Shake Shack (NYSE: SHAK) and Burger King owner Restaurant Brands International (NYSE: QSR) are headed in opposite directions. Shake Shack's stock is down 15% over the last 12 months as its larger competitor has risen 20% to trounce the broader market.
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Does that indicate Shake Shack is a better buy set for growth, or are investors making the smart choice to pick the steadier, more diverse QSR over the burger joint challenger? Shake Shack is known as a better-burger restaurant while Restaurant Brands International has Burger King, which contributed about 42% of the company's EBITDA (earnings before interest, taxes, depreciation, and amortization) in the second quarter, and Tim Hortons, known for coffee, breakfast, and other food items, which contributed the rest.
Let's take a closer look at the two companies.
Shake Shack vs. Restaurant Brands International
Revenue and sales growth over the last complete fiscal year. Source: Yahoo! Finance and company financial filings.
On growth trends and potential, Shake Shack is the clear winner. Revenue spiked higher by 36% in fiscal 2015, and that pace has only accelerated so far this year (sales are up 41% through the first half of 2016). In contrast, Restaurant Brands endured flat overall sales last year and has seen its revenue slip by 1% in the last six months.
Shack Shack's recent growth has come mainly from its expanding store base and not from a boost in sales at existing locations. Comparable-store sales rose by 4.5% last quarter (versus 13% in 2015), a modest pace that executives see continuing for the full year. Restaurant Brands is growing at a slower clip, with Burger King's comps up 0.6% last quarter as Tim Hortons' rose by 2.7%.
Usually, the key growth metric to follow for restaurant chains is comps, since customer traffic gains at existing locations make the business more profitable and demonstrate that the brand is deepening its appeal. In this case, though, investors have to consider the vastly different outlook for an expanding footprint between these two companies. Restaurant Brands is boosting its global store count by less than 4% on a very large global base (over 19,000 at last count). Shake Shack, meanwhile, grew to 95 restaurants in operation at the end of the second quarter, for a 33% increase over the prior year.
Profits and cash returns
Shake Shack last quarter set an important profit milestone, with its restaurant-level operating margin rising to 31% of sales for the first time, up from 30% a year ago. CEO Randy Garutti credited strong customer traffic driven by popular product launches, including a bacon cheddar burger and staple chicken sandwich, for that win.
Image source: Getty Images.
Investors haven't seen the improving finances exactly surge down to the bottom line, though. Shake Shack's 3% profit margin is far from QSR's 13%, and even further from market leader McDonald's (NYSE: MCD), which is around 19%.
Investors can expect Shack Shack's profit to be subdued for the foreseeable future as store opening expenses soak up a substantial portion of earnings. Management's aggressive plan to plow cash into building out its store base (including by adding 18 locations this year, up from an initial target of 16) means that there won't be as much left over for shareholders until that process is complete. Despite having similar food and labor costs, the company's operating margin is roughly one third of Restaurant Brands' 35%. It also isn't likely that Shake Shack will initiate a dividend that's comparable to QSR's 1.4% yield -- let alone McDonald's 3.3% -- at least until it has finished building out its store base.
Shake Shack stock looks expensive on a price-to-earnings basis, but that metric is inflated by the company's heavy expansion spending. Things look more reasonable when you judge valuation against revenue: Investors can own the stock for less than three times the past year's sales, compared to over five times for Restaurant Brands and four times for Mickey D's.
That pricing gap makes Shake Shack the better option over Restaurant Brands International right now, in my opinion, given its healthy sales growth, premium branding, and improving profitability. Investors who buy here should understand that they aren't purchasing an established brand and so a bumpy ride is likely as it will take years of unsteady expansion before the burger joint chain can start producing consistently strong profits.
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Demitrios Kalogeropoulos owns shares of MCD. 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.