Chipotle, the veteran of the group, opened its first store in 1993 and went public in 2006. Its success has spawned a rush of restaurant IPOs, though none have matched the success of the upstart burrito roller, which now has nearly 2,000 stores under its umbrella. Shake Shack, meanwhile, was the brainchild of award-winning restaurateur Danny Meyer, and it began as a simple hot dog cart in New York's Madison Square Park in 2004, which evolved into a kiosk that drew a cult following. Shake Shack has slowly expanded in recent years and is now accelerating store openings following its IPO this January.
For the investor looking to grab a piece of the hot fast-casual industry, Chipotle and Shake Shack present two of the more appealing opportunities. Let's dig a little deeper to see which of these two presents the better investment today.
Food with Integrity
Chipotle stock is up more than 1,000% since its 2006 IPO, and its unit economics continue to be strong. The burrito roller posted a net income margin of 11% last year, and its restaurant-level operating margin of around 28% is the best of any major fast-food chain. However, revenue growth has slowed dramatically this year as the company laps a particularly strong 2014. In its most recent quarter, sales grew just 12.2% with a 2.6% bump in comparable sales. The chart below shows the slowing growth.
Only two other times in Chipotle's public history has revenue growth been this slow, and both times, it bounced back quickly. However, with management only forecasting low-single-digit comparable sales next year, the growth rate is likely to remain muted.
Demand is not the problem. Chipotle restaurants regularly have long lines, and almost all locations operate at capacity during peak hours. Management's obsession with throughput -- how fast restaurants can serve customers -- shows that the growth constraints are on the supply side. The company is increasingly looking at strategies such as mobile ordering, a second make station, and better utensils to speed up service, which could unlock faster growth. The store base continues to expand by more than 10% a year, but management's ability to drive efficiency will be the greatest determinant to the company's future success.
Shake Shack the company bears much in common with Chipotle. Chipotle co-CEO Monty Moran has even cheered on its fast-casual rival, saying, "When you come up with something like Shake Shack, or any better burger concept, or anyone doing a decent job making food that's respectable and decent to eat, such competition, I think, is good for us." Both companies are elevating consumers' expectations of fast food by using high-quality ingredients, modern decor, and traditional cooking methods.
Shake Shack the stock, however, presents a different opportunity to investors than Chipotle. Still fresh out of the gate from its IPO, the stock has been wildly volatile since its debut. Without significant bottom-line profits, shares are difficult to value, and many analysts have claimed that the stock is overvalued, with its high price this summer the result of brand euphoria. Since then, the stock has approached its post-IPO all-time low, giving it a more reasonable entry point for new investors.
Shake Shack has not yet reported third-quarter earnings, but its Q2 was red hot as same-store sales jumped 13%, and overall revenue was up 75%. The chain is small, with just 37 company-operated restaurants as of its last report, but it has outsized brand power as evidenced by its social media following. Thanks to that buzz and its base in the tourist capital of New York, its average unit volume stands around $5 million, head and shoulders above the fast-food industry average, and restaurant-level operating margin shot up nearly 500 basis points in its last quarter to 30.3%, beating Chipotle.
Those metrics would make nearly any other restaurant chain envious. Right now, Shake Shack only envisions opening 450 locations in the U.S, but at its current profitability, those stores would deliver twice as much income as the average Chipotle.
Carnitas vs. Shackburger
I own both Chipotle and Shake Shack, and I think both will outperform the market over the long term, but at this point, I have to say Shake Shack has the greater potential for blockbuster returns.
Unless Chipotle can top its 2016 low-single-digit same-store sales projection, the stock is likely to run flat through next year, and with an across-the-board price increase last year on an uptick on beef entrees this year, it will be a while before the company can justify raising prices again.
Shake Shack, on the other hand, has crushed estimates in its first two reports as a public company, and I'm expecting another strong beat when it reports earnings on November 5. I think analysts are underestimating the power of its brand, which is not only fueling huge comparable growth at home, but has also driven monster sales at its international licensed stores. Though its P/E is in the triple digits now, it has the growth to justify it as earnings per share could hit $1 in just a few years. With a market cap of just $1.5 billion, it has room to grow into a valuation several times that.