Is Shake Shack Inc. a Buy?

Shake Shack (NYSE: SHAK) is a young and very ambitious company. The "better burger" chain operator is undergoing an expansion program to widen its footprint considerably. However, recent fundamental weakness has sapped the value of its shares, which were on rocket fuel just after its 2015 IPO.

Just maybe, however, that decline makes the stock a buy. Let's take a peek under the bun.

A tray of Shake Shack burgers

Image source: Shake Shack.


Now isn't the ideal time to be in the food service industry. The " restaurant recession " is still in effect; many chains have seen their customer counts and sales drop over the past two years or so.

Shake Shack has caught that bug. Its "same-Shack" sales (in its case, restaurants open for two years or more) fell by 1.2% in 2017. Although this wasn't as steep a drop as management had projected, it was still in the minus column. And that figure has been diving; in 2015, the metric grew by just over 13%, while the following year it rose by slightly more than 4%.

Meanwhile, other famous names in the fast-food and fast-casual segments managed to increase their comparable sales recently, in spite of the overall industry slowdown. Chipotle Mexican Grill (NYSE: CMG) posted a 6.4% rise for 2017, while a resurgent McDonald's (NYSE: MCD) saw a 5.3% improvement.

True, Shake Shack has continued to deliver impressive revenue growth; the top line for all of 2017 advanced by 34% to just under $359 million. Yet if we peer behind the counter into the kitchen, we see this isn't as hot as it appears to be. A great deal of that growth came from newly opened restaurants -- those same-Shack numbers tell a truer story.

On the bottom line, adjusted net profit rose by 25% to $21 million. That's a juicy percentage, but it's much lower than in the two previous years.

It's encouraging that the company is ambitious in its growth plans. Its restaurant count stood at 159 at the end of 2017, well up from the 114 the year before. By 2020, it aims to double the former count.

But we should keep in mind that Shake Shack started from a core of restaurants located within dense urban areas such as its first location, New York City. It's now fanning out to less populous sites. That's one reason the average annual revenue for the company-owned stores was down in 2017, to $4.6 million from 2016's $5.0 million.

We should also consider that tastes and trends are fickle in the restaurant business. Up to and a bit after its IPO, Shake Shack was a hot place to eat, and its stock reacted accordingly. When a location opened near me in the micro-city of West Hollywood almost two years ago, it was impossible to get near the place for months. Nowadays, at certain off-peak times there's barely a line.

Meanwhile, the "better burger" concept isn't unique to Shake Shack, and others are piling in. The upcoming switch at McDonald's to fresh, rather than frozen, beef for its meat patties in around 14,000 of its locations should worry Shakies; it narrows the quality gap between the upstart and the fast-food veteran.

Skip the meal

Shake Shack's strategy to grow by building is a sensible one. It will certainly lift the top line and, assuming costs are managed reasonably well, profitability. Yet even with its recent share price weakness, the stock price remains quite rich in relation to the company's anticipated growth. It trades at a five-year forward PEG ratio of 4.9, while popular foodies Chipotle (1.7) and McDonald's (2.4) are far cheaper.

Also, I'm not yet convinced that Shake Shack as a concept has legs. America has been over-burgered these past few years, and there's plenty of competition in the upscale patty segment. On top of that, I doubt the company will significantly build out its international presence anytime soon.

Lastly, while the company's restaurants have a cool look and an appealing menu, it's not really exploring new culinary territory -- burgers in general feel like yesterday's retro food trend to me. Therefore, I wouldn't say the company's stock is a compelling buy just now.

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Eric Volkman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. The Motley Fool is short shares of Shake Shack. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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