Is Shake Shack Inc. a Buy?

Shake Shack (NYSE: SHAK) has lots of opportunities to expand by adding more locations, but it's going to struggle to increase same-store sales at existing locations as it gets bigger.

That problem was evident in its most recent earnings report. The company saw its total revenue rise by nearly 30% to $94.6 million, with sales up 26.8% to $91.1 million. The problem is those increases occurred only because it added restaurants -- same-store sales dropped by 1.6%.

Shake Shack can grow. It can make more money and it can continue to have a devoted fan base. What it's going to struggle to do is make more money at its existing locations, and that's going to act as an anchor on its stock price.

What's wrong with Shake Shack?

Shake Shack has a solid, profitable model, but investors tend to reward same-store sales increases. The burger chain, which has both licensed and company-owned stores, has struggled in that aspect. It expects a full-2017 sales decrease of between 1.5 and 2%. That follows a third quarter during which average weekly sales for domestic company-operated Shacks decreased to $91,000 compared to $103,000 in the third quarter of 2016.

The company blamed that on "the addition of more Shacks at various volumes into the system" in its third-quarter earnings report. That's a major red flag, because it shows that as the chain expands it actually loses something: it becomes less special, and that undermines some of what has driven customers in.

That's an inevitable part of growth, but for Shake Shack the problem may be bigger. In a market where better-burger chains have become common (Five Guys, BurgerFi, In-N-Out, etc.), maintaining a bit of mystery was good for Shake Shack and drove bigger orders when customers finally happened upon one.

Once Shake Shack moves into the neighborhood, most people realize that the chain is not that special. It has good but not spectacular burgers, and solid shakes/frozen treats. It's a good chain, way better than traditional fast food, but not dramatically different from some of the chains mentioned above.

Shake Shack has a plan

If you can't increase same-store sales, removing cost can improve profits. That's something CEO Randy Garutti touched on in his remarks in the Q3 earnings report.

"We continue to innovate and learn through our ever-increasing use of technology in the overall Shack experience, demonstrated most recently with our cashless, kiosk-only, and new kitchen design at Astor Place in New York City," he said. "This Shack is the representation of our relentless focus on excellence, experience, and hospitality through innovation, and you will continue to see more of this from us in the years to come."

Shake Shack is not a buy

As the chain gets bigger it will not only cannibalize existing locations but also see less spending per visit. As it becomes more common to visit the a Shake Shack, customers will stop feeling justified in adding a shake to their burger and fries order.

That would be fine if increased locations led to more visits, but that doesn't seem likely to happen. Shake Shack remains an indulgence -- both in price and calories. Consumers will probably visit about the same amount while spending less when a Shack opens near them.

This is not a bad company. As a private business, it would be a very solid investment. As a stock, however, it's going to struggle, because same-store sales are likely to continue to decrease. The chain should be able to handle that, and there will be a bottom that's still profitable, but this is a company where more locations have proven to be less for investors.


Daniel B. Kline has no position in any of the stocks mentioned. The Motley Fool is short shares of Shake Shack. The Motley Fool has a disclosure policy.