Shake Shack, the New York City burger chain that began with a single location in Madison Square Park, recently filed for a $100 million IPO. Since 2010, the company has grown from 7 locations to the current 62 company-operated and licensed "shacks" worldwide. The company's S-1 filing reveals a lot about its financial status and how it stacks up to other players in the fast casual dining industry.

Manhattan vs. Non-Manhattan Shacks

One thing to notice in detailed financials is how Manhattan-based Shack locations perform vs. those outside of the company's hometown. Manhattan-based Shacks report significantly better financials both from average unit sales ($7.4 million vs. $3.84 million in FY 2013) and Shack-level operating margins (31.2% vs. 20.8% in Q3 2014). The NYC locations have benefited from long lines that result from the city's dense population, high tourism traffic, and the inclusion of the company in many tourist must-eat lists (Yelp).

Without the same environmental factors, it's unlikely that the company's expansion Shacks will ever come close to meeting the financial performance of the NYC spots. Given a limit to how many more Manhattan Shacks the company can realistically build before cannibalizing its existing locations, we can expect that as the company grows, the Shack-level financials will average down toward the non-NYC locations.

*Shack- level Operating Margins account for Sales less Food and Paper expenses, Labor, Occupancy and Related Expenses and Other Operating Expenses. Source: Shake Shack S-1

Looking To Chipotle As A Guide

To help gauge Shake Shack's long term valuation, it helps to look at other players in the fast casual restaurant industry. Chipotle Mexican Grill (NYSE:CMG), a leader in the space, can be a good point of comparison when looking at Shack's potential market. With annual revenues of $3.2 billion in FY 2013 (as reported in it's 2013 10-K), Chipotle currently has a market cap of $21.3 billion and trades at a P/E of around 53.

While Chipotle's operations dwarf Shack's financial metrics, there are many useful parallels in the two companies. Chipotle also reports restaurant operating margins, with these figures coming in at 26.6% of revenue. Current restaurant operating margins for Shack are a little higher at 29%, but as we've already discussed, should be expected to fall as the company expands into more non NYC locations. Over time, the two chains' operating metrics will begin to look similar to one another.

CMG can also act as a guide for how the financial breakdown of Shack's business model will shift over time. Investors looking at Shake Shack's S-1 filing will be immediately struck by the company's overall operating income and net income figures. Corporate-level operating margins (accounting for overhead costs like General and Administrative Expenses, Depreciation and Pre-opening) were only 7% of revenue in FY 2013 and 5% for the first three quarters of 2014. This is clearly far inferior to the 16% operating margins that CMG experienced in FY 2013. This has a dramatic impact on the company's overall profitability, reporting net income in 2013 of only $5.4 million and in the first three quarters of 2014 of $3.5 million.

What investors should look at is how these figures should shift over time. Many of the company-level costs can be attributed to Shake Shack's aggressive growth plans putting it in a different stage than Chipotle. General and Administrative costs currently account for nearly 15% of all revenue compared to 6% at Chipotle. As the burger chain continues its expansion efforts, we should not expect these costs to rise linearly with revenue. Over time this means higher margins and overall profitability. Similarly the Pre-opening costs are another big contributor to the company's expenses at 5% of overall revenue. Expect this too to decrease with time. 

All About Expansion and Growth

Pre-filing rumors have floated around the idea of a $1 billion valuation for the company. This would give the company a P/E ratio of 150-200x depending on how Q4 2014 turns out. Using such benchmarks and making a comparison to established players is unfair and would make such a valuation appear overly expensive. The financials illustrate a restaurant business still quite early in the growth stages of its business life cycle. Over time as Shake Shack expands its location base, the corporate level expenses that weigh down the company's overall profitability should become more in line with others in the fast casual industry.

Focusing on the company's current financial situation also misses the broader point about the company's potential. Investors interested in the Shake Shack IPO and the company's prospects should really be looking toward the total market opportunity it could gain over the course of the next 5 to 10 years. With the ubiquity of burgers as a meal item, there's little reason to think that Shake Shack is anywhere close to reaching its total addressable market. The 62 current locations is only a drop in the bucket when you consider that Chipotle ran 1,698 restaurants worldwide at the end of September 2014 (10-Q). Given the similarities in the restaurant operating metrics, there is still a large opportunity for growth that could mean significant valuation upside for the company.