Fast-food chain Shake Shack (NYSE:SHAK) reported Q4 FY2023 results exceeding Wall Street analysts' expectations, with revenue up 20% year on year to $286.2 million. It made a non-GAAP profit of $0.02 per share, improving from its loss of $0.06 per share in the same quarter last year.
Shake Shack (SHAK) Q4 FY2023 Highlights:
- Revenue: $286.2 million vs analyst estimates of $280.2 million (2.2% beat)
- EPS (non-GAAP): $0.02 vs analyst estimates of $0.01 ($0.01 beat)
- Free Cash Flow of $8.41 million is up from -$9.88 million in the previous quarter (beat)
- Gross Margin (GAAP): 37.1%, up from 36% in the same quarter last year
- Same-Store Sales were up 2.8% year on year (beat vs. expectations of up 1.7% year on year)
- Store Locations: 510 at quarter end, increasing by 74 over the last 12 months
- Market Capitalization: $3.08 billion
Started as a hot dog cart in New York City's Madison Square Park, Shake Shack (NYSE:SHAK) is a fast-food restaurant known for its burgers and milkshakes.
The company was founded in 2004 by Danny Meyer, an acclaimed restaurateur, who envisioned a concept of serving high-quality food made from premium ingredients. Although burgers are its most popular menu items, Shake Shack also offers french fries, hot dogs, chicken sandwiches, and milkshakes made with sustainably-sourced ingredients.
Shake Shack’s diehard fans will argue that the company’s burgers are the best in the business. Preparation is unique, using a "smash and sear" technique that involves quickly pressing a beef patty onto a hot griddle. This leads to caramelized edges while sealing in the juices.
Shake Shack primarily targets consumers who seek the convenience of fast food but with better ingredients and the halo of a famous restaurateur behind the brand. This target customer is therefore willing to pay more for their burgers, hot dogs, and fries compared to mainstream fast-food restaurants.
The average Shake Shack location has a sleek but inviting aesthetic, often incorporating elements of its humble hot dog cart beginnings. To respond to evolving customer demands, the company offers online ordering and delivery through third-party platforms such as DoorDash and Seamless (Grubhub).
Modern Fast Food
Modern fast food is a relatively newer category representing a middle ground between traditional fast food and sit-down restaurants. These establishments feature an expanded menu selection priced above traditional fast food options, often incorporating fresher and cleaner ingredients to serve customers prioritizing quality. These eateries are capitalizing on the perception that your drive-through burger and fries joint is detrimental to your health because of inferior ingredients.Top competitors that also specialize in burgers include The Habit Burger Grill (owned by YUM! Brands, NYSE:YUM), Fatburger (owned by FAT Brands, NASDAQ:FAT), Burger King (owned by Restaurant Brands, NYSE:QSR), McDonald’s (NYSE:MCD), Wendy’s (NASDAQ:WEN), and Jack in the Box (NASDAQ:JACK).
Shake Shack is larger than most restaurant chains and benefits from economies of scale, giving it an edge over its smaller competitors.
As you can see below, the company's annualized revenue growth rate of 16.3% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was excellent as it added more dining locations and increased sales at existing, established restaurants.
This quarter, Shake Shack reported remarkable year-on-year revenue growth of 20%, and its $286.2 million in revenue topped Wall Street's estimates by 2.2%. Looking ahead, Wall Street expects sales to grow 14.2% over the next 12 months, a deceleration from this quarter.
Number of Stores
The number of dining locations a restaurant chain operates is a major determinant of how much it can sell and how quickly company-level sales can grow.
When a chain like Shake Shack is opening new restaurants, it usually means it's investing for growth because there's healthy demand for its meals and there are markets where the concept has few or no locations. Shake Shack's restaurant count increased by 74, or 17%, over the last 12 months to 510 locations in the most recently reported quarter.
Taking a step back, Shake Shack has rapidly opened new restaurants over the last eight quarters, averaging 18.2% annual increases in new locations. This growth is much higher than other restaurant businesses. Analyzing a restaurant's location growth is important because expansion means Shake Shack has more opportunities to feed customers and generate sales.
Same-store sales growth is an important metric that tracks organic growth and demand for a restaurant's established locations.
Shake Shack's demand within its existing restaurants has generally risen over the last two years but lagged behind the broader sector. On average, the company's same-store sales have grown by 6.3% year on year. With positive same-store sales growth amid an increasing number of restaurants, Shake Shack is reaching more diners and growing sales.
In the latest quarter, Shake Shack's same-store sales rose 2.8% year on year. This growth was a deceleration from the 5.1% year-on-year increase it posted 12 months ago, showing the business is still performing well but lost a bit of steam.
Gross Margin & Pricing Power
Gross profit margins are an important measure of a restaurant's pricing power and differentiation, whether it be the dining experience or quality and taste of food.
In Q4, Shake Shack's gross profit margin was 37.1%. up 1.1 percentage points year on year. This means the company makes $0.36 for every $1 in revenue before accounting for its operating expenses.
Shake Shack has good unit economics for a restaurant company, giving it the opportunity to invest in areas such as marketing and talent to stay competitive. As you can see above, it's averaged a healthy 35.8% gross margin over the last two years. Its margin has also been trending up over the last 12 months, averaging 5.5% year-on-year increases each quarter. If this trend continues, it could suggest a less competitive environment where the company has better pricing power and more stable input costs (such as ingredients and transportation expenses).
Operating margin is a key profitability metric for restaurants because it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.
In Q4, Shake Shack generated an operating profit margin of negative 0.5%, up 2.2 percentage points year on year. This increase was encouraging, and we can infer Shake Shack was more disciplined with its expenses or gained leverage on its fixed costs because its operating margin expanded more than its gross margin.The restaurant business is tough to succeed in because of its unpredictability, whether it be employees not showing up for work, sudden changes in consumer preferences, or the cost of ingredients rising thanks to supply shortages. Unfortunately, Shake Shack has been a victim of these challenges over the last two years, and its high expenses have contributed to an average operating margin of negative 1.1%. However, Shake Shack's margin has improved, on average, by 3.5 percentage points each year, an encouraging sign for shareholders. The tide could be turning.
Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.
In Q4, Shake Shack reported EPS at $0.02, up from negative $0.06 in the same quarter a year ago. This print easily cleared Wall Street's estimates, and shareholders should be content with the results.
Between FY2019 and FY2023, Shake Shack's adjusted diluted EPS dropped 49.2%, translating into 15.6% annualized declines. We tend to steer our readers away from companies with falling EPS, especially restaurants, which are arguably some of the hardest businesses to manage because of constantly changing consumer tastes, input costs, and labor dynamics. If there's no earnings growth, it's difficult to build confidence in a company's underlying fundamentals, leaving a low margin of safety around its valuation (making the stock susceptible to large downward swings).
On the bright side, Wall Street expects the company's earnings to grow over the next 12 months, with analysts projecting an average 29.8% year-on-year increase in EPS.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills.
Shake Shack's free cash flow came in at $8.41 million in Q4, representing a 2.9% margin and flipping from negative in the same quarter last year to positive. Seasonal factors aside, this was great for the business.
While Shake Shack posted positive free cash flow this quarter, the broader story hasn't been so clean. Over the last two years, Shake Shack's capital-intensive business model and large investments in new restaurant locations have drained company resources. Its free cash flow margin has been among the worst in the restaurant sector, averaging negative 4%. However, its margin has averaged year-on-year increases of 6 percentage points, showing the company is at least improving.
Return on Invested Capital (ROIC)
EPS and free cash flow tell us whether a company was profitable while growing revenue. But was it capital-efficient? A company’s ROIC explains this by showing how much operating profit a company makes compared to how much money the business raised (debt and equity).
Shake Shack's five-year average ROIC was negative 2.7%, meaning management lost money while trying to expand the business. Its returns were among the worst in the restaurant sector.
The trend in its ROIC, however, is often what surprises the market and drives the stock price. Over the last two years, Shake Shack's ROIC averaged a 3 percentage point increase each year. This is a good sign, and if the company's returns keep rising, there's a chance it could evolve into an investable business.
Key Takeaways from Shake Shack's Q4 Results
We were impressed by the quarter from Shake Shack. The company beat across the board on all key metrics from sale-store sales to revenue to profits to EPS. FCF even came in higher than expected and was positive rather than the loss projected by Wall Street analysts. Zooming out, we think this was a fantastic quarter that should have shareholders cheering. The stock is up 7.8% after reporting and currently trades at $84.07 per share.
Is Now The Time?
Shake Shack may have had a good quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.
Shake Shack isn't a bad business, but it probably wouldn't be one of our picks. Although its revenue growth has been impressive over the last four years, its declining EPS over the last four years makes it hard to trust. And while its new restaurant openings have increased its brand equity, the downside is its relatively low ROIC suggests it has struggled to grow profits historically.
Shake Shack's price-to-earnings ratio based on the next 12 months is 165.0x. We can find things to like about Shake Shack and there's no doubt it's a bit of a market darling, at least for some investors. But it seems there's a lot of optimism already priced in and we wonder if there are better opportunities elsewhere right now.
Wall Street analysts covering the company had a one-year price target of $76.84 per share right before these results (compared to the current share price of $84.07), implying they didn't see much short-term potential in Shake Shack.
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