SHAKE SHACK REPORTS Q3 – STOCK DOWN 19%, WHAT TO DO NOW ?

GAAP earnings per share were $0.31 vs. $0.17 for the quarter, $0.70 vs $0.56 for nine months. Just fine, right ? Comps for the quarter were up 2.0%, a fraction of a point light, but 1.2% of the gain was traffic, which is better than many peers. Unit growth of company stores and licensed locations is meeting expectations. So what’s the problem ?

First, it’s the unit level economics, which has been coming down to earth, as management has long predicted. Secondly, and probably  most important, an unprecedented (for SHAK) level of uncertainty as to how comps and margins are going to develop over the the foreseeable future.

Before going into the details, we refer readers to our multiple warnings here (use the “Search” function on our home page). We are most proud of our mile high overview: We can recall no restaurant company, over our four decades of industry involvement, that has expanded company stores at a 35-40% rate without major inefficiencies, at the very least. There are lots of issues, from that standpoint, here, but it seems like the state of flux within the third party delivery area has combined, in a material way,  with the predictable pressure of growing a system so quickly. It’s been said many times, how a crisis develops: “very slowly and then very quickly”. This is not a crisis in terms of SHAK’s survival, but it is in terms of the credibility necessary to maintain a price earnings multiple over a hundred times expected earnings.

Some operating details: While diluted EPS was up, for both three months and nine months, Operating Income and Income Before Taxes was down. Above those numbers, almost every operating line item was worse for both the three months and nine months. For the three months: Food and Paper costs were up 80 bp to 29.0%, Labor was up 30bp to 27.3%, Other Operating Expenses were up 80bp to 12.4%, Occupancy was up 80bp to 8.2%, G&A was down 20bp to 10.8%, Depreciation was up 40bp to 6.6%. Average weekly sales was 80k per week, down from 86k. Shack level Profit Margin (EBITDA) was down 270bp to 23.1%. Corporate Adjusted EBITDA margin was down 300bp to 14.8%.

Equally important to the deterioration in store level, and corporate, margin was the revision of guidance, seemingly minor in magnitude, but crucial when a stock valuation is so high. For the full ’19 year, store level margin was lowered to 22.0 to 22.5%, from approximately 23.0% and comp sales were guided to about 1.5% from about 2.0%. Especially since the year is so far along, a modest change in the year’s guidance implies a materially weaker Q4.

On top of all the above, management, on the conference call, described the uncertainty related to transitioning to the strategic partnership with Grubhub, further investment in the digital/mobile technology, an ongoing Project Concrete investment (mostly capitalized), the effect of cannibalization, likely higher commodity costs, predictably higher labor costs, the absence of G&A leverage through ’20 and ’21.

All of this contributes to the likelihood of minimal earnings progress over the next year or two. Considering that ’19 has been an “investment” year, and the likelihood that, in spite of continued major unit growth,  ’20 and ’21 may not be much different, reality seems to be setting in among analysts and investors.

In the interest of getting this summary to our readers in a timely fashion, we will leave it there. We encourage interested readers to read the full earnings call transcript, as well as our previous commentary on this subject.

THE STOCK

In terms of SHAK stock: Considering that the EPS consensus estimate for 2020 (per Bloomberg, at the moment) is $0.66 per share (and that may be reduced further), vs. $0.65 in 2019, down from $0.71 in 2018.  SHAK, trading down 19% as this is written, at about $68,  is still about 100 times next year’s EPS. Combining the now evident uncertainties with the reservations previously described in our writings, SHAK seems to be, still, far from a bargain price.

Roger Lipton