Shake Shack Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Shake Shack is a fast casual restaurant chain that serves burgers, chicken, fries, shakes, and more. The company owns and licenses Shacks across the globe, and strives to maintain a premium image by using high-quality ingredients and a distinctive menu, often influenced by local cuisine.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

Shake Shack operates a multifaceted business that combines both company-operated locations and franchised locations.

  • Company-operated Shacks: These are the core of the business where the company manages every aspect of operations from hiring and training staff, supply chain, quality control, and customer experience. This model provides more control over consistency and directly contributes to revenues.
  • Licensed Shacks: Shake Shack partners with other operators to run locations in new territories, typically internationally or in airports. This allows for more rapid expansion, where there are more barriers for direct control. The company generates revenues from fees based on a percentage of sales from these licensed shacks.
  • Product mix: The menu consists of classic American favorites, including hamburgers, chicken sandwiches, hot dogs, crinkle cut fries, milkshakes, and more. The menu is consistent across locations but regional varieties exist.

The company has been experimenting a lot with limited-time-only menu items.

Industry Trends: The restaurant industry is highly fragmented, characterized by intense competition across a variety of formats, including quick service, fast casual, casual dining, fine dining, and more. New competitors appear at a rapid pace, and existing players vie for market share.

  • Increased Competition: The increased competition requires restaurants to offer more personalized services, loyalty rewards, unique ordering experience, and high food quality.
  • Digitalization: There has been an ever growing trend to embrace digitization in the restaurant industry. This includes ordering from mobile apps, website ordering and delivery. Customers have been accustomed to more and more convenience, and companies have to keep up with the demand.
  • Supply Chain Volatility: The food industry is highly sensitive to supply chain issues including food shortages, logistics delays, and labor unrest. Companies must focus on a reliable and resilient supply chain to protect profitability.
  • Inflation: Prices have increased in food, paper, labor, and other inputs. Companies must implement price increase and find solutions to reduce cost pressures.
  • Changing Consumer preferences: Modern consumers want healthier options and ethically sourced products. Companies need to adapt to changing demands to maintain their customer base.

Margins:

Shake Shack has generally seen its operating and profit margins decline across the past couple of years. * In the third quarter of 2023, the adjusted EBITDA margin was 13.2% . A big part of this can be attributed to “restaurant-level profit” which was reported at 20.2% for the same quarter. * The reason behind a lower company-wide EBITDA margin is that the company has to absorb costs from its non-restaurant locations.

Competitive Landscape:

Shake Shack faces strong competition from all kinds of restaurants in the fast-casual segment. Some competitors include:

  • Other fast-casual burger chains: These are Shake Shack’s most direct competitors. These would be companies like Five Guys, In-N-Out, and Habit Burger Grill
  • Large restaurant conglomerates: Many larger restaurant companies, such as Chipotle and Panera Bread, have created strong brands with well established consumer loyalty.
  • Other non-traditional brands: Fast casual concepts are also starting to appear, like fast-casual asian concepts.

What Makes Shake Shack Different?

  • Premium Position: Shake Shack has historically always been marketed as a premium experience, providing premium ingredients and higher-quality food than competitors, at a higher price point.
  • Brand Identity and Culture: The company markets itself as a place to bring together communities, and the experience is rooted in its hospitality. The company emphasizes having an inclusive workplace and creating an emotional experience.
  • Menu Innovation: Shake Shack is constantly innovating on its menu with LTOs, collaborations, and new product categories.

Financials Deep Dive Let’s analyze the financials for Shake Shack, including some metrics from 10Q of September 27, 2023.

Revenue: Shake Shack has seen its revenue increase over the past years, with the total revenue for the 39 weeks ending September 27, 2023, being $771 million, compared with $662 million for the prior year. This revenue is primarily generated through sales at company operated stores, then comes licensing revenue.

  • Revenue for the thirteen weeks ended September 26, 2023, increased 18.6% to $277 million versus the same period last year, with Shack sales increasing 21.2%.
  • The revenue increase was driven by an increase of 4.8% in price and 1.6% increase in traffic. The company has done a good job at offsetting commodity and labor inflation by raising prices.

  • Licensing revenue increased 34.6% from the previous year, with revenues at $11.9 million.

  • Restaurant Level Profit: Is the most direct indication of how profitable Shake Shack’s restaurant locations are. The average restaurant-level profit was 20.2% for the thirteen weeks ending September 27, 2023. This is considered a solid number.
  • Expenses:
    • The labor-related expenses have increased year-over-year, mainly due to increased hourly wages and higher prices for benefits. Labor and related expenses were reported at 28.6% of sales for the thirteen weeks ending September 27, 2023.
  • Operating expenses have increased 11.6% to $75.9 million compared with the same period last year. The company mentions that this was due to increased marketing and technology initiatives.
  • Net Income: The net loss attributed to SHAK was reported to be ($2.6 million) for the thirteen weeks ended September 27, 2023, or ($0.03) per share compared with ($7.6) million or ($0.21) per share for the same period last year.

Balance Sheet Health: Shake Shack has a decent balance sheet, but it has seen a notable increase in long term debt in the recent years, which could be detrimental. The company had a significant operating lease liability for $440 million in the third quarter of 2023.

*   **Assets:** The total assets are reported as $1,699 million. This includes, total cash, cash equivalents, and marketable securities at $344 million, property and equipment at $519 million, goodwill and other intangible assets worth $420 million.    *  **Liabilities:** Total liabilities are $1,075 million as of September 27, 2023, which includes operating lease liabilities at $473 million. Long term debt and debt equivalents at $246 million.
    * There is an increasing amount of long-term debt, with another $250 million in convertible notes.

*   **Equity:** The total equity is $624 million as of September 27, 2023.

Risks to the Moat and Resilience The moat of Shake Shack is not strong. The biggest source of its moat is the brand and the customer loyalty. Both of these are under constant pressure, from competitors trying to lure in new customers through competitive offers. There are also several risks associated with the business that have been discussed in recent earnings calls and reports.

  • Intense Competition: The fast-casual food industry is highly competitive. The company has to compete with fast food, fast casual, fine dining, and other restaurants in general. As other companies are able to come up with a similar or better product than Shake Shack, the company could lose customers and market share, severely impacting performance.
  • Commodity Price Volatility: Changes in the price of raw materials, including food and paper products, are a large risk factor for the business. This also includes the price of gasoline. If the company cannot pass on the costs to the consumers, the margins will get impacted significantly. * Labor Costs: Labor is one of the largest expenses for the company, so any increase in wages could impact profitability. Companies in the service sectors are more susceptible to this risk, since they are a large percentage of the operating budget. * Macroeconomic Factors: The company also noted that its sales are correlated with traffic in their locations, and that they were affected by rising interest rates and a decline in foot traffic. There are many other macro conditions that are beyond their control, which could have significant impact on their business and sales.
  • Expansion: The company’s continued emphasis on expansion into newer domestic and international markets could pose operational challenges. These initiatives also require a significant amount of capital.
  • Accounting practices: In its 2022 10K, the company disclosed some material weakness in the internal control regarding financial accounting. The company said that it fixed it, but there is a chance of further accounting errors in the future.
  • There was also some errors relating to calculation of deferred tax assets in their balance sheet, which the company claimed to be fixed in their reports.

Controversies:

The company mentioned in a recent earnings call, that it would start slowing down expansion, due to macroeconomic reasons, rising interest rates, and reduced consumer demand.

  • The company has struggled to manage prices, increase revenue, and create profits.

Understandability:

I would give the business a 2/5 rating for understandability. On the surface, it is simple to understand what the company does, as it just sells burgers and fries. But it quickly gets complicated, as the sources of profit and revenue are not just from the sales of the company-operated shacks, but also include franchising and partnerships. Furthermore, there is the complex accounting around its different assets and liabilities.

Moat Rating Justification:

Given the above information, Shake Shack gets a moat rating of 2/5. The company possesses some minor strengths when it comes to brand, the customer loyalty that the brand has created, and a moderately sized distribution network. But it lacks any sustainable competitive advantage such as network effects, durable patents, a significant cost advantage that would protect it from other competitors. The strength of brand name fades when competitors have similar or better quality products. This makes Shake Shack not a very stable investment. * * Intangible Assets: While Shake Shack has a recognizable brand, it lacks the same depth of brand loyalty as its competitors. Some loyal customers do stick by the company due to its higher perceived quality and service. But ultimately, this is unlikely to prevent a large scale shift to better offers from competitors. The company also has very little valuable patents. * Switching Costs: The switching costs for Shake Shack is low. Customers face no hurdles when switching to other restaurants. So the company cannot leverage this factor to create a significant competitive advantage. * Network Effects: There is no network effects that help provide a competitive advantage. * Cost Advantage: The company does not have a substantial cost advantage over competitors.