Investors panned the recent earnings report from Shake Shack (NYSE:SHAK) after the fast-food upstart injected volatility into its short-term sales and earnings outlook. The company said last week that, while its longer-term growth plan is intact, home delivery challenges are pressuring market share. Expenses are soaring, meanwhile, even as the company loses efficiency by expanding outside of the high-volume areas in and around New York.
These issues were front and center in a conference call that CEO Randy Garutti and his team held with investors following the earnings announcement. Below, we'll look at a few of the main points that Shake Shack wanted to get across to shareholders in that presentation.
Lowering the bar
Our results to date combined with the expected volatility from our delivery transition are reflected in our year-end same-Shack sales guidance of approximately 1.5% for the year. With the uncertainty around the short- to mid-term financial impact of our delivery transition, there remains more inherent risk in our fourth-quarter performance than would typically be the case at this stage in the year.
-- CFO Tara Comonte
Shake Shack's overall sales met management's expectations, thanks mainly to the 35% increase in the store base. Revenue at existing locations was sluggish, though, with comparable-store sales rising just 2% compared with 3.6% last quarter. McDonald's, by comparison, reported a 5% increase in the U.S. for the period.
The restaurant chain's executives said the slowdown was driven by its switch to an exclusive delivery partnership with Grubhub (NYSE:GRUB). That move required ending its offerings tied to other aggregators like Postmates and DoorDash, which in some regions had better pricing and a faster delivery network. Ending those affiliations put Shake Shack at a disadvantage that management sees affecting results next quarter and into 2020, before the transition becomes an obvious net benefit to the business.
There are a number of new elements impacting our profitability this year, some shorter-term in nature, and some new costs directly related to the changing dynamics within our overall business.
Fast-food chains from McDonald's to Domino's to Dunkin Brands are enjoying rising operating margins this year as cost growth slows. Shake Shack's profitability is heading in the other direction, though.
Part of that decline is expected since the chain is naturally becoming less efficient as it expands to less populous areas of the country. Yet Shake Shack also reported rising costs for paper products, beef, chicken, labor, and its delivery transition. All of these moves contributed to a plunging operating margin that fell to 23% of sales from 25% a year ago. Executives said they're working to mitigate these headwinds, but they'll still result in a more steep margin decline this year than management had predicted just three months ago.
The next 200 stores
As the business has gained a strong foothold in major cities around the U.S. over the last few years, our forward focus is shifting to greater existing-market penetration.
Shake Shack is still on track to reach 200 U.S. locations by the end of next year, marking solid progress toward its ambitious long-term goal of 450 restaurants. Management's thinking is evolving on what those next 250 locations might look like, though.
For one, executives plan to pause on aggressive moves into new markets and instead focus on bulking up in its existing geographies. Increasingly, these new locations might be smaller-format stores in places like food courts, outlet malls, and airports. Many might be focused mainly on takeout and delivery. At the same time, management affirmed that it sees the brand continuing with a focus on being a seated restaurant and meeting place for fast-food fans. "We're committed to ensuring all our Shacks stand as the community gathering places they have always been," Garutti said.