Shake Shack Inc (NYSE:SHAK) stock is on quite a roll this week. The high-flying boutique burger chain is up 30% following last week's better-than-expected earnings report, but a couple of other news items have been the main reason that the stock soared higher over the last few days.
After two days of solid gains early in the week on post-earnings momentum, the stock jumped 8% on Wednesday as its flagship location in New York's Madison Square Park reopened. The grand reopening comes after the restaurant was shuttered for seven months for renovations after Shake Shack resigned the lease with the city. The festivities included unique burger and beer selections, musical guests, replica models of the Shack, and drew the usual long lines formed outside the burger joint. While the reopening of the original location is certainly cause for celebration for the company and its fans, the 8% spike in the stock was surprising.
Then, on Thursday, shares jumped another 8% as word broke that the company had filed to trademark "Chicken Shack," which seems to be in reference to a chicken sandwich. The company has not made an official comment about the trademark, but it did say in a statement that it "tests new menu items constantly." Currently, the only chicken item on the company's menu is a chicken dog as the chain does not offer the burger equivalent of a chicken sandwich. Some analysts have also speculated that the filing could be the beginning of a separate chicken-based chain, but considering Shake Shack has fewer than 100 locations now, a brand new chain may be overly ambitious. Still, diversifying away from burgers with a separate chain, much like what Chipotle Mexican Grill has done with ShopHouse, remains a possibility for Shake Shack in the future.
How to make $200 million in two days
The two-day run-up has pushed Shake Shack shares up by nearly 20%, adding close to $200 million to the company's market cap.
The result has made an already lofty valuation even more inflated, and the bottom-line impact of both items will probably be insignificant. First, while the reopening of its flagship store is certainly a positive for the brand, it's likely to draw away sales from nearby Shacks, which will have a negative impact on same-store sales. Manhattan Shacks are by far the company's most profitable, bringing in an average near $7.4 million, and with store-level operating profit near 30%, we could estimate that the Madison Square location will drive $2.5 million in annual operating profit at most. That number is essentially meaningless on a valuation of $1 billion.
Meanwhile, the chicken sandwich is a more exciting prospect, but still a new menu item is also unlikely to push the bottom line significantly higher. Shake Shack is already enormously popular, and many locations have long lines and are operating near capacity. Adding a chicken sandwich may bring the chain some new fans, but it could also dilute its rock-solid brand and limited menu if the sandwich does not meet its high standards.
When numbers are divorced from reality
With only 66 restaurants, the company will need to add new locations in order to justify its valuation over the long run. Unfortunately, it only plans to open 10 domestic company-owned locations a year for the time being, which is not enough to drive meaningful profit growth especially considering its currently thin net margins.
Still, the market is willing to ignore traditional valuation rules when a company's current financials do not accurately reflect its future prospects. Amazon.com, for example, is operating at near breakeven but has a market value near $200 billion, due to its growth, brand name, and competitive strengths. As a restaurant chain, Shake Shack doesn't have the same economics of a tech company, but it possesses many of the same halo-like qualities as Amazon: a reputation like no other in fast food, huge sales per restaurant, and a passionate fan base.
That's why the stock is so pricey, but the market is only willing to detach price from profits as long as the company's performance remains on track. If Shake Shack misses on earnings or revenue in one of its quarterly reports, the stock is likely to take a beating, especially if it continues to get pumped up on the kind of news we saw this week.