Becoming a great company requires more than having a whiz-bang product or service. There has to be money spent on getting the word out and building more of that amazing product or nurturing the service.
Such is the case at Shake Shack (SHAK), which everyone on Wall Street fell in love with when it went public in late January. To many on the Street, it was a can't-miss opportunity: a better-for-you burger chain in its early growth stages, led by a visionary founder. "Here comes the next Chipotle (CMG)," said the wild-eyed optimists, as their firms watched their early stakes go up, up and up. Although I am a big believer in what the company is doing for the fast food business, and see a clear global opportunity, it has to be balanced with a sense of realism.
Becoming the next Starbucks (SBUX) or Chipotle alongside inflated investor expectations is a tough spot for Shake Shack, or any up-and-coming entity. I think investors were reminded of that last night, as the stock plummeted 6% as soon as the earnings and outlook crossed the wires. In the end, Shake Shack is now heading down a path of becoming a great company, and it will likely mean financial results that aren't as juicy as investors are anticipating at the onset.
Here are three things to keep in mind as analysts come out with research on Shake Shack:
1. Costs to build infrastructure: Shake Shack captured the minds of investors in its prospectus by targeting to double its restaurant count in three years, and triple it within the next five years. But Shake Shack, like any company, has to build out its infrastructure to support the growth. It needs best-in-class staff to support its "fine casual" business model. It needs tech systems and training processes. And it has to introduce a mobile payments system, which as of right now is still in the works. Ideally, the best time to nibble at Shake Shack shares is if the stock loses another 10% or so, as it wouldn't necessarily be factoring in 2016 benefits from more infrastructure being in place. It could, then, get some earnings surprises that stoke the Street's optimism. Currently, the Street could be about to drop EPS estimates on Shake Shack for this year as it builds out its business and contends with beef inflation.
2. Costs to secure products: Shake Shack and Chipotle are starting to run up against one huge roadblock in delivering on their business model -- not enough sources for better-for-you beef and veggies. It's great to be out there promoting a healthy lifestyle, the one that has fueled the earnings for Chipotle since its inception and excited investors. However, these better-for-you fast food companies are opening tons of restaurants, and the supply chain for their products is not keeping pace. What is happening, then, is prolonged bouts of inflation and concerns on the Street on whether already high product prices could be hiked further without alienating customers. Shake Shack expects beef inflation to last until 2017, while Chipotle has guided to 2016. Chipotle is looking at another menu price increase for its steak products by about 5% by mid-year. Shake Shack has lifted prices two times by 3% since September last year (another increase was in January). It has no plans to take another price increase this year, which could eat into profit margins.
3. This is not the only fast food company in the world. Investment banks pitched Shake Shack as destined to take over the world of fast food. I get it, they had to do it -- and many investors ate up the pitches, given the experienced management team and solid concept. However, big-name fast food companies are continuing to open up hundreds of locations in the densely populated regions that Shake Shack wants to enter, or is entering shortly. Chipotle is opening close to 200 locations this year, and then will be serving better-for-you Mexican cuisine from them. Yum! Brands (YUM) remains a beast, people still want the food it serves from KFC, Taco Bell and Pizza Hut (Pizza Hut is starting to turnaround I think in the U.S.). Domino's (DPZ) and Papa John's (PZZA), tons of new franchised locations. Dunkin Donuts (DNKN) sells respectable lunch sandwiches with steak. Starbucks is now selling small shareable dinner plates, and dusting the industry with mobile payment initiatives. This is the market in which Shake Shack competes. And I don't feel investors have taken the countless hours to fully understand it.
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