Is Shake Shack Stock a Buy?

Restaurants have been crushed by the coronavirus, but does that mean Shake Shack is a good value at these prices?

This article was originally written by Billy Duberstein of The Motley Fool

With many stocks down 50%, 60%, or even 70% down from all-time highs amid the current market downturn, some might think of loading up on the stocks of their favorite companies. Certainly, many consumers love the burgers, shakes, and chicken bites from their local Shake Shack (NYSE:SHAK).

Shake Shack has been absolutely mauled by the recent downturn, with the stock down about 60% from the all-time highs set back in September. However, for those thinking of bottom-fishing, just because a stock is down that much doesn’t necessarily mean it’s a buy.

So should investors look to scoop up some Shack on the pullback, or are the burgers and fries still too hot to handle at these prices?

Shake Shack’s dire warning

Unfortunately, I think Shake Shack is still in for a tough run, as Shake Shack was a restaurant that has largely depended on having people come in to a physical restaurant. Though the company is expanding its digital offerings, it had actually endured some struggles on that front recently as well.

On April 2, the company announced that it had seen same-Shack sales plummet between 50% and 90% over the previous two weeks, with the average down 70%. This only counts Shacks that are open for to-go and delivery orders, and not counting the nine Shacks that have been completely closed. 

However, even before the COVID-19 outbreak, Shake Shack hadn’t exactly been hitting it out of the park. In the first two months of 2020, same-Shack sales were down 2%. That was actually an improvement over the fourth quarter, in which same-Shack sales were down 3.6%.

This can partially be explained by the company’s August decision to partner exclusively with GrubHub (NYSE:GRUB) for delivery, as opposed to using all the different delivery services out there today. Shake Shack chose to go this route to have better control of customer data, ensure a closer integration with its systems for just-in-time, faster delivery, and for joint marketing ventures with GrubHub. Apparently, trying to coordinate systems and marketing across the full swath of delivery companies was too complex.

While that may have been the correct long-term decision, near-term results have been impacted as the company is losing orders from these other delivery platforms. It remains to be seen if the long-term upside will in fact be worth the effort.

2019 saw margin compression

Another headwind going for Shake Shack is that its costs continue to go up in just about all aspects. In 2019, all of the costs within its restaurants went up as a percentage of revenue, including food and paper costs, as delivery requires even more in the way of paper packaging.

In addition, the restaurant industry continued to feel pressure from increasing labor costs. While many restaurants are now laying off workers, it’s also possible the government may insist on better salaries and benefit protections for restaurant workers beyond what they had before the crisis. Shake Shack also saw increasing occupancy costs and other operating expenses as the company invested in back-end technology.

Overall, that caused Shake Shack’s operating margin to fall from 6.9% in 2018 to 4.3% in 2019 – already a troubling trend, even before coronavirus. 

Despite the downturn, valuation is still high

Even without counting the severe downturn caused by COVID-19, Shake Shack still trades at 73 times its 2019 earnings, which were roughly flat from 2018. The most recent average analyst estimates anticipate that Shake Shack will post a net loss of $0.25 per share in 2020, and then just $0.31 in EPS in 2021. That means Shake Shack is still trading at 143 times its earnings roughly two years from now.

Of course, Shake Shack is a relatively small company that is set to grow handsomely in the decade ahead. Shake Shack sees a path for at least 450 domestic company-owned Shake Shacks, up from 162 today, with more international licensed shacks as well. 

However, growth costs money, and many new Shake Shacks won’t do the kinds of volumes seen in the company’s home-base New York City restaurants. Now that some of the growth may be delayed by a year or two, investors shouldn’t necessarily count on meaningful profit growth for the intermediate-term. That means that despite the big downturn in the share price, Shake Shack shares remain too expensive for me.

Of course, I also thought that before Shake Shack’s huge run earlier in 2019.

The bull case

Shake Shack does have its own loyal cohort of investors who can look through the near term and see the longer-term opportunity to add hundreds of shacks across the country and the world. That may eventually happen, but the road there will be long, and margins will be a question as the company negotiates labor costs, technology investments, delivery options, potential food inflation, as well as ever-resent competition.

So while my mind is open to changing on Shake Shack’s long-term opportunity, it’s still not cheap enough for my taste at the moment. Many restaurant stocks have rebounded recently, but I happen to think most were too expensive prior to the crisis. While most restaurant stocks are still down a lot after the downturn, the economic pain will be very real for them for at least several quarters, which still makes most restaurants too expensive for me in general. Shake Shack is no different.

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Billy Duberstein has no position in any of the stocks mentioned. His clients may own shares of the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.