Investors looked past a worrying drop in customer traffic in 2017 to let Shake Shack (SHAK 3.61%) shares fully participate in last year's 20% market rally. They focused instead on positive news for the business, including the fact that increased menu prices are boosting profitability. A ramped-up store opening schedule is bringing management closer to their long-term goal of dramatically expanding their restaurant base, too.
With that big picture in mind, let's look at what investors can expect from Shake Shack's fourth-quarter earnings report due out after the market closes on Thursday, Feb. 15.
If there's one metric by which restaurant chains prefer to judge their operating health, it's comparable-store sales. And the outlook on this score isn't bright for Shake Shack. After all, the better burger specialist has trailed the industry's growth pace while missing management's expectations lately.
Executives entered 2017 targeting comps of between 2% and 3% to mark just a slight slowdown from 2016's 4% growth. Then that forecast was lowered on two consecutive quarterly outings, first to a flat result and then to a decline of between 2% and 3%. Shake Shack's outlook edged higher, to a decline of between 1.5% and 2%, back in early November.
Industry conditions didn't improve much over the last few months. Both Starbucks and McDonald's reported decelerating traffic trends recently, which generated comps of 2% and 5.5%, respectively. I'll be watching to see whether Shack Shack's business took a similar turn lower, given that it plunged by nearly 4% in the most recent quarter.
Because of its relatively tiny store base, unit growth plays a much bigger role in Shake Shack's results than it does for established chains like McDonald's. The nine locations it added to its footprint last quarter sent revenue higher by 27%. By comparison, Starbucks is hoping to grow sales in the high single digits for the foreseeable future. Mickey D's base is shrinking, meanwhile, but only because of its refranchising initiative.
Shake Shack is on pace to add 25 new locations to its base for the full 2017 year, which would translate into a 40% increase. CEO Randy Garutti and his team said in early November that their initial plans call for an even more aggressive 2018, with a record 34 stores set to be christened. We'll find out on Thursday whether management has become any more, or less, confident about that expansion plan.
Profits and outlook
Reduced customer traffic has been pressuring profits over the last nine months, and so has the fact that expenses are rising on everything from burger ingredients to wages. Those challenges have only been partially offset by higher menu prices, and so Shake Shack's profitability isn't expanding. Instead, restaurant-level margins are on pace to edge down to 27% of sales this year, compared with 28% in 2016.
Investors can expect volatility around these figures, but they're still worth watching. The longer-term picture is more important, and that shows a solidly profitable business, with average weekly sales holding steady at about $96,000 per location, which translated into $73 million of operating income per unit in 2016, up from $27 million two years prior.
Shake Shack aims to operate as many as 450 locations over the long run, compared with the 143 it had in place as of the end of the third quarter. Garutti isn't likely to change that aggressive expansion target next week. However, if sales at its current restaurants keep shrinking, investors might doubt whether the industry can support all those new burger joints.