Shake Shack Revenues Grew 37% in Q2 -- Here's Why That's Not Nearly Enough

By Markets Fool.com

It might not be so bad as a restaurant on every corner, but Shake Shack's accelerated store opening plan hints at deeper troubles for the better burger joint. Image source: Mike Mozart via Flickr.

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Another quarter, another disappointing result from better burger joint Shake Shack (NYSE: SHAK). Even though revenues rose 37% from the year-ago period, it's growth that's not nearly sustainable enough to justify the stock's still lofty valuations.

The factors present at Shake Shack's IPO last year that should have been yellow flags for investors then have not diminished with time, and other than the reversal in commodity costs, they may be even more nettlesome for the burger chain today.

  • The market remains saturated with "better burger" stands.
  • Revenue growth still lags new store openings.
  • Comparable sales growth continues to decline.
  • Average unit volumes are expected to drop.

From Five Guys to The Habit (NASDAQ: HABT), In-n-Out to Smashburger, better burger joints are becoming a dime a dozen. Even McDonald's (NYSE: MCD) has responded to the increased competition by improving its ingredients and image to better reflect the changes these pricey hamburger joints have effected on the market.

An argument can even be made that McDonald's has done a better job of meeting these changes than any of its high-end rivals as the fast-food king has now recorded three straight quarters of higher same-store sales after several years of declines. There was even talk McDonald's might be in the market to buy Shake Shack, but the quick-serve joint is in a better spot than its better-burger rival, and snapping it up would be a step backwards for it.

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Here's why Shake Shack's quarter shapes up as bad news for it and its investors.

Where's the beef? Everywhere!

As noted, the competition is as thick as one of Shake Shack's burgers, but the chains are slowing down on the number of new store openings as the market gets saturated. The Habit, for example, says it's only going to open 29 to 31 new stores this year compared to the 30 to 32 it previously planned on. A small change for sure, but coupled with expectations that comps will only grow 2% to 2.5% this year instead of the 3% it previously forecast indicates that it recognizes the changing market.

Still, Shake Shack says it's going to open even more stores than it once planned on. It will now open 18 new Shacks this year, up from its previous guidance of 13 that it started the year with.

Not made to order

Shake Shack needs to open so many new stores because it's trying to maintain the facade of revenue growth. Same-Shack sales rose just 4.5% in the latest period, well below the 13% spike it enjoyed last year as a result of its IPO. It's all part of the trend of falling comps it has experienced for the past few years. In fact, of that comps figure, only 1.2% of the gain can be attributed to more customers -- the rest came from price hikes.

So only by opening more restaurants can its revenue figure keep expanding, but even that is down year over year. Even as it does so, though,it's targeting lower annual unit volumes of $3 million -- well below the $5 million its company-operated stores currently generate, and even less than the $3.4 million generated by those it licenses.

As the stores in its portfolio age, Shake Shack also anticipates its costs for them rising. Operating expenses as a percentage of revenues jumped 130 basis points this past quarter to 9.3%, and the company anticipates that rising inexorably in the future.

As frothy as one of its shakes

Despite all of this, the market is still valuing Shake Shack's stock at 90 times earnings and more than 60 times estimates. The pressure on the restaurateur to maintain the semblance of growth to justify those nosebleed valuations is what's driving it to open more stores, but that's only going to cause its metrics to deteriorate further, and it's stock, though down 37% from its 52-week highs, will fall further still.

Propping up the company with artificial growth doesn't make this better-burger shop a better investment; investors would do well to avoid Shake Shack's stock.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.