Shake Shack (NYSE:SHAK), the New York City-based roadside style hamburger chain, has grown by leaps and bounds over the last few years. Starting as just a single cart in Madison Square Park in 2004, the company now boasts 66 locations in the U.S. and internationally. Looking to build on that strong start, the company plans on adding 10 locations this year, and continues to announce new expansion plans and pipelines for 2016 and beyond.
Shake Shack's stock has risen alongside the physical growth of the company. Since the IPO in late January of this year, shares have increased in value by over 60%. As of Wednesday, shares were trading over $74, putting the company's market cap at nearly $2.7 billion. That is a lofty valuation for a small fast-food chain with a limited footprint. In fact, I believe it is overvalued. Consider a couple of points as to why.
Value of each Shack
Of Shake Shack's current 66 restaurants, only 34 are operated by the company (meaning the revenue from operations flows directly to the business). The other 32, including all 27 international locations, are licensed establishments, which means that Shake Shack only makes a small percentage of sales from these restaurants. What are the implications of this?
Let's assume Shake Shack's value as a company can be solely derived by how many venues it operates. If we use the company's nearly $2.7 billion valuation, that means each of the 34 wholly owned and operated Shacks are valued at roughly $84 million apiece. Even if we add back in the licensed locations, each of the 66 total Shacks would still tote a value of over $40 million. That seems to be a steep price for a single hamburger joint.
For the sake of comparison, let's use the high-growth fast-food chain Chipotle (NYSE:CMG), which has over 1,800 restaurants (all company-owned) and a market valuation of almost $19 billion. Using the same calculation, this values each Chipotle venue at over $10 million, a substantial difference from Shake Shack's $84 million per owned-location premium. So what is a Shake Shack restaurant earning on average?
Revenue for each Shack
Shake Shack reported total sales of $36 million for the 13-week quarter ending April 1, 2015 (excluding revenue of $1.76 million from the licensed locations that are not operated by the company). Dividing that amount by the 34 company-operated restaurants gives us just over $1 million in revenue attributable to each Shack for the quarter. On a quarterly basis, that appears to be a pretty healthy number for total revenue per restaurant.
Here's the catch: The company reported a $9.3 million "Shack-level" operating profit from that total revenue, which averages to almost $275,000 per location. ("Shack level operating profit" is different from operating profit for the company overall, which was actually negative for this quarter. The company uses this figure to measure the profitability of its restaurants without the overhead of the rest of the company.) If we assume that margin will hold and project that number out for the whole year, each restaurant stands to profit over $1 million for 2015. Although these are impressive numbers for a burger restaurant, the $84 million per hamburger stand valuation still seems perilously high to me.
Again, for context, let's compare these numbers to Chipotle, which reported net income of over $122 million for the quarter ending March 31, 2015. This attributes almost $70,000 per location, or over $250,000 a year. That is a per restaurant premium of roughly 36x, using the $10 million per location from above, to Shake Shack's 84x per restaurant premium.)
Foolish final thoughts
At over $74 in price, Shake Shack shares appear to have soared well beyond their fair value. The stock price seems to be very optimistic about future growth prospects through new restaurant openings that company management has communicated to investors. Even if these future growth plans pan out, the stock still appears grossly overvalued and seems to be ignoring the reality of current cash flows and business size. Perhaps overzealous investors feel this is the newest fast-food success story, but it could be long before results are actually delivered to the table. It is far too soon to tell if its future growth strategy will prove successful for Shake Shack and its investors, making this particular stock too pricey for my tastes at the moment.