Description

Instead of fighting fast casual concepts with the trifecta of double digit comps + double digit unit growth + large TAM, why not short a $4.3b quickly maturing concept that has…

• Declining traffic and a LSD comp from aggressively pushing price.

• Declining new unit productivity.

• Is closing stores for the first time ever.

• An activist that got control, helped juice margins, and is now almost completely gone after the stock went up 125%.

• Trades at over 100x earnings.

• Used to sell a unique hamburger (smashburger) that has now been commoditized.

Everyone is familiar with Shake Shack. Selling burgers out of a box is not complex. So yes, this is a simple thesis. Only play if you want!

Declining Traffic

Shake Shack’s low single digit comp growth is not indicative of a healthy growth concept. Traffic has declined 5 of the last 7 quarters despite a majority of Shack Shacks being relatively new. ~40% of stores have opened in the past 3 years.

Declining Productivity

SHAK’s AUVs are not growing, despite the continued price increases. New unit productivity has recently started to decline as well. This is evidence of brand saturation and maturation. 

Despite stalled sales growth, SHAK has been able to cut costs and significantly improve margins the past few years. Store level margins have rebounded to 22% in 2Q24, the same as 2019 when sales were half of current levels and the concept was much hotter. Restaurant level operating margin improvement has been driven through price increases and leverage on food and labor costs. 

I would argue these margin improvements are unsustainable if traffic continues to decline. Traffic trends are indicative of a declining value prop and experience. 

Closing Stores

SHAK recently announced the closure of 9 stores on August 27th. These are the first store closures in history. Bulls have argued this is positive to profitability, which it is, but this is just 1.6% of the store base. The $15mm of cash costs to prune the portfolio is half of 2024’s operating income. Will this be a recurring theme? I bet it will be. 

Activist Out

In early 2023, Engaged Capital waged a months-long campaign to change up Shake Shack’s board and implement operational changes. They won in May 2023. The stock is up 125% since and margins have improved. 2025 EPS estimates have gone from $0.30 to $1. Engaged owns <1% of the company currently and I suspect is now completely gone.

Valuation

SHAK currently trades at 100x 2025 EPS estimates. 2025 Estimates imply ~3% comp and a near doubling of corporate EBIT. These numbers seem aggressive unless the consumer gets stronger. If we have a recession, SHAK’s earnings will go negative. 

At 25% store level margins (near peak levels) on $1.5b of sales (up 25% from 2024), I get to $1.50 of adjusted EPS. So 67x a very optimistic number. “But SHAK will always trade at a super premium.” My bet is that it is when, not if, SHAK trades at a reasonable valuation if traffic trends continue negative. 

Peter Lynch observations

I have always been a big fan of the product. My enthusiasm has waned over the years as a result of declining consistency in product quality and experience. I still go, but less frequently. I recently visited the first/premium Dallas location on a nice Friday night. There used to be long wait times. It was empty, I was shocked. 

Fast forward a month, I ordered takeout from a strip mall location closer to my house for my son’s birthday party. The workers looked more like McDonalds workers vs Chick-Fil-A type employees of the past, and I had to go back to pick up what they forgot in my order. Even worse, the burgers ended up half eaten because they were grossly undercooked. I had no interest in driving back a second time. 

Check twitter if you think my experience is unique. Search “shake shack” and there are endless posts like this: example1, example2, example3. $20+ for an ok burger, fries and coke is becoming a harder pill for most consumers to swallow. There is asymmetric downside macro vulnerability here. 

For those in the “go woke, go broke” crowd, that’s an extra downside kicker here. https://aflegal.org/america-first-legal-files-federal-civil-rights-complaint-against-shake-shack-for-illegal-race-and-sex-discrimination/

Lastly, SHAK pioneered the smashburger across America. New local smashburger joints are popping up everywhere. Flat top grills have exploded in popularity as people are making their own at home. SHAK’s infamous burger seems to have been commoditized. 

Catalyst

Missing numbers

Insider selling

Consumer weakness/comps missing