SHAKE SHACK REPORTS Q2 – STOCK DOWN 10% -WAS IT THAT BAD?
Before discussing Q2, we refer you to our conclusion from the extensive report we wrote on 5/10. For those readers with an active interest in SHAK, we encourage you to read the full report.
CONCLUSION – From 5/10/18, after SHAK had run up 30% following Q1 report
As you no doubt suspect, while we have the utmost respect for this management team, our conclusion is that SHAK is priced beyond “perfection” at approximately 100x ’18 projected EPS and perhaps 70x what we consider an optimistic view of ’19. If you like EBITDA as a measure, based on “Adjusted Corporate EBITDA” of $65B in calendar ’17, the $2.2B market capitalization represents 33x TTM EBITDA. Especially considering that store level economics, while still more attractive than many other restaurant companies, are not as alluring as back in the day when Manhattan locations were annualizing at $7.4M and paying for themselves at the store level (before depreciation) in fifteen months. Management here is as good as it gets, but they are not magicians. This is still a people business, serving burgers, not providing a proprietary cancer cure.
SECOND QUARTER RESULTS
The report was generally in line with analyst expectations, which were largely echoing management guidance. Same store sales were up 1.1% (on top of a 1.8% decline a year ago), which might have been a fraction of a percent less than some analysts hoped for. What might have cooled the ardor was that traffic was down again, 2.6% this time. Keep in mind that only 50 Shacks are in the comp base, less than half the company operated system. Also in line with guidance, but a small dose of reality, average weekly sales for domestic company stores declined 3.3% to a still impressive $89,000. Again, as predicted, store level profit (EBITDA) declined 60 bp to 28.2%, or 27.5% normalized for the one time benefit of deferred rent. Importantly, G&A expenses increased to 10.8% of revenues, up from 10.6%, and, especially with the expense of “Project Concrete”, are unlikely to be leveraged by the higher sales in the next year or so. Of course, the tax burden was lower than a year ago, 17.5% versus 29.2%, allowing net income after taxes to be up 29.1%. More indicative of the current operating progress is the operating income that was up a more modest 10.9% and “adjusted EBITDA” that was up 12.9%. Management here is, appropriately, “playing the long game”, investing in corporate functions as well as store level management and crew (with industry leading compensation levels) to build on the admirable operating culture that is in place.
Guidance for the balance of 2018 was maintained, and that was part of the problem. Analysts were hoping, and the stock price was discounting, an improvement in some of the operating expectations. Cited were some delays in getting the last portion of the stores planned for 2018 opened in time to contribute to results this year. Other than that, the costs of Project Concrete, to be spread over 2018 and 2019, was increased from $4-6M to $6-8M.
We can’t resist pointing out that management is fortunate that analysts seem willing to treat a substantial “investment” in G&A, dubbed “Project Concrete” as a non-recurring event, as if additional infrastructure will not be necessary as Shake Shack expands their brand around the world at what we consider a breakneck pace. It’s good to be “king”, with probably the highest investment community regard (and valuation) among publicly held restaurant companies.
For more background information, we refer readers to our discussions dated May 10th and our full descriptive report dated 12/13/17.
SHAK has come down because it has been priced beyond “perfection” and never should have run up after Q1. The concept, as good as it is, can be expected to do an AUV somewhere between $3-3.5M per unit as the system is built out. Store level EBITDA will end up in the 20-23% range. A 23% EBITDA generation on $3.25M of sales would be $747K of EBITDA, or a 37% store level cash on cash return on the $2M investment , an admirable operating model. If we look down the road a few years to when SHAK has a couple of hundred units, growing not quite so fast, and growing after tax earnings and EBITDA at perhaps 25% annually, the stock might have a 40x multiple on expected after tax earnings. The problem is that the P/E on ’19 EPS estimates (that could be a reach) is twice that. It will therefore take SHAK several years beyond ’19, until 2022, for the fundamentals to catch up with today’s stock valuation of $2B. Of course, it’s possible that the P/E on next twelve month earnings could be even higher than it is currently, but the P/E range that the stock sells at will likely be contracting as time goes on. This expectation is under the optimistic assumption that there are no major mistakes along the way, in which case there would obviously be an immediate major adjustment downward. This discussion may be one reason why there has been almost continuous liquidation of common shares by insiders and private equity owners, to the tune of hundreds of millions of dollars ever since SHAK came public early in 2015.