Investors became more cautious about Shake Shack (SHAK 2.79%) stock after the restaurant chain's surprisingly weak third-quarter results were released in early November. That report included a few warning signs on both the top and bottom lines, with sales growth slowing and costs spiking.
This week, the "better burger" specialist demonstrated that the worst isn't yet behind the business, which is struggling to stand out in a competitive fast-food industry.
Let's take a closer look at the key fourth-quarter operating trends.
Image source: Getty Images.
Sales trends worsened
The chain's third-quarter report suggested investors might be in for a bumpy ride, but growth trends were still worse than expected. Comparable-store sales sank back into negative territory to almost completely reverse Shake Shack's encouraging first-half gains. Comps were down 4% after rising 2% last quarter and jumping 4% in the fiscal second quarter.
The main factor behind the slump was customer traffic, which dove 5.4%. Shake Shack had enjoyed positive results on this metric through most of 2019, making it stand out against rivals like McDonald's. Management cited several reasons for the negative swing, including a challenging comparison with the prior year, fewer limited-time menu offerings, and the potential cannibalization from new stores launching in existing markets. Shake Shack also continued to struggle with its transition to an exclusive delivery partnership with Grubhub. Overall, comps rose by just 1% for the year while McDonald's increased 6%.
Financial pain
The news wasn't any better on the financial side of the ledger. Average sales volumes continued declining, falling to $71,000 per week from $81,000 a year ago as the store footprint continued shifting away from high-volume metro areas like New York. The company barely broke even on an operating income basis thanks to higher costs on food, paper, labor, and the delivery rollout. Shake Shack's adjusted profit margin fell to 22% of sales for the full year from 25% in 2018.
Executives chose to stress the chain's robust store expansion, saying in a press release that the 73 new restaurant launches represented "our largest class of Shacks ever." CEO Randy Garutti said these openings were especially encouraging in countries like China, Mexico, and the Philippines. The success of the licensed locations was "a reminder of the global strength and potential of the brand," he said.
Looking ahead
Garutti and his team projected a 2020 fiscal year that looks more like the end of 2019 than the encouraging beginning. Comps should decline overall even as new store openings push consolidated sales higher. A busy year for new menu launches is expected to help attract more diners.
Operating profit margin likely won't budge from the 22% level, meaning it could be some time before that metric starts climbing back toward the 27% rate that investors saw in 2017.
Average annual sales volumes should continue decreasing, to roughly $3.8 million from $4.1 million last year and $4.4 million in 2018. Management is betting that these worsening financial metrics will be more than offset by Shake Shack's bigger sales opportunity. Yet the case for aggressive global expansion looks weaker in the context of falling customer traffic at the restaurant's existing locations.
