Shake Shack (NYSE: SHAK) recently released its quarterly earnings for the period ending June 30, 2017, and the numbers were far from impressive. Though earnings increased from the same period last year, excitement is tempered when a deeper analysis of the burger chain is performed.
Shake Shack pulled in quarterly revenues of $91.32 million and net earnings of $4.88 million. The company’s gross margins slimmed from 27.85 percent in the second quarter of ’16 to 25.62 percent in the second quarter of ’17. However, year-over-year cash flow remained the same.
As noted above, earnings increased compared this this time period in the previous year, yet pretax and operating margins declined. This prompts us to explore the underlying causes of this lukewarm performance, why you may need to seriously consider dropping the stock.
Disappointing Same-store Sales
Plenty of investors are shorting Shaking Shack for good reason. The burger chain’s lackluster quarterly results are especially concerning when one examines same-store sales. Shake Shack reported a drop in same-store sales of 1.8 percent. Furthermore, the company’s brass reduced its full year guidance. The drop in same-store sales is the second straight decrease in “comps”. All in all, Shake Shack traffic declined by over 4 percent.
It is important to highlight the unique way in which Shake Shack measures same-store sale. Most companies compare sales within stores open for at least a full year. Shake Shack analyzes sales at stores open for a minimum of two years for this important metric. This means the company’s fairly new stores aren’t included in the analysis. This is an issue, as more than half the company’s stores were opened in the last two years. In fact, less than 40 of the company’s 134 locations have been open for two years or longer.
Investors aren’t consoled by the fact that Shake Shack’s comparable base comprises less than half of the stores owned by the company. Though the enterprise is a fairly young fast food chain, there will come a point in time when its business can’t be buoyed by the continual opening of brand new stores.
The lackluster same-store sales help explain why short sellers hold over 11 million Shake Shack shares. Short sales of the company’s sock have jumped nearly 90 percent since January. In fact, these short sales have soared by an astonishing 69.3 percent since the beginning of the year. Investors are borrowing shares for short selling with considerable success. SHAK short sellers have generated an average of a 10 percent return on their positions across the year.
The Novelty Has Officially Worn Off
Shake Shack is trading at more than 50 times its projected ’18 earnings. This is cause for concern, especially when one considers the fact that the company isn’t operating in a niche with considerable room for growth. Trading at 50 times next year’s projected earnings isn’t a red flag for a business in the tech sphere yet it is a serious concern for a burger chain. Add in the fact that Shake Shack’s P/E ratio is over 55 and it is easy to understand why investors are growing increasingly bearish about this burger chain.
Such a lofty P/E ratio combined with decreasing comps is a nasty one-two punch for an alleged growth stock.
Shake Shack clearly has a customer retention problem. People are more than willing to give the burger chain a chance, yet many are not returning for subsequent visits. The shine is wearing off Shake Shack’s business.
Some investors are insistent that Shake Shack’s new stores are stealing sales from those that have been open for a year or longer. The company’s leaders should have opened up new restaurants across an array of cities instead of zeroing in on a limited number of markets. This is a major problem for long-term growth.
Shake Shack has 10 sites in Manhattan alone. The company will soon add two more locations to the Manhattan market for an even dozen. In total, 15 Shake Shack locations are in New York City. The company’s next biggest market is Washington DC, where it has five stores. This targeting of pricey real estate with ample traffic is leading to self-cannibalization.
Though it is certainly more efficient in terms of logistics and corporate management for numerous stores to be located by one another, the company would have been better served to space out its stores throughout the country. The unfortunate truth is most Americans have never seen a Shake Shack in-person.
Regards,
Ethan Warrick
Editor
Wealth Authority
