Shake Shack (NYSE:SHAK) has been slow to grow its total footprint over its 12-year history, preferring instead to develop only the best locations and ensure quality control over rapid growth. However, Shake Shack CEO Randy Garutti believes that his company can eventually have 450 company-owned restaurants in the U.S. alone and many more licensed worldwide.
Shake Shack's location growth forecasts are optimistic. The market's forecast for where Shake Shacks earnings will go are also overly-confident based on its high valuation at 88 times earnings, even after the recent share price dip. Are these forecasts unrealistic?
Why did the stock take a hit after a profit beat?
After Shake Shack reported Q2 earnings on Aug. 10, the stock plummeted 14% over the next week. However, that's not because earnings were bad -- Shake Shack's net income tripled over the same quarter last year to $3.3 million, for earnings per share of $0.14, which was above analyst expectations.
The main reason investors pulled back on the stock seems to be that same-store sales growth is slowing. "Same-Shack sales" rose just 4.5% in the recent quarter year over year. That's down from 13% during Q2 2015 over the year prior.
There are a few reasons to take this slow same-Shack growth with a grain of salt: The company only reports on locations that have been open at least two years (which is an attempt to remove volatility), less than half of currently opened locations are included so far. The 28 locations not included are likely growing at a much faster rate. Also, that figure doesn't include the 44 licensed locations, including every international location, which also seem to be performing well and which contributed to Shake Shack's overall 37% sales growth year over year during the quarter.
While Shake Shack forecasted same-Shack sales to remain around 4.5% for full-year 2016, it increased total revenue guidance up to $256 million on the high end, from the $249 million previously guided. That extra revenue will partially come from from two additional locations to open by the end of the year, for 18 total new locations this year instead of the 16 previously scheduled.
"With only 53 domestic company-operated Shacks," Garutti said in the most recent earnings call, "just imagine where we can grow from here." While same-Shack sales are slowing, more rapid Shack growth could actually make the company's targets realistic.
Shake Shack prepares for its next 100 Shacks
It took Shake Shack five years to add its second location after the first opened in New York in 2004, but it has since added 51 new company-owned locations and another 47 licensed stores worldwide in six countries around Europe and Asia. Shake Shack's 100th location worldwide opened in Boston on Aug. 16.
To celebrate the milestone, the company gave out 100 free burgers at each of its locations that morning. The line for the free ShackBurgers were out the door at many locations. This response from Shake Shack fans is normal -- when Shake Shack opened its most recent international location in Seoul, South Korea in July, it was a similar scene as customers live streamed their experience and local media filmed the event. As Shake Shack continues to expand, they continue to reach a cult-like following at each new location, a good sign as they prepare to open their next 100 stores.
Shake Shack's growth forecasts: too optimistic?
The forecast that the market has given this burger chain -- that its earnings will grow fast enough to support its 88 times earnings valuation -- is certainly optimistic. Yet, it may be entirely realistic as opening new locations is on track to drive income growth for years to come. With 18 new locations this year and with the same location growth expected next year and beyond, the chain will be in line to double its number of locations in about five or six years. Shake Shack also recently announced more domestic licensing opportunities such as in airports and arenas.
There will be plenty of risks ahead, such as changing consumer preferences toward healthier foods, economic conditions, and new market entrants competing for Shake Shack's customers. We need to see that Shake Shack can maintain or increase its Shack growth rate, while maintaining the cult-like following that its developed. Based on the response in Boston and Seoul, Shake Shack seems to be doing that just fine.
Even with the expensive valuation at 88 times earnings, SunTrust analyst Jake Bartlett recently upgraded Shake Shack to a "buy," saying that the recent price dip creates an opportunity to buy into a company with plenty of long-term growth ahead. New location growth looks set to continue as well as an increasing profit margin -- that is helping earnings to grow even faster than sales. Shake Shack's optimistic forecasts no longer look out of reach.
Seth McNew has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.