Shake Shack Stock: Upgrading To Buy On Expansion And Marketing Plans (NYSE:SHAK)

Back in August, I placed a “Hold” rating on Shake Shack (NYSE:SHAK), saying while the company’s long-term outlook looked solid, there were some near-term headwinds it had to deal with first. The stock is up about 10% since then, pretty much in line with the S&P over the same period.

Company Profile

As a reminder, SHAK owns and licenses its upscale quick service restaurants in the U.S. and international. The company is best known for its high-end burgers, but it also sells other items such as milkshakes, chicken sandwiches and bites, fries, hot dogs, and frozen custard. It also serves alcohol in some locations.

At the end of Q3, the company had 495 locations. It owned and operated 280 restaurants in the U.S., while licensing 39 domestically. It also had 176 international licensed restaurants locations across the globe. SHAK receives initial territory fees, opening fees, and ongoing sales-based royalty fees from licensed restaurants.

Opportunities and Headwinds

When I first wrote about SHAK in August, I was worried about the impact of prices rolling off and the macro environment. Thus far any worry about the macro environment have thus far been unfounded. The U.S. economy has continued to chug along, despite inflationary pressures and white collar layoffs in fields like technology.

Restaurant sales, meanwhile, have continued to be strong. December marked the 10^th straight month of sales growth for the industry, as consumers still focus on experiences more than goods coming out of the pandemic. Even after adjusting for inflation, industry sales are up 4.2% over the past 10 months.

The fourth quarter, which has yet to be reported, meanwhile will mark the transition from high-single digit price increases to more traditional low-single digit price increases. Despite that, same-store sales were up a solid 3.5% to start the quarter in October. The company also reiterated its Q4 guidance in December that its same-restaurant sales would be up low single digits in Q3.

However, the company isn’t completely standing still on price increases. In mid-January, SHAK confirmed that it had enacted a 5% increase on prices for third-party delivery. The prices on third-party delivery apps will often be higher, as restaurants look to offset the cost charged by these firms. Delivery has been a nice growth driver for the quick service industry, and consumers thus far have been willing to pay the higher menu prices for the added convenience of third-party delivery.

While these potential headwinds have largely gone by the wayside, others have popped up. One of the biggest is food inflation, especially with regards to beef. Beef makes up between 25-30% of its total food costs, and is expected to see a mid-teens cost increase in Q4.

Beef prices are expected to stay elevated in 2024 due to supply/demand dynamics. While consumer appetites for beef have not waned and increased following the pandemic, the number of beef cattle has. Meanwhile, it takes years to increase the herd.

Rising minimum wages also continue to be an industry headwind. Twenty-two states raised their minimum wage in 2024. California fast-food workers, meanwhile, were see their pay increased to $20 an hour in April for companies with more than 60 locations in the U.S. California is home to about 44 Shake Shacks, about 13% of its locations.

On the positive front, expansion is still a big driver for SHAK. In 2023, the company opened about 40 new company owned locations and licensed another ~40. It’s projecting opening a similar amount of both in 2024. The company doesn’t even have a presence in 17 states, and there is still a lot of in-filling opportunities in states it is in currently. I think the company could ultimately support between 1,500-2000 U.S. locations. Just in California, I think it could increase its locations by 8x based on the number of In-N-Out Burgers there are in the state.

Technology and kiosks was another area I pointed out as a driver in my original article, and on that end the company has delivered. It has rolled out kiosks to nearly all its locations. This helped improve its margins by 400 basis points last quarter.

Increasing marketing in the restaurant industry is a big theme entering 2024, and SHAK is no exception.

Speaking at a Morgan Stanley Conference last month, CEO Randall Garutti said:

“The challenge is we’re not big enough for the Shake Shack TV commercial on the Super Bowl. We just don’t have enough doors to take back that investment. But we need to market more. We’re widely geographically dispersed. And there’s a lot of people who don’t know [SHAK]. One of the things that always amazes us in certain places, we know we have a lot of work to do to build true brand awareness and trial. There’s more people than we think that don’t know what a Shake Shack is or are entrenched in their local habits or burger or whatever. So, what’s been most successful and what are we leaning into now. First of all, we’re going to increase our marketing funds. You should expect to see that this year, into next year. That will happen in as many directed personalized marketing channels as possible. Really strong performance marketing, return on ad spend. We’re seeing really good returns there. … And from time to time, we may try connected TV and localized places. If we have a region of the country where we know we need to build brand awareness, we may try really popping up with directed performance marketing and personalized marketing. So you’re going to see more in our channels and all our digital channels in ways that we need to increase the brand. So I think as we look ahead in the next 3 to 5 years, we should be looking to continue to increase our marketing spend in smart ways where we see return.”

This looks like a smart plan. SHAK has some great brand awareness in areas like New York, where it first started, but there are other areas where the brands isn’t as well known. Companies like rival McDonald’s (MCD) have long been marketing masters, so there is no reason that SHAK cannot pick up its game in the marketing demand given its size.

Valuation

SHAK stock trades at nearly 23x the 2024 EBITDA consensus of $153.7 million and nearly 19x the 2025 EBITDA consensus of $186.1 million.

From an EBITDAR perspective, it trades at ~15x 2023 numbers and ~12.5x 2024 numbers.

It’s projected to grow revenue 15% this year and next.

SHAK trades at a premium to traditional burger chains, but at a discount to faster-growing QSRs.

Given its growth I value the company around 15x 2025 EBITDAR of about $276 million. That would be around $95.

Conclusion

While SHAK does face some headwinds with beef costs and minimum wage, I still think it has one of the better expansion stories in the quick service industry. It’d done a nice job on the margin front, helped by its kiosk investments, and I think it has room to draw in guests through marketing.

The company will be looking for a new CEO this year, but current CEO Randy Garutti will stay on till one is found and help with the transition. This is an attractive job, so I expect the company to be able to hire a top-notch candidate.

Given my favorable long-term outlook, I’m going to upgrade the stock to “Buy” with a $95 price target.