Scott Olson
Shake Shack (NYSE:SHAK) is a popular, growing hamburger joint. That said, it is my premise that the share price is far out of line with the fundamentals of the business and future prospects and, despite recent losses in the share price, the stock is trading at such elevated multiples it will be hard to profit from an investment in the company at this time. Like many popular restaurants that were publicly traded early in their rise, traded at high valuations, and later struggled to either maintain these multiples or even operate profitably, Shake Shack may suffer the same fate. While I have enjoyed my few visits to their restaurants, a cautionary article is warranted.
Despite Recent Losses, Multiples Are Very High
Since early August, SHAK share price has dropped from just under $80 a share to closing at $69.86 on August 29th. This is a 12.66% drop in basically a month. Granted, August has been a bad month in the market for most stocks, but this is a significant retracement by Shake Shack. Ominously, these losses put the share price close to what appears to be a support line near $65, below which there was a rapid rise from the mid-50s. (Note: I am not a technical trader, and I invite someone more familiar with this methodology to comment or submit a more in-depth analysis article.) I am more a fundamentals investor with a value/value-growth bias. Yes, this has made me miss some good companies over the years, but also protected me from large drops, in most cases.
Fundamentally, SHAK trades at very high multiples, both in comparison to its industry competitors and in the abstract. My investment analysis has been shaped by Graham, Buffet and Martin Whitman. The latter often wrote about being an “outside passive minority investor” or OPMI, and I took this as considering my stock purchases as buying a small percentage of a business, and wanting my dollar invested to return cash flow and earnings. So looking at the multiples became a key test, and SHAK’s, in my opinion, fail that test.
While Shake Shack is growing (more on that in a minute from the company’s recent 10-Q) the multiples for that growth show buyers are paying a high premium. Forward P/E ratios, both GAAP and Non-GAAP, are well over 1,500% of industry sector median, with GAAP FWD price/earnings being 293.45 (Per SA Valuation tab). Price to sales, both trailing twelve months and forward, are higher than the sector median, but not as badly as P/E. TTM P/S is 2.74, with a sector median of .87, over 3x.
Granted, Shake Shack is growing, where many in their sector are stable or even shrinking. Also, ratios can stay higher longer for some restaurants over multiple years. I’ll humbly mention my frequent, and frequently pre-mature WING articles. But WING also serves as a cautionary tale and a much more recent one than Boston Market, Krispy Kreme, Po’ Boys, and Kenny Rogers Roasters. Wingstop recently also lost share value, dropping 25% since May and almost being flat since mid-September of 2022.
Shake Shack Also Faces Headwinds
A previous article here on Seeking Alpha mentioned the potential headwind restaurant dining may face as student loans begin requiring payments again soon. This is just one headwind facing Shake Shack, and by extension, the entire sector. Inflation has abated in some areas, but remains persistent in others, or prices remain inflated, such as gasoline and housing. The “wealth effect” from low mortgage rates, easy to get and low interest HELOCs, zero interest credit cards, no student loan payments and cash from the government have ended or are working their way out of the economy. While there is some wage growth, this is also a negative for Shake Shack, as the quality customer experience a premium “fast casual” restaurant should have to distinguish itself from a larger chain such as McDonald’s or Burger King requires a premium labor force, which will be more costly to hire, train and retain going forward.
One paragraph in Shake Shack’s recent 10-Q is also a red flag:
“Shack sales for the thirteen weeks ended June 28, 2023 increased 17.4% to $261.8 million versus the same period last year. Shack sales for the twenty-six weeks ended June 28, 2023 increased 20.5% to $506.1 million versus the same period last year. The increases in Shack sales for the thirteen and twenty-six weeks ended June 28, 2023 were primarily due to the opening of 40 new domestic Company-operated Shacks between June 29, 2022 and June 28, 2023, which contributed $31.2 million and $53.0 million, respectively, as well as increased menu prices, which contributed $17.2 million and $35.0 million, respectively, partially offset by a decline in items per check.” (Shake Shack 10-Q, August 4, 2023, retrieved 8/29/2023 from Seeking Alpha, italics by the author of this article)
To emphasize, increases in sales were “primarily due” to opening more restaurants and higher prices (ok, at least they are passing on costs) but also offset by a decline in order size. Not a train wreck, nor will I make it out to be one, but at a minimum a warning that things could be turning.
Risks-I Might Be Wrong (Again)
As pointed out above, I have previously written articles on Wingstop that read much like this one. Both companies perform their core functions well, and admittedly have good products. Also like Chipotle, Shake Shack could be rewarded with multiples far above their sector competitors, and as the company continues to grow and generate more revenue (if not also profits) the share price could recover and even set new highs. If this happens, the recent drop in share price since the release of earnings and the 10-Q on August 4th may be a good buying opportunity.
Buy? Sell? Hold? Options?
I currently do not own any Shake Shack, nor do I have any option positions as a sometimes seller of premium in covered calls, bear call spreads or cash secured puts. I don’t plan on buying Shake Shack shares, as the valuation is just too dear for my orientation as an investor. If I owned shares that were “above water” I’d consider selling out of the money covered calls, both to collect premiums and lock in a profit if there was a quick bounce. Even with the above explanation of high multiples I don’t think the share price will rapidly drop. That said, a quick glance at the call premium may make a bear call spread, out in the October expiration and out of the money may make sense, with the risk being a rapid recovery in share price. The upper bound on the call spread would set the upside risk, and should be carefully considered to meet each person’s risk tolerance and capital if pursuing an options strategy.
Best wishes for investment success!
