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SHAKE SHACK (SHAK) – SELLS OFF AFTER EARNINGS REPORT – WHAT’S GOING ON?
SHAKE SHACK SELLS OFF AFTER EARNINGS REPORT – WHAT’S GOING ON?
We have written many times of our admiration for this company, founded by the legendary Danny Meyer, in terms of the employee culture, operating skills, and their successful management of an extremely aggressive expansion plan. The “cult” of Shake Shack goes far beyond their NYC roots, and openings literally worldwide have supported this notion.
In a nutshell: when a stock is “priced for perfection” ($37) at over 70x calendar 17 earnings and over 60x estimated ’18 earnings, all operating parameters have to be “in gear”, hopefully accelerating, certainly not decelerating. That means: same store sales and traffic, unit growth rate, store level margins, new unit “productivity” of sales and margins.
We don’t have time here to go into all the details of the current results, but in a nutshell: reality is setting in:
Management has continually pointed out that AUVs away from NYC will be closer to $3M annually than the incredible $7M/store within their hometown. It was pointed out that store level EBITDA would be closer to 20% rather than the previous 30% range, at the lower levels. Analysts, and investors heard this, but haven’t wanted to exactly believe this, as new stores continued, until recently, to open materially above $3M, and average volumes held close to $5M. We will come back to this parameter shortly.
Yesterday, the third quarter report met estimates of earnings, same store sales were down, but a little less than expected, due to menu price increases, traffic was down more, but the expansion rate was increased for next year. Labor costs are up, as expected, especially since SHAK prides themselves on treating employees very well. Overall store level margins are expected to contract further, and G&A expense will not decline as a percent of sales due to the acclerated rate of company store expansion (35-40%) on the base. All of this could be “accepted” by analysts and investors, but here’s the rub:
Each quarter the Company tells us what the weekly AUVs were for domestic company operated stores. This is the way it has gone:
Q3’16 $103,000 Q3’15 $103,000 even
Q4’16 $90,000 Q4’15 $89,000 +1.1%
Q1’17 $86,000 Q1’16 $90,000 -4.5%
Q2’17 $92,000 Q2’16 $102,000 -9.8%
Q3’17 $91,000 Q3’16 $103,000 -11.7%
Clearly, new units are opening “lower”, by our calculation, at about $3.3M. Analysts explored this development on the conference call, and the company confirmed that this range applies, has been predicted all along. The supplemental slides showed that the cash on cash return for a store at $2.8M -$3.2M is 14% in the first year(after $400,000 of pre-opening expense) and 34% thereafter. While more than acceptable, this is a sobering reality compared to the 56% year one cash on cash return for a $5.0M unit, with 79% thereafter. Since the aggressive expansion plan is obviously focused on markets away from NYC, analysts have to assume that the margins will more rapidly approach the lower numbers than they had previously modeled. This is especially true since management was very clear that labor expenses will continue higher, commodities will provide no relief, and corporate G&A will be ratcheted upward to support growth and technology requirements.
In summary: Only the growth rate, of units, is “in gear”, accelerating in fact. Same store sales and traffic are challenged, which is an industry wide issue, store level margins at existing stores won’t improve and will be materially lower at new stores, and G&A won’t be leveraged in the short term. Worst of all, new stores are opening at the previously predicted lower volumes, which removes the possibility of earnings surprises on the upside. A case can also be made that a growth rate, for company stores, of this magnitude, has its own set of dangers, in addition to the more predictable unit level challenges. Investors and analysts have appropriately, in our view, reacted cautiously to the latest news.
SHAKE “SHOCK” (SHAK) – VIDEO FROM 3RD DAY OF NEW LOCATION – KIOSK ORDER & PAY – NO CASHIERS
SHAKE SHACK “EVOLVES” TO ELIMINATE CASHIERS -PROGRESSIVE TO BE SURE, UNINTENDED CONSEQUENCES WILL TAKE A WHILE TO EVALUATE
Danny Meyer, founder of Shake Shack, is no longer actively involved in management of this leader within the “fine” casual dining industry. His cultural influence is no doubt being maintained as one of the restaurant industry’s most progressive voices.
Shake Shack, no doubt anticipating the inevitable material rise in the cost of labor, has just opened a unit at Astor Place in Manhattan which has no cashiers. You can’t accuse Shake Shack, no doubt channeling its founder, Danny Meyer, of lagging the crowd in terms of anticipating changes within the hospitality industry. Combined with mobile order and pay, about 10 POS “kiosks” allow customers to place orders as well as pay. Cash is not accepted. We took a twenty five second video at 1:00pm today (link below), the third day of operations, panning the store interior. On the viewer’s right is the array of ordering stations. SHAK management is not naive about the need to explain the new system and provide customers as much “training” as necessary, so several employees are circulating among the customers, helping where necessary (including myself). I found the system fairly easy to navigate, and used the chip on my card to pay. The customer then moves to the center of the store, and waits in front of the pass through section where names are called out. Mobile orders presumably are handled over the same counter. There is a drink and condiment station, left of center, where customers can set themselves up as they wait for their orders. There is a modest amount of seating as the camera pans to the left, indicating that the Company feels that most orders will be taken off premises. I will briefly discuss my reaction after you have viewed the video below:
The business model is “a-changin”. Danny Meyer literally wrote the book in dining hospitality, “Setting The Table”. His fine dining restaurants have distinguished themselves from this standpoint and he is appropriately viewed as one of the long time greats in the industry. At Union Square Hospitality Corporation, his elimination of tipping two years ago was his effort to equalize compensation between the back of the house and front, and this (I call it “unresolved”) experiment has continued to this day. USHC, however, is privately held, and the operating margins (which we suspect have suffered) don’t come under the line by line scrutiny of analysts and investors. Shake Shack (SHAK), publicly held, must bow to the needs, and demands of the publicly held constituents. Growth rates, and operating margins, have to be maintained or valuation will suffer. We can’t prove it, obviously, but SHAK (if still private) might not be moving quite so aggressively in eliminating cashiers (which includes a significant personal “touch”) and going to a production based model.
FROM THE CUSTOMER’S STANDPOINT: SHAK will not lose its cult-like status any time soon. We don’t expect volumes to suffer substantially with this new approach, however: at the end of the day, it’s (mostly) a burger, fries, and shakes, preferred by many, but not by all. Lot’s of Californians think In and Out is the ultimate, some prefer the fresh cut fries at Five Guys, and the burgers at Schnipper’s here in NYC are pretty good if there is not a Shake Shack nearby. I believe that what has distinguished Shake Shack, as much as anything else, as been the hospitality quotient. Their staff has been a cut above the big three burger chains, just as been the case at Starbucks. Credit the influence of founders, Howard Shultz and Danny Meyer. Cutting to the chase: the absence of cashiers is not going to gain customers, and could cost some.
FROM THE EMPLOYEES’ STANDPOINT: Shake Shack is no doubt going to try to maintain the hospitality experience, as best they can, but eliminating cashiers is not an upgrade. There are lots of young people who correctly view a job at SHAK (or Starbucks) as a stepping stone in the retail/hospitality industry. They get an on-the-job education and get paid (modestly) at the same time. I’ve written about the Starbucks barista who told me “working at Starbucks makes me a better person” and I suspect that there are more than a few Shake Shack crew who feel that way as well. The new business model increases the value of “production” rather than customer contact, so it is going to be a lot less satisfying for that young person who really loves to interact with people, but is now just pumping out product.
Bottom Line: No Cash, and No Cashiers, may be progressive, even necessary, but will likely have unintended consequences, for employees, customers & shareholders.
SHAKE SHACK REPORTS TODAY AFTER THE CLOSE, OUR LATEST RESEARCH WRITEUP
SHAKE SHACK REPORTS TODAY AFTER THE CLOSE. OUR LATEST RESEARCH WRITEUP HAS BEEN SELECTED FOR RE-PUBLICATION AT SEEKING ALPHA, LINK BELOW:
SHAKE SHACK INC. – UPDATED WRITEUP – click above at “publicly held companies”
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DANNY MEYER ELIMINATES TIPPING. WELL ADVISED? BE CAREFUL OUT THERE!
DANNY MEYER ELIMINATES TIPPING. WELL ADVISED? BE CAREFUL OUT THERE!
The talk of the town and the country, among restaurateurs and diners alike is the no-tipping policy that Danny Meyer is about to embrace in his highly regarded full service locations. No one is more respected in the industry than Meyer, with good reason. He has built a great company within the fine dining sector, in addition to launching the hugely successful Shake Shack fast casual chain. If anyone can spearhead the no-tipping approach, it is he, but we have our doubts. In any event, the outcome will not be known for months or even years. There are three constituencies to satisfy here: the employees, the customers and the management. We list the employees first just because they are the face of the company, and continuously display the corporate culture to the dining public. If they are unhappy with the quality of the food served, the performance of the kitchen, their personal compensation and treatment by corporate management, it will be continuously communicated to the customer base.
I’ve been an analyst, investment banker, investor and adviser relating to the restaurant industry for over three decades. This is one of the more radical (call it “contemplated”) “adjustments” to the labor portion of “prime costs” ( food and labor) that I’ve seen in all that time, indeed the dining out culture that has become ingrained in our lifestyle.
It is important to understand the motivation behind Meyer’s (and some predecessors) move. As Meyer has described, the kitchen staff is paid by salary (or hourly) while the servers can make much more money including tips. The back of the house is of course critical to customer satisfaction, so it has to be discouraging and unfair to the kitchen when the servers are celebrating at the end of a great evening, having made hundreds of dollars, and the kitchen staff has made a fraction of that. It is important to understand that labor laws have for years inserted themselves into the tip allocation process, when tips are pooled; in general protecting the servers whose hourly rate is usually below the minimum wage. Tips can therefore not be allocated (more than nominally) to back of the house employees, leaving their compensation to management by way of salaries and bonuses. Assuming that front of the house tips are pooled among servers and their compensation can’t be cut materially, the change implemented by Danny Meyer’s amounts to a compensation raise for the back of the house, and an increase in overall labor costs.
Considering the second “stakeholders”, the customers: Some customers won’t mind if prices go up 20%-30%, including tips, since they were tipping at least 20% anyway, can afford it, and they really like the food and service. They are customers no matter what, which may especially apply to the restaurants managed by Meyer. Also, some customers don’t like the burden of the tip decision, so will welcome relief from this responsibility. In our opinion, this contingency is small, however. More important is the group that normally tips at perhaps the 15%-20% range, so this price rise will be a noticeable increase in the cost of dining. While some customers will tolerate it, we believe that a material number will not. Traffic is hard to come by, for all retailers, and wise managements are exceedingly thoughtful before implementing price increases. Our conclusion here: this new policy will not increase traffic, and will likely lose at least a few customers for all but the very strongest operators.
The third contingency is corporate management. Without question, the contemplated change will simplify the labor equation; compensate the back of the house more appropriately which will reduce turnover and training, and the burden of coping with governmental oversight. Operating margins are hard to maintain and management must get an appropriate return on investment if they are to prosper. In a better economy, with stronger sales, margin pressure would not be so substantial, but these days there is only one solution to higher costs, and that is higher prices.
Our bottom line: There is no one better equipped that Danny Meyer to implement this new policy, based on his relationships with employees and customers alike. We feel, however, this policy may hurt even him, over time, in terms of customer traffic. Most other full service restaurant companies would be ill advised to follow his lead, in our opinion. The economy, and the competition, is too unforgiving to tolerate what will amount to a material rise in dining prices. If I owned shares in a publicly held full service restaurant company, which I do not, I would be highly suspect of this change that is relatively radical in a very sensitive environment. In any event, even Danny Meyer intends to phase this approach in over a year or more, so this will take a while to play out. In the meantime, we say to restaurateurs and investors alike: be careful out there!