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Location Is Shake Shack Inc.'s Secret Sauce

By James Sullivan - Dec 26, 2015 at 11:12AM

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Shake Shack's expansion plans and site-picking expertise should help make it a solid long-term investment.

The Mall of America in Bloomington, Minn., is the largest mall in the United States and the most visited in the world. That kind of foot traffic makes it a desirable location for food establishments of all kinds to set up shop. No surprise, then, that Shake Shack (SHAK 1.07%) is planning to open a 2,800-square-foot restaurant next summer as part of the mall's "Culinary on North" expansion. While this is only one new planned opening, it's good news for Shake Shack shareholders. It should help alleviate some expansion fears, and it's a microcosm of what makes the company so great in the first place.

New York City comps are tough to beat

Original Shake Shack, Madison Square Park, New York. Source: Shake Shack.

Shake Shack started as a hot dog cart in Madison Square Park in New York. It's the brainchild of renowned restaurateur Danny Meyer, and so much of what makes it great is also what scares investors: its New York City roots. Many great burger chains are regional and there are questions about how well the Shake Shack brand will translate to the rest of the country. 

Shake Shack opened its first permanent kiosk in Madison Square Park in 2004, opened its first restaurant outside New York City in 2010, and ended September 2015 with 41 domestic company-operated Shacks. In the quarter ended in September, average weekly sales for domestic company-owned stores were $103,000 per week. This was up 9.6% from the same period last year.

In its quarterly report delivered Nov. 5, Shake Shack said same-Shack sales (comps) increased 17.1% in Q3. It's important to keep in mind that the company includes in its comps figures only Shacks that have been open for 24 months or longer. This is intended to allow new stores to work out operational kinks before impacting the same-store comps number. The same-Shack sales increase outpaced the sales increase for domestic company-owned stores generally. While this means that older stores continue to outperform newer stores, this is not a NYC vs. the rest of the country phenomenon.

For the third quarter of 2015, the comparable-Shack base included 16 Shacks, versus 12 for the year-ago quarter. CFO Jeff Ute on the latest earnings call stated, "16 Shacks in the base, only six of them are in our original market of New York City. We want to highlight that our same-Shack sales results for the quarter are relatively consistent across all of the markets. And that continues to demonstrate the strength of our brand outside of New York City."

The best of what's around
There are more than 10 Shacks in New York City, six of which are currently included in reported comparable sales figures. Management is guiding for 2016 openings to average around $3.3 million in annual sales and for the long-term number past 2016 to come in between $2.8 and $3.2 million per Shack. While these numbers are significantly lower than the greater than $5 million average sales figure, they still trump the average sales of competitors like Chipotle and Panera.  These are enviable sales figures and management has continued to upgrade its guidance on new openings from 10 to 12 to now 14 per year. I would expect this rate of growth to continue to accelerate. It is a a long way away from Chipotle's 1,700-plus locations.

Shake Shack, Newbury Street, Boston. Source: Shake Shack.

In 2016, Shake Shack has plans to enter West Hollywood, Phoenix, and Dallas, just to name a few huge markets. You won't find a Shack on the interstate, on a seedy dead-end block, or in an area where it doesn't truly belong. Its real estate executives have picked the best locations in the past, and I expect this trend to continue in cities across the United States. Current comps will be impossible to replicate over a much larger store base, but don't bet against this excellent team of operators to deliver sales greater than $3 million per store from three or four times the number of locations in the decade to come.

In and of the local neighborhood

Shake Shack. Theater District, New York. Source: Shake Shack.

Shake Shack doesn't fall into the trap of ramming a round peg into a square hole when it moves into a new neighborhood. Some elements of Shack design are universal. If a customer is in a store in Austin, Bridgewater, or Chicago, there will be differences, but the core feel is the same. On the other hand, there are elements catering directly to the neighborhood. This approach includes special regional menu items, decor, and design nods to the local area. In just New York, the Shack in Madison Square Park feels decidedly different from the location under the Brooklyn Bridge or the glimmering lights of the Theater District location. This differentiation will allow the stores to have an appeal in Louisville or Louisiana that might not be felt with a faceless and more generic competitor.

Shake Shack, Boca Raton, Fla. Source: Shake Shack.

Focus on the long term
Shake Shack is on a controlled and deeply thought-out expansion plan. The Mall of America location isn't opening until next summer, and management expects to open "at least 14 domestic company-operated Shacks next year and beyond." The company isn't rushing to expand the base as quickly as possible. Doing so would jeopardize quality and force the real estate team to acquire substandard locations.

I'm sure expansion will speed up at some point, but as a long-term investor, I like the methodical approach being implemented. In five years, the current store count will have more than doubled, the future will be clearer for this fine-casual-dining company, and I'll still be holding my shares.

I recommend investors take a deeper look into what separates companies from one another. It's not always what it appears to be on the surface. Shake Shack's food is great, but its real estate is its real secret sauce. 

James Sullivan owns shares of CMG and SHAK. The Motley Fool owns shares of and recommends CMG. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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