chain and that it further addresses its risks by limiting the number of suppliers for major ingredients.  For example, in 2016 all beef patties were purchased from 7 suppliers (70% was purchased from one of them) and it has 10 butchers located throughout the country to produce burgers fresh daily. As to distribution to the stores, the company contracts with a single broadline distributor which is responsible for supplying over 80% of core food and beverage ingredients and all paper goods and chemicals to each Shack from 12 regional distribution centers.

Of the company’s $268.5M of revenues in 2016 96.6% was generated by the company’s 64 stores (all domestic), while the balance was licensing revenues from the 50 licensed units (7 domestic, 43 international).   The company believes there is the potential for at least 450 domestic units. In 2016 the company units averaged $4,981K (down from $5,367K in 2012 (an average skewed by high proportion of Manhattan units with AUV’s>$7M).  Indeed, the concept’s exceptional brand appeal, as evidenced by press and social media acclaim, has broadened its acceptance domestically and internationally. The company has continually predicted that AUVs would come down as more locations opened away from the original NYC region, and that has finally been the case during Q2 and Q3’17. Store level profitability, though still among the highest in the restaurant industry has, has come down as well, as expected, from an impressive 28.3% in calendar ’16. Shack units, which are all leased, average 3,000-3,500 sq ft (seating for 75-100) and require a cash outlay of $2.M including our estimate of pre-opening expense.  In 2017 company earlier in the year planned 22-23 new units, year generating AUV’s of “at least $3.2M and Shack-level operating profit margins of at least 21%.” As it turns out, 24-26 company units will have opened, at those expected AUVs and store level profits. Even at these modest levels of productivity, materially lower than had been the case through calendar ‘16, cash-on-cash returns would be about 30%.

Considering the modest number of stores in the system, and as a public company for less than 3 years, its continuing robust unit level-performance, including locations far from its NYC roots, is probably the best current gauge of SHAK’s promise. The company’s heavy SGA and pre-opening expense, typical of an early stage enterprise, still weigh on margins. To this point, the consolidated EBIT and EBITDA margins in 2016 were only 10.4% and 15.8%, respectively, down from 11.0% and 16.4%, respectively, in 2015. Similarly, ROE, at 10.1%, while not all that impressive to date, is still expected to expand as a critical mass is reached that more efficiently carries the G&A structure necessary to support the rapid unit growth.

SHAK’s balance sheet debt includes $13.2M of deemed landlord financing (essentially capitalized lease obligations), $34.8M of deferred rent, and $2.6M of other long term liabilities, against $231.8M of equity.  The company also has a $280.1M tax liability payable on behalf of its pre IPO Series B shareholders as they convert their shares into Series A shares.  SHAK is financing its rapid growth (24-26 company stores in 2017) internally which consumes virtually all its cash from operations together with cash on hand.

Shareholder Returns:

Shake Shack came public on 1/29/15, selling 5.75M shares at $21.00 per share. The stock traded, parabolically,  to over $90.00 by May’15, came down to $30.00 in early ’16, has traded in a range from the low 30s to low 40s since, before breaking out to the high 40s recently. A secondary offering was done on 8/12/15, 4.0M shares for selling shareholders, at $60.00/share. There is no dividend. There has been very consistent “insider” selling from late ’15 to the present.

SHAK: Recent Developments: Per Q3’17 Earnings Release, New Slide Deck, Conf. Call

In its Q3’17, SHAK generally met expectations for revenues, comps and EPS, though not “surprising” on the upside to the extent that it has often done in its first two years as a public company. Company revenues grew 26.9% YOY on a negative 1.6% comp (on top of a positive 2.9% in “16Q3 and what will be 38-41% company operated unit growth in ‘17. Since stores don’t enter the comp base until 2 years after opening, the comp base is small (only 39 of 89 US company stores). Traffic in Q4 was down 3.8%, offset by price increases of 2.2%.  This pattern of higher ticket and slowing traffic is consistent with the industry, but in SHAK’s case the price increase has been relatively modest with the ticket mix boosted by premium LTO’s. AUVs for domestic company operated Shacks decreased noticeably, for the second quarter in a row, to $91,000/week, versus $103,000 in Q3’16. Shack level EBITDA decreased 160 bp to a still admirable 27.2%.  In terms of “prime costs”, CGS was down 10 bp to 28.3% in Q3, Labor was up 80 bp to 26.1%. Other Operating expenses were up 90 bp to 10.1%. Occupancy and Related expenses were down 10 bp to 8.3%. Below the store operating line, G&A was down 90 bp to 9.7%.  The Company continues to point out that the averages have likely been boosted by units opened in high density markets, and continues to guide to $3.2M annually for upcoming units.

Adjusted pro forma net income was up 13.1% in Q3’17. Adjusted EBITDA was up 19.9%, Net Income A.T., increased 15.7%, all less than the revenue increase of 26.9%, as a result of lower store level EBITDA margin. At the unit level, labor costs have been up all year because of increases in the compensation structure implemented at the beginning of the year. The company proudly proclaims it already pays above current and minimum wage levels, a policy that allows it to attract and retain high caliber employees.

Management raised guidance slightly for FY17 revenues to $354-355M-$353M, as a result of extra openings, more than offsetting slightly lower comps.They also increased the guidance for licensed openings in ’17 to 18, up from 15 previously. They guided to store EBITDA of 26.5-27.0%, 50 bp lower on the top of the range.


Preliminary, and partial,  guidance for ’18, included 32-35 new company domestic openings and 16—18 licensed stores,  36-40% and 24-26% on the respective base.  AUVs of the new stores are guided at $2.8-3.2M, but management confirmed that both classes of ’16 and ’17 are annualizing above that range. During the conference call discussion, management confirmed that store level labor will continue to rise, modest price increases will likely be offset by traffic headwinds, cost of goods will deleverage slightly, short term at least.  Below the store level EBITDA line, higher technology expense (the mobile app, ordering kiosks, etc.), training and other pre-opening expense, the bi-ennial manager retreat, a new corporate office, and “materially higher” depreciation expense will drag on bottom line results. As management put it, “across the board, it is a year of investment”. As indicated in our conclusion, this discussion leads us to believe that margins, at the store level and bottom line, are more likely to be lower than higher.

The conference call discussion included:

  • 20% of new company stores in’18 will be in new markets, and  in various formats: 1/3 urban, 1/3 free standing, and 1/3 in premier mall/lifestyle centers.
  • The licensing program, with premier partners abroad, is especially successful in South Korea and Japan, less so in the Mideast, with new arrangements in Hong Kong, Macau and Shanghai.
  • Innovations include split kitchens to get more throughput, kiosk only cashless approach (at Astor Place in NYC), ongoing mobile app development and emphasis, delivery pilots with DoorDash and Caviar.
  • Corporate office moving, with a new innovation center for menu creation and kitchen design.
  • There was discussion of new disclosure, by region, of AUVs and store level margins. Basically, the $5.0 AUV generates 28% store level EBITDA margin, 56% C/C first year return, 78% thereafter. Even at $2.8-$3.2M AUV, there is an 18-22% store EBITDA, with 14% C/C in year 1 and 34% thereafter. The point the company makes: even at the lower AUVs, which may apply to many new stores, the long term returns are excellent. Whether that is enough to satisfy analysts, at 60 or 70x expected earnings, remains to be seen.


Overall, we consider SHAK to be one of the best managed companies in the fast (or “fine”) casual restaurant segment, especially considering their relatively early stage which includes almost unprecedented unit growth of company stores. The “culture” is in place, but is not taken for granted by management. When unit level growth is so high, we suggest that many expenses are shuttled (or arbitrarily allocated) between unit level and corporate support. For example, trainees (charged to pre-opening) help out in existing stores (possibly reducing hours for more experienced crew), supervisors (charged to corporate) spend a lot of time in relatively young locations. The result of these examples would be store profits overstated, offset by higher pre-opening and higher corporate G&A. A “steady state” situation is not really in place, but in this case, no matter how expenses are allocated, the 9 months of 2017 pre-tax operating income, at $28.0M, or 10.7% of revenues, with corporate EBITDA at 16.6% is an admirable starting point from which to leverage the situation over the long term. Store level margins have become to come down, with the expected lower volumes at new stores, but the G&A percentage against higher overall sales will no doubt be leveraged over time, though possibly not in ’18. Licensing revenue of $9.1M for 9 months of ’17 certainly helps, but there was no doubt material G&A expense against that contribution and licensing income is not going away. Putting it all together, we can’t think of another restaurant company, over the years, that has produced results this impressive at a similar stage.

SHAK stock is a somewhat different discussion. See our comments above for our current conclusion.

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Dave & Busters’s – (PLAY) – The Battle of the Bulls & Bears!

Recent Development: Per Q3’17 Company Release and Conference Call

Dave & Buster’s continued to perform well in a difficult restaurant spending environment, no doubt due to the “experiential” nature of their concept. 56.9% of revenues now comes from Amusements, with about 15% from alcoholic beverages, so slightly less than 30% comes from food.

Comparable stores, 75 out of 101 current locations, showed decreased sales of 1.3%, very close to the 1.1% decrease estimated by analysts, and the storms were responsible for 50 bp of that decrease. The EPS result exceeded analysts estimates by $0.03 per share, but the tax was only 28.7% vs. 37.1% YTY. Pretax income was flat YTY. Corporate operating EBITDA margin was flat at 18.2% of revenues, up 9.8% YTY. Store level operating EBITDA margin was down 20 bp, to a still impressive 25.9% of revenues.

Comp stores sales in Amusements increased 1.1% and in Food & Beverage decreased 4.2%, a continuation of recent trends. It is noteworthy that these results were against a strong quarter a year earlier when overall comps were up 5.9%, including Amusements at 10.4%.

Operating costs were well controlled, total cost of sales down 60 bp, F&B costs up 10 bp with 2.3% in food pricing, 0.8% in beverage pricing, slight commodity inflation. Cost of Amusements was down 80 bp. Labor with benefits was 90 bp better, from lower incentive pay, favorable medical claims, and the leverage from higher Amusement sales. It’s worth noting that average hourly wage inflation was 4.4%. Other store operating expenses were up by 170 bp, driven by higher rent and more marketing. As noted above, store level EBITDA margin was down only 20 bp, to 25.9%.

The balance sheet remained strong, with $316M of debt, just over one time TTM EBITDA. In the current YTD $123.4M of stock has been repurchased, at an average price of $58.76. There remains $147 million available under the current authorization.

Guidance for all of ’17 was adjusted slightly to include a decrease of corporate EBITDA growth to “low to mid teens”. This reflects the impact of the three storms, a delayed opening in Puerto Rico, the challenging macro environment, and pre-opening expenses. Since Adjusted EBITDA was up 17.6% for nine months and EBITDA was up 15.7%, that guidance implies Q4 EBITDA somewhere south of 15%. Corporate EBITDA for Q3 was up 10.8% and Adjusted EBITDA was up 12.0%. Comp sales expectations are being guided lower by about a point to “flat to up 0.75%” for all of ’17, and, importantly, management noted that Q4 has started “slower than expected”.  It was noted that this year includes 53 weeks that helps revenues by about $20M and EBITDA by $4M. It’s unclear whether the Q4 guidance has been “adjusted” for the extra week this year.

Relative to longer term expectations, management discussed at some length that increasing competition is affecting sales, in particular from TopGolf and Main Event, both of whom are expanding aggressively. There is also a cannibalization effect as PLAY opens additional stores in existing markets. As management pointed out, these elements were less prevalent even a couple of years ago. Also, analysts expressed some concern that non-comp units seem to be doing less well lately, relative to the existing comp base.  Management responded that some of the recent stores, while categorized as “large” are not at the top of the size range and with the size mix trending lower, the AUVs should be expected to decline as well. In terms of margin contraction to be expected in Q4 (and perhaps beyond), higher rents higher marketing expense, and higher commodity costs are expected to affect results.

Management declined, until early in ’18 (presumably with final fiscal 1/31/18 results) to provide guidance for next year.

Management described at some length its intention to build a smaller format store, sized from 15k to 20k square feet, with the possibility of 20-40 locations, in smaller markets, over the long term. It is expected that this format, with a cash investment of $5M (excluding Tenant Improvement Allowance) would generate $4-5M revenues, with a “steady state” C/C return in the low 20s. Management emphasized that, while the expected ROIC will be attractive, it is expected to be less than the current legacy locations. The first location would open in Rogers, AK in early ’18. This smaller format provides some extra runway for future growth, above the previously stated 200 or so US locations.

The Positives:

  • (1) Cash on cash returns are still among the very highest in the restaurant and retail universe.
  • (2) There is a very long runway for future growth, which  has been extended by virtue of the smaller format.
  • (3) The balance sheet continues to be strong, relatively unleveraged, with substantial cash flow for unit expansion, stock repurchase, and dividends possible as well.
  • (4) There is potential improvement in the food element, separately and/or in conjunction with the new smaller format, including a Fast Casual approach to food & beverage.
  • (5) A lower corporate tax rate would improve future after tax EPS, though it obviously would not affect EBITDA.

The Negatives:

  • (1) Comps have been coming down, narrowing overall, with a continuation movement toward Amusements, now 56.9% of revenues. With less than 30% of sales from food, D&B is more of an amusement park than a restaurant.
  • (2) Average Unit Volumes are coming down, at least partially due to the increasing mix of smaller stores.
  • 3) Margins at the store level have been coming down modestly, and may not recover due to higher marketing, higher rents, higher commodity prices, and sluggish traffic trends, especially within the food & beverage segment
  • 4) Competition, and cannibalization is playing an increasing role in suppressing sales and margins.
  • (5) Depreciation, that is the useful life of Amusements,  continues to be an underlying issue. EBITDA is a valid measure of “cash on cash” return at the store level, but it seems to require increasing amounts of original (undepreciated) capital as the years go on.  Noone can be sure of the useful life of Amusements. The Company declares that it is “between five and twenty years”. We discuss this issue at more length in the full Corporate Writeup on our  website (9/14/17) at :  We have not seen this issued addressed in either company documents or analyst discussions. If our concerns are misguided,  we welcome further discussion of this issue by the company or the money management community.
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