What happened
Shares of Shake Shack (SHAK -0.45%), which owns fast-casual burger restaurants with the same name, opened sharply lower on Friday following the company's fourth-quarter 2021 earnings release.
There was good news and bad news to digest, and investors started the day with a negative bent on things. That said, the shares managed to recover from the early 14% drop as the day wore on. By roughly 2 p.m. ET today, the stock was off by just 3% or so.
Image source: Getty Images.
What investors really need to ponder here is the long-term outlook versus the short-term future. For example, while Shake Shack managed to beat Wall Street consensus estimates on the top and bottom lines, normally something investors cheer, it didn't provide a full-year 2022 outlook. And the guidance it gave for the first quarter of 2022 wasn't particularly good, with sales expected to be below what was achieved in the fourth quarter. The culprits here, the coronavirus and inflation, are no surprise. It is understandable that investors would be wary given the uncertain backdrop today.
The long and short of it
That said, there's another current here that you can't ignore. Shake Shack is a modest-size restaurant chain that is in expansion mode. For example, it opened 19 new locations in the fourth quarter of 2021. For a company like McDonald's, with a $187 billion market cap, that would be a rounding error. But for Shake Shack, with its $3 billion market cap, that's a pretty impressive increase. It ended the period with 369 locations, so the 19 new openings represent a nearly 5.5% increase in the quarter.
For the full year, the company increased its store count by 58 locations, or around 18.5%. That's material growth, and it was achieved during a global pandemic.
This is actually more positive than it seems. Mom-and-pop restaurant chains have been hit particularly hard by the coronavirus and have been shutting down. That's left strong real estate vacant for chain restaurants, like Shake Shack, to step in and open in desirable locations that weren't available before.
To be fair, as management's guidance pointed out, there's still a great deal of uncertainty on the customer-demand side due to the coronavirus. But the company had record systemwide sales in the fourth quarter of 2021, so it is still moving solidly forward with growth and perhaps with a property backdrop that is more positive than it at first appears.
Add to this the fact that many of Shake Shack's most profitable locations are in big cities that are still struggling as people continue to work from home instead of commuting to the office. That's a clear negative today, but if you assume that cities like New York eventually start to pick up again, then Shake Shake could see a return to more-normal operating levels at these locations. That would be a big positive for its revenue and earnings on top of the growth that's being driven by new store openings.
The fly in the ointment
The interesting thing, if you are a bit of a business geek, is that the sales growth here from new restaurant openings, despite the ongoing pandemic headwinds, highlights one of the most complicated things to understand about small, fast-growing restaurant chains.
There's a tightrope that management has to walk between same-store performance and store openings. The big risk is that so many new stores are opened that the new locations start to cannibalize existing locations. This happens time and time again, often because public companies are trying to appease Wall Street's demand for rapid growth. It's not a good outcome and hints that a restaurant company's stock might not be worth owning.
The problem right now for investors in Shake Shack is trying to figure out the difference between the pandemic headwind and the risk that the chain is growing too quickly. Given the fourth-quarter results, it seems that the pandemic is the bigger problem right now.
And that suggests that, assuming the world eventually goes back to some semblance of normal, Shake Shack could again be a Wall Street darling as it continues to successfully expand its business footprint. That is, of course, once the pandemic is in the rearview mirror.
