Description

We believe that Shake Shack (SHAK) presents a compelling short opportunity at current prices.  The company is headquartered in New York, NY and owns and operates 58 quick casual restaurants across the U.S. and licenses over 40 units, primarily in international markets. SHAK seeks to differentiate itself by offering fresh, simple, high-quality food at a good value.  pcm983 provided an excellent overview of the business in a write-up from early 2015.  While we like the menu, we are not sure that the concept is all that differentiated from other premium U.S. burger concepts.  In addition, the company operates in a highly competitive industry with no barriers to entry and the concept is still unproven in smaller markets.  Even if SHAK reaches 450 domestic units at ~$3 mil. average unit volume (AUV) (in line with management’s targets), the current valuation is hard to justify and there is little margin of error for long investors.  The current valuation of 64x NTM EPS and 23x EV/NTM EBITDA implies AUV’s or a unit opportunity above levels that we believe are achievable under reasonable circumstances. 

We also remain concerned that on a small restaurant base that is focused in NYC, SHAK is experiencing deceleration in unit sales trends as the initial euphoria wears off.   Year 2 same restaurant sales typically see a 5% drop in sales with just a low single-digit increase starting in year 3.  In addition, total same restaurant sales continue to decelerate from +13.3% in 2015 to 4% to 5% in 2016E and just 2% to 3% in 2017E, including an expected 2017 price increase of 1.5% to 2.0%.  While the company does have a 24 month period (vs. 19 for many of its peers) before restaurants enter the comp base, SHAK’s same restaurant sales numbers are well below what we typically see for growing concepts in the early stages of their growth cycles with small restaurant bases.  New units continue to open at AUV’s of over $3 mil. but we believe that as the company expands its restaurant base into smaller markets with less foot traffic, experiences cannibalization in larger markets and has fewer high profile larger markets to enter, initial AUV’s will decline over time and perhaps fall below the ~$3 mil. longer-term target.  In 2013, the company disclosed that units outside of Manhattan were generating a $3.8 mil. AUV on a tiny restaurant base in large markets and we see downside risk to this number over time.  The company is also generating sales per square foot of over $1,000, well above its peers and at a level that we do not believe is sustainable over the long-term.  Expansion into the western U.S. region will also put SHAK in direct competition with In-N-Out Burger (~313 stores).    

We utilized a 20 year DCF model to check our valuation assumptions for SHAK.  We assume that the company reaches 450 company owned units and 450 licensed units in ~20 years with unit growth of about 20 units per year for both company owed and licensed units.  In addition, we expect a ~20% EBITDA margin on company owned unit sales (lower unit margins over time offset by G&A leverage) and a 50% EBITDA margin on licensed unit sales.  A $3 mil. AUV for company owned stores (in line with management’s target) with a 10% discount rate suggests a SHAK value of ~$20 per share.  There are only a handful of public restaurant concepts that have been able to sustain AUV’s of over $3 mil. including FOGO and BJRI.  The current valuation seems to imply a SHAK AUV of closer to $5 mil., similar to the level SHAK’s current 58 restaurant comp base that is located in the largest and most attractive markets is generating.  Overall, we believe that it is challenging to justify the current valuation for SHAK and that slowing same store sales and AUV declines will pressure the valuation over-time. 

We note that management and large early investors have been selling SHAK shares.  Chairman Daniel Meyer appears to have recently reduced his minimum price threshold to $38.00 from $40.00 minimum for his 10b5-1 stock sale plan.  Large investor Richard Coraine also sold outside of a 10b5-1 plan around the $38 level.  Another large investor, Laura Sloate, also sold outside of her 10b5-1 plan near the $38 price level.  Lastly, the CFO who has been with the company since 2013, is leaving after the Q4 2016 reporting cycle and this creates some uncertainty for SHAK investors.  

RISKS

New products offerings could drive AUV’s above the levels that we anticipate.

Commodity costs could become more favorable.

U.S. tax reform could be a tailwind for SHAK.

Catalyst

Declines in AUV's as SHAK enters new markets