Shake Shack Inc. Is Pricey But Its Future Looks Delicious

By James SullivanFool.com

Source: Shake Shack

Shake Shack is a fast casual restaurant specializing in hamburgers, hot dogs, custard, and other traditional staples of roadside burger stands. It also happens to be the brainchild of one of New York's foremost restaurateur's Danny Meyer.

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Mr. Meyer has taken many of the hospitality lessons that he applies to his fine dining establishments such as Union Square Cafe and Gramercy Tavern and incorporated them into Shake Shack. By eliminating pastry chefs, linens, and cutlery, Shake Shack is able to provide quality products at a price point above traditional fast food but well below a full service dining experience.

Since the company's IPO in January of this year the stock has been a darling of some in the financial community while many others continue to scream that it's drastically overvalued. I believe in the long term future of the company and last quarter's results reinforce that belief.

Q2 results overviewShake Shack remains a growth story and needs to put up huge comparablesto even come close to justifying its valuation and it delivered on nearly every metric when it reported its most recent quarterly results -- revenue was up74.7% year-over-year, Shack sales were up 77.9%, and perhaps most impressive of all Same-Shack sales increased 12.9%. This report indicates that the company is successfully growing both through expansion of its store base and increased sales in its existing stores.

The company as a whole is growing revenues rapidly and is looking to add 12new domestic company-operated Shacks total in 2015, and at least that number in 2016 and beyond. While this may not seem like much, as other fast casual chainsare targeting location growth in the hundreds,it is rapid growth from a base of only 37 domestic company-operatedlocations as of July 1st 2015.

Forgetting about thelicensed stores for a moment, of which there are 5 in the U.S. and 29 internationally, let's take a look at just these domestic company-operated properties. At a market cap of around $2 billion, each of the 37 Shacks is currently valued at around $54 million. Those attempting to paint Shake Shack as an overvalued company use this argument to point out the absurdity of the current share price. But the number of these Shacks should double over the next 3 years and I think expansion efforts will ramp up from there. CEO Randy Garutti has indicated a goal to triple in 5 years with a long term goal of 450 domestic company-operated Shacks. At 12 new stores a year this would take over 34 years to accomplish. I don't think this is what management has in mind. Management recently upped their target from 10 stores a year to 12 and I am betting that the roll out to 450 will happen much faster than most analysts are expecting.

$100,000 a week not sustainable? Or is it?The company reported average weekly sales for domestic company-operated Shacks of $102,000 in the most recent quarter. This is an impressive number especially when considering the trajectory, up 7.4% year-over-year. Shake Shack must do itsbest to maintain these types of sales numbers even as it expandsoutside of New York City and into other areas.

On this point things seem to be progressingsmoothly. The company attributes the bump in average weekly sales to, "increased menu prices, favorable shifts in sales mix from menu innovation and strong performance from several Shacks opened in the latter half of fiscal 2014, includingLas VegasandChicago." The fears of this being a New York-centric business are overblown. There are plenty of untapped and underserved markets in theUnited States that will allow for the high volume that this company needs to continue to generate around $5 million in revenue per Shack. There are currently no Shacks in California, home to a number of major metropolitan areas, and only two in Texas, both of which are in Austin. Cities such as Houston, Dallas, Los Angeles, San Francisco, and Phoenix, all in the top-10 by population, have no Shake Shack locations.

Geographic proximity ... blessing or curseShake Shack has been an interesting case study about the value where a business is located. I think a lot of the IPO euphoria surrounding the company stems from Wall Street knowing and loving the product. This is the danger of living your investing life within a bubble. Chris Hill, host of the excellent Motley Fool Podcast "MarketFoolery," recently talked about driving through North Carolina and being amazed at how manyBojangles restaurants he saw. He imagined that living in North Carolina would make him more inclined to put that company's stock on his radar. As was discussed on the show this may or may not be a good decision.

The flip side of this risk is the added intelligence that proximity provides for an investor. Danny Meyer's brand of hospitality is widely regarded as the gold standard in NYC and it shines through in the Shake Shack experience, setting the locations apart from other burger chains. I think it's impossible to fully gauge the potential of Shake Shack without fully understanding the power of this culture.

It's possible that being in New York is giving me burger colored glasses when it comes to assessing Shake Shack as a stock. I think it's more likely that it has afforded me a bit of additional information that can't be gleaned from an annual report or 10Q but which can make all the difference in the world in an investment. I've eaten in many of Danny Meyer's other restaurants, see the euphoria and lines at Shake Shack locations throughout the city on a near daily basis, and understand that this isn't "just another burger joint." Its employees are happier, its food is better, and the overall customer experience is superior. Looking at the financials, it may appear similar to many quick service competitors, but its culture sets it apart. There is no place on an income statement or balance sheet for "leadership" or "strong culture" yet these have material impacts on a company's long term value. Seeing it up close is how an investor gets alerted to these strengths before the broader investing world.

Shake Shack's flavors certainly won't please every set of taste buds but if you have the appetite for a big growth stock and can stomach some volatility I'd recommend taking a deeper look into this wonderful business.

The article Shake Shack Inc. Is Pricey But Its Future Looks Delicious originally appeared on Fool.com.

James Sullivan owns shares of Shake Shack. 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.

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