The objective of this exercise is to research a company to a reasonable depth using a reasonable amount of time, with the belief that a) whatever level of research conducted, there will still remain an area of unknown b) the most efficient way to get better at analyzing is with a manageable single cycle, that gets iteratively better c) getting my hands dirty by covering a breadth of companies will yield a new sense of understanding or at least provide the subsequent sense of direction.
1. How the Business Makes Money
Shack Shack makes money by selling premium burgers, chicken sandwiches, hotdogs, fries, milkshakes and other beverages. As per the Google Maps photo for Shack Shack Madison Square Park location uploaded in July 2024, ShackBurger single patty is priced at $8, and Shack Stack $13.3. McDonald’s pricing as per a March 2024 upload in Manhattan is $3.2 for Cheeseburger and $9.8 for Double Bacon Quarter Pounder with Cheese. Along with Five Guys, Shack Shack is a burger place that the average customer would be spending well over $10 for a meal. Shake Shack recognizes this premium brand image as their core identity. As with Starbucks, their marketing campaigns are rarely about discount promos. They are usually LTO menus such as White Truffle Burger, special day events like valentine day dinner event, collabs, and ones promoting brand image and quality of ingredients.
As of 23Q4 there were 518 stores world wide, 334 domestic and 184 international. All 184 international location was licensed. 39 of the 334 domestic locations were licensed. As of 24Q2 there were 547 stores worldwide, 311 are company-operated and 236 are licensed. To sum up, they have a clear preference to operate their own stores in the US and franchise overseas. Meanwhile, foreign expansion remains a key growth strategy for the company.
10-K 2023
Shake Shack serves modern, fun and elevated versions of American classics using only premium ingredients. We are known for our made-to-order 100% Angus beef burgers, crispy chicken, hand-spun milkshakes, house-made lemonades, beer, wine, and more. With our fine-dining roots and a commitment to crafting uplifting experiences, Shake Shack has become a cult-brand and created a new category, fine-casual.
Our mission is to Stand For Something Good in all aspects of our business, including the talented team we hire and train, the premium ingredients making up our menu, our community engagement and the design of our Shacks. Stand For Something Good is a call to action for all of our stakeholders — our team, guests, communities, suppliers and investors — and we actively invite them all to share in this philosophy with us. This commitment drives our integration into the local communities in which we operate and fosters a deep and lasting connection with our guests.”
Source: Shake Shack
Company revenue was $1.1b in 2023. Gross profit was $480m (44%), operating profit $28m (2.5%) and net profit $20m (1.8%). This is what is stated in Yahoo Finance. However, this is only half the picture. Comparing it to 10-K, Yahoo’s COGS only includes “Food and paper costs” and “Labor and related expenses”. This is different from Chipotle’s Yahoo Finance gross profit in which occupancy and other restaurant operating costs is included. I think the later is a better representation of gross profit, since kitchen rent, electricity used for preparing food would be costs associated with producing the goods and services. Comp, or “same-Shack-sales”, increased 4.0% in 24Q2 compared to the same period last year, driven by a 4.8% increase in price mix partially offset by a 0.8% decline in guest traffic.
Restaurant level margin, in Shake Shake’s terminology “Shack-level operating profit margin” is 20%. System-wide sales was $1.8b and AUV for domestic company-operated Shack was $3.9m. Digital sales accounted for 35% of sales in 23Q4. Wingstop has about 2k stores. Their system-wide sale is $3.5b and AUV is $2m for reference. One Shack Shack restaurant records roughly twice revenue as one Wingstop store.
However, I’m guessing that Shack locations are much prime, with more traffic, greater square footage, staff and rent. It would be interesting to compare average labor cost & occupancy cost per store. Immediately it is apparent that margins are very thin for this business. The company recorded an operating loss from 2020 to 2022 and barely managed to make money in 2023. Even before Covid, their margins were low. Status quo is unappealing, however if they manage to effectively cut costs, the upside for margins could be greater than other chains.
Video Summary – Why Shake Shack Is Borrowing Ideas from Fast Food Restaurants | WSJ The Economics Of
– Brand emphasizes that it is not fast food. But it’s getting expansion ideas from fast food and have to compete in the space for growth. Shack Shack has to speed up operations, expand into drive-throughs, rest stop locations, and further implementation of kiosks.
– All food is made to order.
– Started as a pop up stand for hotdogs in Madison Square Park. Founded by Danny Meyer in 2004, selling premium burgers, expanded to 500 locations internationally, with a market cap of $4b.
– McDonald’s does 70% of sales from drive-through.
– Decreasing wait time is priority for Shack Shack drive-thru.
– Shack Shack needs to balance premium feel and speed to justify pricing, all while maintaining quality and providing good hospitality.
– Expedition initiatives: prepare lettuce in restaurant -> use pre-cut lettuce
– Shack Shack is mostly company-operated, but they are leveraging on licensing, especially overseas.
– Data analysis for optimizing ingredient order is critical for each location’s ability to manage waste and have enough inventory.
Video Summary – Shake Shack CEO Rob Lynch joins CNBC for first interview since assuming role
– Rob Lynch has been with P&G, Kraft Heinz, Taco Bell, Arby’s, and Papa John’s before joining Shack Shack in May 2024.
– Top challenge: “We need to scale, we need to grow.”
– Enhance hospitality and leverage technology.
– Not participating in the value war – the $5 offers. Shake Shack is about premium food and hospitality.
– Implemented new marketing scheme.
– New model around labor.
– Closing a number of restaurants, especially in California as minimum wage became $20/h. Looked at 320 Shacks and had to close 9 locations that are not delivering good results.
– Is there a strategy to reduce wait time? – We’re doing everything we can. e.g. equipment, process innovation. data analytics for optimizing drive-through. Working to increase throughput.
– Less than 10% are drive-throughs, but it will expand.
Source: WSJ, Guggenheim Securities
2. Key elements of recent earnings call & IR materials
From 24Q2 earnings call
– Rob Lych took over Randy Garutti as CEO and runs first earnings call. He spent a good portion of his first 3 months in stores in San Diego and Houston.
– His areas of focus are 1) increasing comp by doubling down on premium branding through good marketing and global expansion. 2) opening more restaurants with good returns, reducing opening costs and expanding drive-through. 3) increasing restaurant level margins by expanding from the current urban stores targeting customers visiting on foot and focus on digital orders and drive-throughs.
– 24Q2 revenue grew 16% YoY to $316m, system-wide sales grew 14% YoY to $484m, opened 23 new restaurants, restaurant level profit margins grew 100bps (21%->22%), generated a record FCF of $21m.
– Mexico, UAE, Philippines, Japan was great, offset by China.
– 120bps improvement in food and paper cost, representing 27.8% of shack sales from menu price increase and enhancement in supply chain.
– 50bps improvement in labor cost, representing 28.2% of shack sales despite a 90bps impact from wage inflation in California.
– Guidance: revenue $311m in Q3, low single digit comp growth, 20-20.5% restaurant level profit margins.
– CEO will aggressively push drive-throughs, coupled with combos that would aid the speed of ordering.
– CEO didn’t give a satisfactory answer to an analyst inquiring outlook of store margins – just listed the typical words like “equipment”, “technology”, “operational processes”, “effective with our labor”
– CFO mentioned better labor planning to account for peak periods and pleased with the results.
– Shack Shack is moving to a more standardized kitchen model than would reduce build costs.
Summary & Impression
A lot of emphasis was on restaurant margin improvement. This is natural given the single digit operating profit margin of the company. It is different from Wingstop with double digit comp growth driven by transactions growth and high restaurant level margins. Wingstop’s restaurant margin is 26% including the 5% of sales used for nationwide marketing. For Shake Shack, restaurant margin is 22% but it doesn’t seem to include marketing expense as it says “The Company has elected to reclassify certain marketing expenses from Other operating expenses to General and administrative expenses in the accompanying Consolidated Financial Statements for prior periods to be comparable with the classification for the fifty-two weeks ended December 27, 2023.”
3. If I had to predict the prospects of the business
I have doubts that the company can significantly better their margins. The CEO mentioned increasing restaurant level margins by expanding from the current urban stores targeting customers visiting on foot and focus on digital orders and drive-throughs. This is basically admitting that existing urban stores’ margins are hard to improve. The effect of delivery-only stores and drive-through is just bettering the store mix, so that the margins get better on average. These types of stores will have better margins, since they wouldn’t need to occupy large spaces in prime locations. However, occupancy related expense is 7.6% of revenue. Food and labor accounts for 30% each, a far bigger chunk. Delivery-only stores and drive-throughs will require same amount of food and labor wouldn’t it? Also, hospitality being a big selling point, I wonder how many people would be comfortable paying the higher price tag just for the taste when doing take-outs or delivery. People don’t deliver Michelin star food. Hospitality is half the experience. Then the question becomes, can Shake Shack’s taste and quality justify the higher price?
I believe that premium burgers is an actual niche. There is demand for that. However, compared to Five Guys or Chipotle, I have always felt that the portion is too small in the case of Shake Shack. I think more drastic measures need to be explored to enhance the profitability of the business.
For example, they should try more automation in the preparation of the meal. For instance dual-side grilling as Chipotle is trying out. Maybe while one side is grilling, they could place an iron-like plate on top at the same time. Also, they could take measures to further their loyal fan base, who would be eager to try out LTO menus whenever it comes out, similar to what Starbucks is doing with their Starbucks Rewards program. It needs to be sort of a loyal cult, to be more than random customers visiting once every 6-12 months. Drive-throughs and delivery only stores will do well in tapping into market share, but I don’t think it could go far beyond that.
The new CEO did place an emphasis on marketing. It’ll be necessary to keep up to their latest campaigns on social media.
I have a clearer picture of how to analyze restaurant companies
– Restaurant level margin is very important as it represents the competitiveness of the type of food they are selling as well as the price effectiveness.
– Analysis of labor, food, marketing, rent cost and pre-opening cost should be done across the board and observed in comparison.
– Evaluate whether the menu has global appeal and expansion strategy is realistic
– Observe if there is hype or backlash building up on social media.
– Check the trend of comp growth and see if new menus can bring in new customers or add to the ticket mix
– Check the trend of store expansion
Moving forward it will be important to keep track of
– Performance of new marketing schemes led by the new CEO – will it lead to comp growth by increase in transactions or average ticket sales
– Performance of labor scheduling, build-cost reduction schemes
– Whether restaurant-level margins are being improved.
– Reception of drive-through to customers and whether the strategy is working
Source: Shake Shack Blog
Written from scratch by Meston Ecoa
May contain incorrect data and information