SHAK is on the Hedgeye Restaurants Best Ideas list as a SHORT.
SHAK may be the second coming in the hamburger space, but its valuation reflects its superior status as a public company. That being said, I’m not telling you something you don’t already know.
I’m an old school restaurant analyst and I can’t get past what I see as a classic mistake being made by the management team. Instead of taking the conservative approach of building out its new units with a geographic concentration that allows for SHAK to maintain economies of scale and building brand awareness, management has gone the route that has been the death of nearly every concept that has tried. By opening stores in vast geographic locations, it’s nearly impossible for the young company to maintain its high standards of execution which make up the current brand cache!
This strategy is more commonly known as planting flags. With only 71 stores opened, if SHAK is successful with the current real estate strategy of planting flags globally, it would be the first company I have ever followed to successfully create shareholder value in this way. Of the 71 stores, there are 29 licensed SHAK’s opened in 8 different international countries.
So that makes the SHAK empire currently operating in 13 states and 8 countries! Amazing stuff for such a young company. In a consumer business in which maintaining brand integrity is critical, SHAK is pushing the envelope on growth making that integrity very hard to maintain.
Importantly, the company is not slowing down the aggressive geographic expansion. In 2Q15 the newest state the company added to the list is the first unit in Texas. Over the past year it has opened units in New York, New Jersey, Illinois and Florida. In 2016, the company plans to open new units in two new states, California and Arizona.
OTHER THINGS TO CONSIDER:
AGGRESSIVE PRICE INCREASES - Same-store sales increased 12.9% in 2Q15 versus a 4.5% last year. This consisted of a 4.3% increase in traffic, combined with an 8.6% increase in price and mix.
HEDGEYE - In a raging bull market, operating most of your stores in NYC, the company might be able to get away with this. Clearly, this is not sustainable and is inflating the margin structure of the company. What do you think will happen to margins when traffic slows and management needs to be more promotional?
LIMITED INFORMATION – In an unusual move for any restaurant company the comparable Shack store base includes only those Shacks that are open for 24 months or longer. Of course management feels that this “is the best comparison given the long honeymoon periods at our new Shacks.” A comp is a comp by the way! Therefore, the comparable Shack base in the second quarter of 2015 included only 16 Shacks compared to only 10 Shacks in the second quarter of 2014 in which NYC represents 37% and 60% of the comp base, respectively.
HEDGEYE – Until we see more stores enter the comp base in non-core markets, will we see how the company is really performing. Given the two year lag on getting stores in the base it could be an extended period. Two years is a long time and anything can happen to the brand status with consumers.
SIGN OF THINGS TO COME – Since-same store sales will provide only limited analysis on the company’s performance, average weekly sales will be more of a focus over time. In 2Q15, average weekly sales for domestic company-operated Shacks increased 7.4% to $102,000 for 2Q15 from $95,000 last year. This growth was significantly below the 2Q15 12.9% same-store sales figure. Additionally, average weekly sales figures were driven higher by menu price increases and the Las Vegas unit opening in 2H14.
HEDGEYE - I can only imagine what AUV’s would look like without the Las Vegas store. I suspect Joe day trader and the media don realize that average weekly sales over the long-term will be in a secular decline!