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How Shake Shack Inc. Makes Most of Its Money

By Demitri Kalogeropoulos - Aug 27, 2017 at 5:14PM

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A closer look at this casual dining specialist's growing business.

Shake Shack (SHAK 2.27%) traces its roots to a single hot dog cart that operated in New York City's Madison Square Park in 2001. Today, the company owns more than 60 burger joints across the U.S. and is hoping to multiply that base many times over during the next several years.

Below, we'll look at the fast-growing casual dining specialist's main sources of sales and profit gains.

A man taking a bite of a burger.

Image source: Getty Images.

Expanding its store base

Established restaurant chains must rely on improving the sales they generate at existing locations to deliver growth. McDonald's (MCD 1.12%) 8% revenue boost last quarter, for example, came mostly from a 7% increase in comparable-store sales.

But Shake Shack's tiny physical footprint makes its store expansion far more critical to sales gains. Revenue spiked higher by 42% last year. That gain was almost entirely due to the addition of 20 new restaurants, though, which marked a 36% boost in the store count. 

Shake Shack has seen its restaurant base soar to over 70 locations from just 21 four years ago. Management's aggressive growth plans point to many more years of similar gains ahead. The company believes the market will eventually support 450 Shake Shacks, and executives plan to open at least 22 new stores each year to move toward that goal. 

The New York region

Shake Shack has a presence in 16 states around the U.S., including the California market it just entered last year. However, its footprint is heavily focused in the Northeast region of the United States, and specifically in the New York City metropolitan area. Shake Shack counts 19 restaurants in New York or about one fifth of the company-owned store base.

The concentration exposes the burger chain to risks that national rivals don't face. For example, winter storms that hit the Northeast would have a disproportionately negative impact on the business, as would even a small disruption in its New York or New Jersey distribution centers.

Looking ahead

Shake Shack needs to post healthy comparable-store sales results to provide support for management's claim that their branding, menu, and pricing strategies are resonating with customers. That success keeps the door open to continue the aggressive expansion pace that executives have targeted.

A hand holding a large cheeseburger.

Image source: Getty Images.

Improving comps also make existing locations more profitable, which provides added funding for the company's geographic expansion while boosting Shake Shack's long-term earning potential. It's a virtuous circle that goes from rising average sales volumes to a higher store count to sharply higher revenue and profits.

However, the chain's latest operating trends don't paint a rosy growth picture. Customer traffic slumped by 4% last quarter, compared to a 2% increase for McDonald's. Rising menu prices helped offset some of that decline, but Shake Shack's overall comps still fell 2% last quarter.

Shake Shack CEO Randy Garutti and his executive team lowered their sales growth guidance in early August and now expect comps to fall this year as the company posts its second straight year of reduced operating profit margin.

The good news for the business today is that rising prices are helping sales volumes tick higher at existing locations. As a result, management recently increased its 2017 store opening target to between 23 and 24 restaurants.

Still, until comps trends can at least match the broader industry, Shake Shack won't have the financial resources or the operating momentum required to move out of its regional focus and achieve the national scale it needs to challenge the restaurant titans.

Demitrios Kalogeropoulos owns shares of McDonald's. The Motley Fool is short Shake Shack. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Shake Shack Inc. Stock Quote
Shake Shack Inc.
SHAK
$53.11 (2.27%) $1.18
McDonald's Corporation Stock Quote
McDonald's Corporation
MCD
$262.18 (1.12%) $2.90

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