Restaurant Industry Weakness Catches Up to Shake Shack Inc

By Motley Fool Staff Markets Fool.com

In this video, theMarket Fooleryteamturns their attention to Shake Shack(NYSE: SHAK)and its fourth quarter and full-year fiscal 2016 earnings results. On the surface, top line growth was impressive, but a closer look at the numbers proved to be necessary.

Continue Reading Below

Is the market still too enthusiastic about this burger upstart? Or should investors just be happy to see growth at a time when most of the restaurant sector is feeling the pinch.

A full transcript follows the video.

10 stocks we like better than Shake Shack
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Shake Shack wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

Continue Reading Below

*Stock Advisor returns as of February 6, 2017

This podcast was recorded on March 2, 2017.

Chris Hill: Let's move on to Shake Shack.

Fourth quarter revenuegrew more than 40%, and that's great,until you realize that a lot of that, Aaron,is from new locations opening up. Theirsame-store sales, just 1.5%. That's not going to get it done.

Aaron Bush:Yeah, that'spretty normal, it seems, these days. Butwhen you realize that last year, it was 11%,that's a pretty substantial deceleration. I think, for the most part,this quarter it was pretty good. The top line was movingin the right direction. That is probably the number one thinginvestors would want to see. It's stillprofitable. They just launched a mobile ordering app,which is, I think, David and I were talking about,we wish some other companies would do that. So, they might be a little bit ahead of the game here,which is a good thing. Myissue with the Shake Shack ishow much optimism is basedinto the price.

Hill:There'sa little less optimism today.

Bush:Yeah,a little less optimism. But still, evencompared to a few months ago,it's still not that different.

David Kretzmann:It's 70 times earnings, still.

Bush:Yeah. So,when I see same-store sales dramatically decelerate, labor costs go up and squeezeoperating margins, franchisingisn't moving the needle, andthat's a big part of their strategy now internationally. Competition in the burger space isabout as rough as it gets. AndI think that as they expand,they'll have more issues standing out. But I think, perhaps,most importantly, there's a pretty wide discrepancy between what's priced into the stockand the economic reality. Just a few numbers, each store, on average, delivers $5 million in revenue. Butthe market is pricing each store at about $20 million. So,take that for what it's worth. That doesn't entirely include all of the licensing stores,but it's hard to do apples to apples on that. So, that'svery aggressive. If you look at the entire system,management has guided investors toexpect $1.12 in earnings per share by 2020,which is kind of specific. Butright now, Shake Shack is trading at 32 times that, andthat is expected to come in two or three years. That'saggressive, and it makes me a little hesitant.

Kretzmann:They did raise theirsales guidance for this year by 0.03%, though. Let's not overlook that.

Bush:Wow. Give them some credit.

Hill:I'm going to give them just a tiny bit of credit for that,because when you look at restaurants in general,I'm going to grade them on the curve in that regard.

Kretzmann:At least they're guiding higher.

Hill:Yes,ever so slightly higher, but higher nonetheless.

Kretzmann:Theopportunity here with the Shake Shack,right now, they just have 114 locations. Seems like a conceptthat could be quite a bit bigger than that. So I think that is part of the reasoninvestors are comfortable paying ahigher valuation. Some other things I really like withShake Shack that a lot of other restaurants are in this position,especially smaller concepts like this, they'realready free cash flow positive,they have almost $75 million in cash, and no debt. So, they'reable to open these new stores through their own cash. Theydon't have to go into debt,they don't have to issue stock. That's an attractive position, that's a similar position to whatBuffalo Wild WingsandChipotlewere in 10 years ago or so. But,certainly, the premium that Shake Shack is commanding today ... youneed to see some stronger performance within those locations. But you do have to give the company somewhat of a break,because restaurants have hada very difficult past couple years. But still, 1.5% comps isn't going to get the job done.

Hill:We weretalking aboutDomino's Pizzathe other day, andthe numbers that they've been putting up. I threw out the question,restaurants are struggling,is part of the reason that restaurants are struggling becausecompanies like Domino's Pizza aremaking it really easy for people not to leave their homes?

Kretzmann:Everyone who'sgoing to Domino's, yeah.

Hill:Right,that's the thing, they're getting Domino's to come to them.

Kretzmann:Yeah,because Domino's same-store salesin a quarter that has been brutal for most restaurants, even pretty solid concepts,Domino's same-store sales --

Hill:Over 12%.

Kretzmann:Yeah,incredible numbers. And that's an acceleration from the past couple years. So,restaurants need to take more notes from Domino's,because the streak that they're onis unbelievable.

Bush:That's domestic?

Kretzmann:That's domestic.

Aaron Bush owns shares of Chipotle Mexican Grill. Chris Hill owns shares of Chipotle Mexican Grill. David Kretzmann owns shares of Buffalo Wild Wings, Chipotle Mexican Grill, and Domino's Pizza. The Motley Fool owns shares of and recommends Buffalo Wild Wings and Chipotle Mexican Grill. The Motley Fool is short Domino's Pizza and Shake Shack and has the following options: short June 2017 $140 puts on Domino's Pizza. The Motley Fool has a disclosure policy.