Shake Shack Unveils Ambition to Equal Five Guys' Size. Warranting Focus from Investors Due to Its Potential Reward and Danger.
Shake Shack, famously known as SHAK, recently upped its long-term vision by triple-fold. This ambitious move, shared at the 27th Annual ICR Conference, has sent ripples through its shareholders since its public debut a decade ago.
Originally aimed for 450 company-owned U.S. restaurants, Shake Shack has made tremendous strides, boasting ten times the initial number. Now, management intends to push even further, eyeing a whopping 1,500 domestic company-owned restaurants. For context, this would make it approximately on par with burger chain Five Guys and significantly larger than other chains like Carl's Jr. and Whataburger.
However, this significant leap presents an intricate challenge for the shareholders. If executed successfully, Shake Shack can reinvent itself at scale; yet, there's potential risk involved.
Navigating the risks with 1,500 locations
The restaurant business can grow in two ways: either by opening new company-owned locations or franchising out to third parties. The former is costlier and slower, but if the unit economics are promising, it can be a worthwhile venture. Shake Shack does employ both methods, but its ambitious target involves primarily expanding company-owned locations—more than three times the original goal with nearly 400% growth from the current company-owned footprint.
The investment thesis hinges on whether Shake Shack can maintain attractive unit economics at this scale. According to management, US Shake Shack locations currently generate an average of $4.1 million in annual sales, while achieving a restaurant-level operating margin of 22.7%. But, keep in mind that Shake Shack is heavily concentrated in urban areas, with 39% of its domestic company-owned locations situated there.
As the company expands, it necessarily moves into suburban areas, which leads to a decline in average unit volume. Expanding to 1,500 locations can place additional strain on this AUV and will likely feature lower sales volume than the average location. Management anticipates an AUV between $2.8 million and $4.0 million, which clearly indicates the newer locations will have lower sales volume than the current ones.
Research shows revenue growth is essential for stock performance over the long term. However, not all growth companies perform well. Companies that grow at the expense of lowering their profit margins may struggle in the long run. Shake Shack risks stumbling upon this issue as it embarks on its massive growth plan.
Making it all worthwhile
Two factors could potentially offset these risks:
- Focus on operational efficiency: If management keeps expenses not directly related to running restaurants to a minimum, the gap between restaurant-level profit margin and overall profit margin may gradually widen, increasing overall profitability.
- Optimizing new locations: Changing how Shake Shack develops new locations to incorporate smaller units, drive-throughs, and throughput optimization may enhance profitability for suburban locations while retaining lower sales volume.
If Shake Shack can reach its company-owned goal of 1,500 restaurants and generate $5 billion in annual revenue (assuming an AUV of $3.3 million), it has significant long-term, multibagger potential. Yet, it continues to face challenges such as execution risks, cost-effectiveness, market saturation, pricing vulnerability, supply chain disruptions, regulatory changes, and brand maintenance in suburban markets.
In summary, while the ambitious expansion plan offers the potential for significant growth, it also presents risks that must be carefully navigated. Understanding these factors will help investors make informed decisions about Shake Shack's stock potential.
To finance this expansion, Shake Shack might need to seek further investments in the finance market, potentially attracting strategic partners or institutional investors interested in the burgeoning fast food sector.
Successful execution of this plan could contribute to boosting the company's share price, appealing to investors looking for high-growth opportunities in the investing scene.
