Shake Shack's Shake Up

Shake Shack SHAK released its September quarter earnings after-hours on Tuesday (November 4th), and traders ripped this stock down over 20% the following day. The report demonstrated a marginal top and bottom-line beat, but investors and traders were looking for any reason to sell after this stock's massive run-up this year.

There was very little to dislike about this earnings report except a small Q4 guidance slip in comparable-store growth and margins. The firm also said they would be temporarily closing some of its stores for renovations.

One of the critical issues that drove the softer than expected same-store growth guidance for Q4 is its decision to use Grubhub GRUB as its sole delivery service. This transition is expected to be fully integrated with Grubhub by Q4, and analysts are concerned that management is understating its guidance cut.

As of September, Grubhub is no longer the largest food delivery app, according to data analytics' firm Second Measure. They lost this title to Doordash, which has been prolifically building out its user base. Grubhub doesn't control some of Shake Shacks biggest markets like LA, Miami, and Dallas (which you can see from Second Measures figure below). This transition will have adverse effects on the company's digital sales.

The Growth Story

Shake Shack started as a small food stand in Madison Square Park and now has over 254 Shacks worldwide. This once lonely food vendor is now a publicly-traded stock, which has far outperformed the broader market this year, despite its significant share price drop today.

The stock was up over 120% YTD back in September and is now trading just over 47% after its ostensibly disappointing earnings. SHAK's run-up this year is a product of impressive sales growth and its attraction from retail investors who enjoy their product. The firm just entered the medium-cap range, which could have allowed this stock to hit specific portfolio parameters that allowed managers to buy.

Regardless of the reason this stock had seen an over 120% returns in 9 months, this stock had run-up beyond its intrinsic value. I believe that this break down was necessary to bring this stock back to reasonable valuations.

The Restaurant Space

The retail food & restaurant industry has traded down over 6% since the beginning of October, with some of America’s favorite restaurant stocks falling even further. I am concluding that this is at least partially a product of valuation concerns.

This sector is currently being priced at over 23 times earnings, which is substantially above the broader markets 17.7x. The largest downward movers include McDonald’s MCD, Chipotle CMG, and obviously Shake Shack.

Chipotle is the priciest burrito stock out there, currently trading at a 43x forward P/E. This has come down sizably from the over 50x forward P/E it was sporting before its Q3 earnings near the end of October.

CMG has had a similar 2019 rally narrative to SHAK, with gains of over 70%. Despite its positive earnings results at the end of October, the stock has tracked down. This share price slide was a product of valuations that had risen too high, and the market is correcting.

Take Away

What you are probably wondering is whether or not this one day 20% share price plummet is a buying opportunity for SHAK.

Shake Shack has a proven business model illustrating high double-digit sales growth. The company is quickly expanding globally with over 55 new locations just this year (over 25% store growth), and the year isn't even over. The exclusive deal with Grubhub is a slight speed bump, but the demand for Shake Shack seems strong enough that this will not hinder consumers from getting their fix. I like this stock as a long term investment in the retail restaurant space.

As for the remainder of the restaurant space, I think this correction is a positive sign for anyone considering a long position in one these stocks.

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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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