What Will Turn Shake Shack's Stock Around?

By Markets Fool.com

Shake Shackhas posted impressive growth since going public at the beginning of last year. And for the first five months or so, its stock followed suit. But by the time summer 2015 rolled around, shares were in decline and have been ever since.

Continue Reading Below

The culprits? A stock market correction, profit-taking by investors, and heavy selling from early institutional owners after their lock-up period expired last summer.

Even so, the company seems poised to continue growing its business. The question now is whether or not its stock will do the same?


Photo source: www.investor.shakeshack.com

2015 growth and company projections for 2016
For its 2015 fiscal year, Shake Shack opened 12 company owned and operated restaurants in the US and six international franchised locations. In the third quarter 2015 earnings release, the company reiterated plans to open at least 14 new US locations and eight more international ones this year.

This is great news for shareholders, as Shake Shack has calculated its average operating profit (or Shack-level operating profit margin) at about 30% across all locations during the third quarter of 2015, an increase from 25% during the prior year. Net profit was at 2.9% during the third quarter of 2015, up from 1.6% a year ago. Revenue also increased 67% during the quarter compared to the prior-year period.

Continue Reading Below

It seems that the company is starting to reap the rewards of all those new locations. So, at what point could that growth translate over to the stock?

Valuing shares based on business fundamentals
Let's start by looking at revenue from company-owned "Shacks." As of last count, the company had 43 owned and operated locations. These restaurants generated almost $134 million in revenue for the nine months ended September 30, 2015, representing 96% of total revenue. Average revenue per restaurant was $3.1 million for that time period. With an average operating profit of almost 30%, that puts each restaurant's operating profit at just under $1 million so far. Let's compare that number with some other fast-casual companies:

Metric from last earnings report (total nine-month period ending in fiscal third quarter 2015)

Revenue from company-owned locations

Number of company owned locations

Restaurant-level operating profit margin

Average restaurant operating profit

Shake Shack

$133.9 million

43

29.1%

$0.91 million

Chipotle

$3.5 billion

1,931

28%

$0.51 million

Zoe's Kitchen

$173.7 million

158

21.6%

$0.23 million

Source: Fiscal Third Quarter Earnings Reports

As you can see from this chart, Shake Shack has great numbers at the restaurant level. The company believes it can maintain these margins for new locations going forward, and continues to post positive same-restaurant sales -- 17.1% for the third quarter of 2015. If this momentum can be kept up, opening new restaurants would be a very profitable endeavor.

Another measure we can use to value Shake Shack's stock growth potential is forward price to earnings, expected earnings growth rate, and PEG ratio. Here's a breakdown:

Deriving the PEG ratio helps us determine how much we're paying for future growth of a company. Let's compare Shake Shack's PEG ratio with the companies we used above:

Company

PEG Ratio (based on next five years earnings growth estimates)

Shake Shack

3.50

Chipotle

3.53

Zoe's Kitchen

6.17

Fast-Food and Fast-Casual Restaurant Industry Average

2.68

Chart and figures calculated by author

Using the PEG ratio, Shake Shack is more expensive than the restaurant industry average. When looking at fast-casual peers Chipotle and Zoe's Kitchen, however, Shake Shack looks to be fairly valued at current share prices and future growth expectations.

Is the stock poised for a turnaround?
Given Shake Shack's results last year, its pipeline for new locations, profitable restaurant-level operating margins, and fair PEG ratio valuation, I believe its stock is ripe for a rebound. It looks to me that current share prices in the low- to mid- $30's, while not a bargain, is a fair price to pay for the upstart burger company. If you believe the company can continue successfully building profitable locations, as well as increase same-restaurant sales, Shake Shack could be a profitable long-term holding.

The article What Will Turn Shake Shack's Stock Around? originally appeared on Fool.com.

Nicholas Rossolillo has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Chipotle Mexican Grill and Zoe's Kitchen. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.