Shake Shack Inc. Stock Is Getting Too Cheap to Ignore

It's been a wild ride in the year since Shake Shack (SHAK 0.34%) debuted on the public markets.

After shares sold for $21 in its IPO, investor euphoria sent the high-end burger chain all the way to $95 last May before it came back within the market's gravitational pull. The stock closed out 2015 near $40, but has already lost 20% so far this year amid the broad sell-off, which has hurt growth stocks more than others.

At $31, Shake Shack is at a post-IPO low, which offers an excellent entry point. Though it may seem ridiculous to call a stock with a triple-digit P/E ratio cheap, price is always relative to value, and Shake Shack offers tremendous long-term potential. Let's take a look at few of the factors that could turn this stock into a multi-bagger.

Earnings are going through the roof
There's a pattern emerging in Shake Shack's earnings reports.

Source: Yahoo! Finance

During each of the company's three quarters as a publicly traded company, it has trounced earnings estimates. Analysts keep underestimating the growth story here. Same-store sales are up double digits thus far in 2015, and there are plenty of reasons to think the company will blow past analysts' estimates of $0.07 a share for the fourth quarter. 

Analysts expect revenue to decline sequentially from Q3 by 6% despite new restaurant openings in Q3 and Q4. For comparison, last year revenue jumped 10% from Q3 to Q4, and Shake Shack added four domestic company-owned Shacks in Q3 and two more in Q4.  Those new openings should ensure revenue improves over last quarter. 

Analysts have bumped up their forward estimates with every new report, but their long-term projection signals earnings growth nearly screeching to a halt. The consensus is for EPS to grow from $0.32 in 2015 to just $0.39 in 2016 and only $0.50 by 2018. Considering the popularity of the brand and its new store openings ahead, it's possible Shake Shack could post a $0.50 per share profit in 2016. At the very least, it should be well ahead of that figure by 2018. 

New stores are killing it
Shake Shack has already raised its long-term guidance for new store openings from an annual minimum of 10 to 12, and its new locations are doing better than expected. In its most recent quarter, average weekly sales increased 9.6% to $103,000, indicating that new locations are not bringing down the chain's overall performance. Management had warned in its prospectus that expanding outside of New York would lower average unit volumes, but that has not been the case. It specifically cited strong performances from new openings in Las Vegas and Chicago, and the honeymoon effect the brand produces is so strong that new stores tend to produce stronger sales in their first year than their second. 

A new Las Vegas location is one of many that has outperformed expectations. Image source: Shake Shack

CEO Randy Garutti called the company's recent opening in Woodbury Commons, an outlet mall center about an hour from New York City, an "eye-opening success." The new restaurant is outside the chain's traditional environment of high-traffic, urban locations, and the success of the experiment could lead to the company expanding into new unconventional locations. Such a decision could also it to grow past its goal of 450 domestic company-owned locations.    

New menu items
The company recently went national with its new chicken sandwich, the Chick'n Shack. The item had been added to the menu at Shake Shack's three Brooklyn locations this summer and proved popular, winning rave reviews and selling out.

Last week, the company announced it would add the buttermilk-marinated sandwich to restaurants across the country. This not only expands Shake Shack's reach to customers who may not love burgers, but it should also help its profitability in the near term, as prices for beef have been much higher than those for poultry.

The sandwich's success  also paves the way for other menu additions, though considering it took Shake Shack two years to develop the Chick'n Shack, we may not see any for a while.

Plenty of brand equity
Shake Shack still has fewer than 100 restaurants globally, but it possesses the brand equity and awareness of much larger brands. Its social media presence is huge, with more Instagram followers than Wendy's (WEN -0.10%), a burger chain with more than 60 times as many stores. On a followers-per-store basis, there is no comparison with the major chains. Shake Shack has more than 3,000 while McDonald's Corp. (MCD 0.38%) has just 52.

This a unique story in the restaurant industry. Shake Shack has average unit volumes of $5 million, close to double those of any major restaurant chain, and it is more profitable on a restaurant-operating level to boot.

Part of the reason that the company's keeps crushing analysts' estimates is that management wants it that way. It has consistently provided conservative guidance in order to manage expectations, a familiar game on Wall Street, especially for growth companies that want to keep their stocks from overheating.

But even though Shake Shack shares have now gone from hot out of the fryer to ice cold, management's guidance for the fourth quarter still seems unreasonably low. It expects same-store sales to dive from 17% in the third quarter all the way to the 1% to 4% range in the fourth quarter, despite the impact of a 3% price hike at the beginning of 2015. In other words, the guidance indicates traffic could fall slightly, which seems unrealistic given the momentum from the third quarter.    

The same is true for 2016 guidance. With at least 14 store openings planned for next year, its domestic company-owned store base will grow by at least 33% in 2016. Same-store sales are projected to increase by between 2.5% and 3%, yet revenue is only projected to increase 26%. That ain't right. Unless the new stores woefully underperform and second-year store sales tank, the stock will blow by that sales guidance. The nationwide rollout of the Chick'n Shack should also help juice comps.

Wall Street will wake up at some point, but until then, look for the earnings to keep racing past analysts' estimates. Eventually, the share price will follow too.