The wait is finally over. Shake Shack’s(SHAK) initial public offering has arrived. Zoe’s Mediterranean Kitchen Inc (ZOE), up almost 100% since its 2014 IPO, and everyone’s favorite Mexian Grill, Chipotle(CMG), returned more 1500% since 2006, have set the stage for the new breeds to feel like tech stocks with some flavor. SHAK will be issuing 5.75 million shares at $21, raising $120.75 million. This values the company at approximately at $700 million. Will the company’s sub-par financial results in recent quarters halt the momentum? I don’t believe so. Here’s why.
Shake Shack started out as a burger stand in Madison Square Park at the heart of Manhattan and has grown to 63 locations worldwide, including prime locations in Moscow, London and Dubai. The creation by famous NYC restaurateur Danny Meyer, SHAK is a restaurant chain in the “fast casual” category serving burgers, hot dogs, fries, shakes and their famous frozen custards. They provide customers a new consumption experience through fast food made from fresh and healthy ingredients in a majestic setting.
Shake Shack has three main sources of revenue: domestic company operated stores are directly owned and operated by SHAK who keeps all of the proceeds and domestic/international licensed stores that are operated by international partners that pay a licensing fee.
Licensed sales represented 5.6% of total revenues for the 39 weeks ending in September 2014. Since most of the SHAK’s future growth is expected outside of Manhattan, and even the US, the company has focused its efforts on international growth (see above), and is expected to continue to do so in the future. As of 2014, the company counted 36 domestic and 27 international locations.
The company contends that hamburgers are by far the largest dine-out segment in the US, accounting for more than $72 billion in total sales. This makes the burger category twice as big as pizza. The international market for Burgers is over $135 billion and continuing to grow due to increasing disposable income and a rising middle class in developing countries. This is a major growth pipeline for Shake Shack moving forward.
Mounting consumer awareness and demand for fresh, hormone free, locally sourced and sustainable ingredients will only add to SHAK’s momentum. The company is also taking advantage of social media trends, garnering large followings on Twitter, Facebook and Instagram. Through this social media presence, word of mouth and product placement on HBO’s the News Room and Late Night with Jimmy Fallon, SHAK has significantly increased its brand awareness. They are now ranked 9th on the Restaurant Social Media Index, above of both Subway and Starbucks.
The fast-casual dining trend as a whole is growing at a much faster pace than both fast food and low-end casual dining (above).
Financials Will See a Shake Up
The value of each Shake Shack restaurant is approximately $9 million, or 3.6 X the value of a McDonald’s franchise ($2.5 million). This absurd figure is expected to fall significantly as more locations are opened however.
Shake Shack experienced high revenue growth in the past due to new store openings, with a CAGR of over 40% over the 4 years ending in 2013. Over recent quarters however, sales have slowed with Shack sales coming in at $78.9 million for the 39 weeks ending September 24th, compared to $78.5 million in for the FS ended December 2th 2013. Same Shack sales, the company’s equivalent to same store sales, have also decelerated from 5.5% for 2013 to 3% for 3 quarters of 2014. This puts the company in line with peers like Habit Burger and McDonald’s. In comparison, Chipotle (NASDAQ:CMG) had close to 20% same store sales for the same 3 quarters.
In addition, the company has seen a decline in profitability with net income falling from $2.11 million to $1.15 million due to increased cost in restaurant openings. With expansion in sight, profitability will be a secondary measure after top line growth.
Zoe’s Mediterranean Kitchen (NYSE:ZOES), another fast-casual restaurant that went public in the Q1 2014, employs the same hybrid company-operated/franchise business growth model as Shake Shack.
At the time of the offering, ZOES had a relatively similar number of locations to Shake Shack at 79. Revenue growth, on the other hand, was much higher for ZOES at 45% (above). However, they were much less profitable, incurring a net loss in the past 4 years and losing almost $9.8 million in the 16 weeks prior to their public offering. Since increasing store count to 116, Zoe’s revenues surged to $115 million for the 40 weeks ended October 6th 2014, up 50% from the same time the preview year and their net loss fell by $1.3m. Zoe’s Kitchen’s stock is now trading at $31, more than 100% above its IPO price of $15.
Shack Shack’s CEO is planning to use the IPO proceeds to open more than 10 domestic company-operated locations every year and to continue their overseas licensing strategy with the objective of reaching 450 Shacks in new and domestic markets.
Projecting a similar trajectory for SHAK to that of Zoe’s, it would be reasonable to assume that the company will experienced with a large increase in sales due to location expansion. This spreading out will be accompanied by increased operating expenses however. Overall, profit margin will be weak to start but improve over time as expansion costs dwindle and sales stabilize at their newly opened locations (it takes 12-24 months of operations on average for ZOES).
How Tasty is Valuation?
Extrapolating their 39 week sales number for 2014, Shake Shack was on track to earn $112 million in revenue for FS 2014. With HABT and ZOES post-IPO revenue growth average of 46%, we estimate revenues of $163.5 million for SHAK in 2015. Based on a market share of $700 million, SHAK would be valuing itself at approximately 5.8x sales, an 65% premium over its peer (above).
For a company with extremely strong brand equity, sound management principles and aggressive international growth plans, this premium is warranted. Investors should have an increased appetite for more than just Shake Shacks’s food. However, be careful not to chase to stock as there will surely be volatility during the first week. A price range as high as the high $20s could be justified. Anything higher and it may be best to wait on the sidelines for a better opportunity.