Shares of Shake Shack (NYSE:SHAK) popped 11% after the burger joint published second-quarter earnings on August 10. The stock reached $75 per share, giving the company a market capitalization of approximately $3 billion. That puts Shake Shack directly on par with The Wendy's Company (NASDAQ:WEN), which also has a $3 billion market capitalization.
But even though Shake Shack and Wendy's share similar market values, they are in different places as companies. Wendy's is an established company with a presence across the country, while Shake Shack is just beginning to branch out. Shake Shack enjoys the benefit of hype and high expectations, which is why its valuation has soared.
But investors should ask themselves whether Shake Shack should really be valued as much as Wendy's, or if perhaps the expectations have gotten ahead of themselves.
A delicious quarter
Shake Shack reported $0.09 per share in earnings last quarter, tripling the consensus forecast of $0.03 per share. Revenue soared by 75%, reaching $48.5 million last quarter and also beating expectations. Lastly, sales at locations open at least two years ("same-Shack sales") rose 13% year over year, which was much higher than the 8.6% expected.
These growth rates far outpace Wendy's results. Same-restaurant sales, which measure sales at locations open at least one year, grew 2.4% at company-owned restaurants, and 2.2% systemwide.
It makes sense that the stock would rise after beating analyst expectations across so many metrics. Not to mention, Shake Shack is one of the market's hottest stocks right now. Since its initial public offering earlier this year, its shares have zoomed from $45 per share to $90 per share, quickly doubling in price, in just five months.
But Shake Shack's stock price has fallen since then, as reality appears to be setting in, and investors should put Shake Shack's incredible ride into proper context.
Is Shake Shack worth more than Wendy's?
It's hard to believe that Shake Shack could be worth more than, or even as much as, Wendy's. I say that simply because Shake Shack has a tiny restaurant footprint. Shake Shack has approximately 70 restaurants, whereas Wendy's operates more than 6,400 locations. Based on their $3 billion market capitalizations, this means that each Shake Shack location is valued at approximately $42 million per restaurant compared to only $462,000 per unit at Wendy's.
This demonstrates how investor expectations can get out of hand. Investors paying such a high multiple for Shake Shack are projecting extremely high growth rates into the future. Indeed, Shake Shack's excellent growth in recent periods makes it look like the sky is the limit. But Shake Shack's restaurants, to this point, are highly concentrated mostly in New York City, where traffic is high. Sooner or later, it will have to expand to other, less dense areas of the country.
Management acknowledged this reality on the last conference call, saying that same-Shack growth over the long term is likely to be in the low single digits, and that average weekly sales over the long term will actually decline based on the factors mentioned above.
Plus, Shake Shack's expansion isn't going to happen immediately. It's going to be a more gradual process than investors are probably counting on. Management stated during last quarter's conference call that the company expects to open 12 domestic company-operated restaurants and just five international locations the rest of the year.
As a result, investors buying in at these levels are making a risky bet that Shake Shack's momentum can continue without any hiccups. However, that seems to clash with what management itself has to say.