SHAKE SHACK INC. 
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Originally founded in 2001 by Danny Meyer's Union Square Hospitality Group (USHG), which owns and operate many restaurants in New York City such as Union Square Café, Gramercy Tavern and Blue Smoke, Shake Shack began as a hot dog cart to support the rejuvenation of New York City's Madison Square Park. It rapidly grew and now has more than 240 locations in 32 US States and over 140 international locations across London, Hong Kong, Shanghai, Singapore, Mexico City, Istanbul, Dubai, Tokyo, Seoul and more. It continues to expand domestically and internationally.
The Quick Service Restaurant (QSR) business is very competitive, but potentially very attractive when it works and same store sales increase year after year, thanks to the very high operating leverage. On a like-for-like basis (i.e. excluding growth effects) there is indeed a more or less stable fixed cost base at the headquarters level. On the other hand, if we take 300pts in same-store sales on average at the store level, this means a clear expansion of the gross margin, which is therefore directly on the bottom line: This is the operational leverage. And so, in these favorable dynamics we generally see very strong multiple expansions.
Two phases of development
As far as finance is concerned, we can see that over the last 10 years, Shake Shack raised relatively little capital ($300m in equity and $230m in debt, i.e. $530m in total) to finance an investment program of $700m. At the same time, its sales have increased from $57M to $865M and they are approaching $1B. The company operated 21 locations in 2012 and now has more than 380.
The group's evolution was largely done in two phases: Until 2017, the capex was always limited by the cash flow, which is a very conservative approach. However, between 2017 and 2022 there was an acceleration and the capex is now typically twice as high as the CFO.
Looking at the number of restaurants, it looks like there was a first phase of validation of the concept until 2017, when the group counted 159 locations and a second phase of clear acceleration of openings, since the company now has more than 380 units. This assumption is confirmed by the WCR (Working Capital Requirements), which swallows much more cash than before.
There are two possible reasons for this more aggressive strategy for the last 5 years:
- Because it was working so well, the company went all out after having validated the concept
- Or It wasn't working well enough so it went all out on volume to try to use the famous operational leverage that I mentioned above
At the moment, Shake Shack does not generate profits, as everything goes into the openings. Let's look at the EBITDA to evaluate the exploitation. What do we see? Well, it's not great because EBITDA in 2022 is the same as in 2016: We are in clear stagnation. This is even if we restate the costs of opening new locations that the management has taken care to include in its income statement. That's why the price of the stock has been stagnating, despite the very strong growth. The turnover has almost quadrupled but the EBITDA hasn't moved much.
A very competitive industry
Since there's a very strong turnover expansion, we can deduce that the problem of profitability is linked to costs... It is clear that inflation and the new need for QSR to invest in technology add big constraints at this level. Moreover, Shake Shack has a strong international strategy and this is necessarily more expensive than when you want to cover a domestic market in North America.
On the top line, it's not going to be easy to boost the turnover because you don't have much room to increase the price of hot dogs. In such a competitive market, there is a ceiling that hard to exceed.
On the value side, we are at x25 EV/EBITDA, which is roughly the same as Chipotle (which is making money) and higher than McDo (x18 EV/EBITDA)... So frankly, unless you are a hard-core believer, it doesn't seem that we are on a depressed value here. In my opinion, there are more enticing bets out here in the QSR industry…
