Even companies with great products have to worry about inflation. With the latest print of the Consumer Price Index (CPI) coming in the hottest (e.g., the most inflationary) since May 1981, it's past time to figure out how rising prices might affect demand for some of the most popular products.
When Americans pinch pennies, you would expect value-driven offerings like Walmart, McDonald's, and Dollar General to benefit. On the other side of that equation is trendy burger joint Shake Shack (SHAK 4.81%). The company is already feeling the effects of an overheated economy. The stock is down more than 50% from its highs. If that doesn't change, shareholders could be in for more trouble ahead.
Image source: Getty Images.
Sagging margins is not a new trend
Profitability has been declining for years, even before the pandemic and certainly before the recent spike in prices. In 2018, management cited increased labor costs as one reason for declining profit margins. In 2019, it cited higher commodity costs -- especially beef and paper -- along with increased staffing levels as key contributors to another decline in margins.
A global pandemic made 2020 a poor comparison for any period in the past century. Yet in closing 2021, management once again cited labor and commodity inflation as holding back profit margins. In an attempt to offset the impact, Shake Shack raised prices last October and again in March. The blame for crimped margins is certainly warranted. But it's not new for the company to have expenses outpace sales growth.
SHAK Revenue (TTM) data by YCharts
Productivity has also been declining
A good way to strip away the impact of higher input costs is to figure out if the company is getting more productive. Revenue per employee is one way to measure that. Unfortunately, the picture here is no rosier.
Investors look for companies that scale -- that is, they're able to spend less for growth the larger it gets. Microsoft and Adobe write code and generally don't need to hire more employees regardless of how many people buy the software. It's easier for software, but not isolated to that industry. Costco has been increasing sales per employee for three decades. It's a bit trickier for a restaurant.
Opening new restaurants still requires cashiers, people to prep the food, and drivers if you offer delivery. For Shake Shack, the metric has been headed in the wrong direction for a while.
SHAK Revenue Per Employee (Annual) data by YCharts
A tough road ahead
Management isn't giving many clues about the year ahead. COVID uncertainty has limited its visibility. The price increases will add up to between 6% and 7% on menu items. And the premiums added to orders on delivery apps will be up to 15% higher than in-store menu prices. That should blunt the impact if sales can hold up.
At some point, customers won't be able to absorb those kinds of price increases. And when they cut back, Shake Shack could be in the crosshairs. According to a recent CNBC survey, there are already signs that even high-income consumers are curbing travel and dining out. That should make shareholders very nervous.
