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Why 2017 Was a Year to Remember for Shake Shack Inc.

By Demitri Kalogeropoulos – Jan 17, 2018 at 8:45AM

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The better burger chain bulked up its store base, which helped sales spike despite weak customer traffic trends.

By the time Shake Shack (SHAK -2.28%) officially closes the books on fiscal 2017, the burger chain will have added 25 stores to its sales base to mark its fastest expansion rate yet. It faced a few serious challenges during the year, including a stubborn customer traffic slump at existing shacks. But, overall, Shake Shake made solid progress toward achieving national scale in a brutally competitive industry.

Sales growth through store expansion

There's no denying that Shake Shack stumbled in its comparable-store sales growth, a critical metric by which restaurant chains measure their operating strength. Management initially projected a 2017 comps improvement of 2% to 3%, marking a slowdown from the prior year's 4% boost.

But executives lowered that outlook on two consecutive quarterly outings -- first to a flat result, and then to a decline of 2% to 3%. Shake Shack now expects to book its first negative comps result on record, and that slowing trend stands in sharp contrast to industry giant McDonald's (MCD 0.65%), which grew at a 6% or better rate through most of the year.

A man takes a bite of a burger.

Image source: Getty Images.

Yet Shake Shack's store base isn't anything close to the 36,000 locations that the burger titan operates (there were just 39 shacks in early November), and so its physical expansion rate is its main sales and profit driver.

Things proceeded better than expected by that measure. The company is on pace for 25 new store openings for the year, or a bit more than the 22 it had initially projected. That growth has sent sales up 35% over the last nine months, while McDonald's revenue has dropped 6%.

Profits and 2018 outlook

The profit picture worsened slightly during the year but held up well given the intense industry competition. Higher menu prices helped offset most of the extra cash Shake Shack had to dedicate toward labor costs and other expenses. Thus, profitability should stop at 27% of sales for the year. That's a bit lower than the 28% it managed in 2016, but it's still high enough that the chain doesn't have to worry about booking operating losses. Instead, Wall Street is predicting $0.52 per share of adjusted profit for the year, compared to $0.46 per share last year.

Shake Shack's stock raced higher toward the end of 2017 after investors got two pieces of good news about the business. First, CEO Randy Garutti and his team lifted their comps outlook as customer traffic trends improved to a 3.8% drop in the third quarter compared to a 4.3% decline in the prior quarter. Second -- and much more important to revenue growth -- Shake Shack raised expectations around its store expansion. The company now believes it can open between 32 and 35 new stores in 2018, versus 25 last year and 20 in 2015.

That increase would put Shake Shack at just under 200 locations by the start of 2019, but that's still less than half of the 450 restaurants that management believes the market will eventually support.

The better-burger upstart still has lots of work to do before it can realistically push for that national scale. Investors' immediate concern is around whether customer traffic trends keep strengthening to deliver a return to positive comps. If that doesn't happen in 2018, Shake Shack may have to downgrade its expansion hopes as management focuses on reconnecting with fast food fans and their frequently shifting tastes.

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

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