On Shake Shack

I tweeted about Shake Shack (SHAK) a few weeks ago:

just bought some Shake Shack $SHAK . biggest driver of value is a) eventual store count, b) revenue per store.

they have about 300 stores now, I think that can easily double to 600.

— mspacey (@mspacey4415) August 5, 2020

Here's the gist of the thesis. Shake Shack can eventually reach 1,000 stores. At 600 stores (achievable within 3-5 years), and assume lower revenue per store for the new stores, I get to $89 a share using 20x EBITDA. That would be roughly a double in 3-5 years from my purchase price of $50.

The 20x EBITDA assumes growth runway beyond the 600 stores modeled here. That multiple may seem high but keep in mind currently it's at >25x.  In any case, it's all about growth runway and if Shake Shack can maintain its competitive position in the future (which in turn will allow them to uphold profitability).

Now, margin assumptions. As I mentioned in my tweet, Shake Shack is currently suffering from dis-economy of scale given its growth strategy. They are going after the big cities and claiming a foothold there. So if you have one store in Salt Lake City, you're setting up an entire supply chain to service that one store. 

That is obviously not optimal for margins. But things get better as you densify. The second store in the area might lead to some cannibalization, but will also allow them to leverage fixed costs. The 3rd and 4th stores will further enhance relative market positioning, as well as economy of scale... and so on. 

So as Shake Shack further penetrates the geographic areas they are already in, I expect margins to benefit.

To put things in perspective, in the affluent Bay Area (North California), Shake Shack only has 4 stores!  (San Francisco, Mateo, Palo Alto, and San Jose).

I go to the Palo Alto store, and even in the Covid-19 era there's usually a line of people waiting outside for online orders. 

Think about this for a second, Shake Shack invaded In-N-Out country - and have done pretty well!

To wrap up this section. I believe Shake Shack can easily get to 600 stores just by penetrating existing areas of operation. As they densify their operations, they can get leverage on existing infrastructure and improve margins.

A Telling Misconception

One push back I have gotten multiple times is "why would anyone buy a $10 fast food burger!?"

The answer is they don't. Shake Shack burgers are $6-7 dollars, not much more than than buying a Big Mac at McDonald's. Shake Shack burgers are made of 4 ounce patties, while Big Mac is made of two 1.6 oz patties. Then you factor in quality differences, I would say SHAK is an outright bargain.

But it's telling that people assumes Shake Shack sells $10 burgers. People hear about SHAK through friends and social media, see its nice stores (and lines out the doors), and assume it's some kind of snobby "premium" burger. 

They would be right about the premium part. Shake Shack is not your regular fast food burger, and can't be compared to such. It occupies an unique "premium fast food" position that few fast food operators can claim. 

It's the cheap glamour burger. The Michelin of fast food burgers. Founded by industry celebrity Danny Meyer.

Some people will have ideological aversion to this kind of categorization, but buzz matters. There's just some extra magic to Shake Shack beyond a quality burger at the right price. 

I was in Manhanttan through the 2000's when there's only the Madison Square Park location. I saw the buzz it generated. People regularly wait in line for an hour just for $5 burger. Even in early 2010's after they opened shacks throughout the city, the Madison Square location still has lines around the park.

As Shack Shack invades international big cities, they take that buzz with them. Below is a view of the newly opened Beijing store. I'm pretty sure people don't wait hours for Hardee's opening!

I thought one hour was long... First customer at @shakeshack in Beijing said she’s been waiting for five hours to get the hot dog 🌭.😳 $SHAK pic.twitter.com/1jNUV6b2Yn

— Eunice Yoon (@onlyyoontv) August 12, 2020

Other Puts and Takes

• Shack Shack patties have a distinct texture versus competitors such as In-N-Out or Five Guys. This is due to their proprietary blend from Pat LaFrieda and a smash-and-scrape technique.

• Declining same store sales. SHAK has a different sales pattern compared to most. Since the company enters a market with so much buzz, the stores typically start with high revenue per store, then drop off in the second year. Sales eventually stabilize, and I think will improve as they add options such as drive through and curb side pick up.

• This idea that Shake Shack might be hurt by higher mix of delivery orders (assuming those have lower margins). 
• SHAK can pick sole delivery partner as leverage (I guess that's what they do with GrubHub). 
• SHAK also has an excellent mobile app (better than McDonald's in my opinion, and I'm a big fan of MCD!). This means they won't depend on delivery partners to drive traffic.

• The real risk is if the company expand too quick and loses its quality and reputation. Other than that, I think it's a sure thing. 

• My average cost basis is slightly below $50/share. The plan was to average down and really load up if the stock ever go down to 30's. Instead, it's seen a quick run up. I will likely add a little when it reaches $60.