Monday, February 3, 2020

A Possible AIM Small Cap Equity Holding: Shake Shack Inc. (SHAK, $82.77): “Stale Shack”

Shake Shack Inc. (SHAK, $82.77): “Stale Shack”
By: Luca Cardamone, AIM student at Marquette University

Disclosure: The AIM Equity Fund does not currently holds this position, but is considering the position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.


Shake Shack Inc. (NYSE: SHAK) is a casual fast-food chain that offers non-GMO products such as all-natural hamburgers, hot dogs, custards, craft beer, and wine. The New York based company operates through more than 200 stores that are strategically located in food courts, airports and urban areas. The company is expanding domestically and internationally through company owned (~58%) and company licensed Shacks.

• On August 2019, the company entered an integrated partnership with Grub Hub (a food order and delivery website) in order to promote growth from delivery and improve digital presence.

• After positive results in Hong Kong and Shanghai, Shake Shack agreed with Maxim's Caterers and decided to expand in China. The company plans on opening 15 stores in Beijing over 10 years, beginning in late 2020.

• The company recently launched an innovation kitchen that elaborates new recipes to attract and please customers. The innovation kitchen creates and tests possible new menu items and LTO (limited time offers).

• Food and paper costs in the quarter were 29% of Shack sales, an increase of 90 basis points over the prior year.

Key points: 

Shake Shack is one of the many fast-casual restaurants, a concept that is quickly gaining popularity. Despite SHAK being in this sector, management is not focusing in improving its menu and product quality. Even if it’s true that the company offers non-GMO items and hormone an antibiotic-free beef the company is not keeping up with the leading peers that are offering more variegated healthy alternatives such as lower calorie food, reduced sugar, and reduced sodium options. This could be a potential area to improve that will help the company to gain success over the others as one of the main company’s struggles is to capitalize on food.

On the other hand, the company is focusing its growth on technology, innovation, and global expansion. As of now, the company has 245 stores, over 16 different countries with mainland China being the main target for the expansion after the success in Hong Kong and Shanghai. SHAK is focusing on technology as demonstrated by the “project concrete”. This project involves electronic kiosks that are going to substitute the regular cashiers to achieve faster ordering and processing. After a fully automated and cash-free store was tested in New York and resulted in customer backlash, the company decided to opt for a combination of kiosks and cashier stores so that customers can be educated during this technologization.

The company has invested in an innovation kitchen that is creating new dishes to attract new customers and keep engaged the old ones. Depending on the response to the new item SHAK decides whether keeping the new dish in the menu or promote it as an LTO (limited time offer). Chick’n Bites is an example of an item that management decided to keep on the menu due to high consumer requests. However, this product is negatively affecting the company in terms of profitability as SHAK is incurring higher food and paper costs. Costs are driven higher also from higher packaging costs due to increasing deliveries due to the recent partnership with Grub Hub.

Since October 2018, the company ESG rating has been lowered from 'A' to 'BBB'. The downgrade is mainly due to the recognition that the management efficiency is average and similar to its peers.

What has the stock done lately?

SHAK was incorporated into the AIM small cap equity fund on December 2nd, 2016. The stock was purchased at a price of $35.75 and since then it increased to $82.77 with a possible profit of 131.52%. After a progressive increase over time reaching an all-time high of $105.84 in September 2019, the stock started falling due to decreasing margins and free cash flow. Over the last month, the stock sank ~11%.

Past Year Performance: 

Since last year, SHAK has increased ~79% in value. Sales increased by 31.32% and net income rose by 18.81%. However net margin fell by 9.63% along with operating profit margin that was down 2.7% over the year due to higher costs for food and expansion. The store number increased by 17.79% while average sales per store decreased by 35%. Due to the company incurring greater marketing expenses, and labor inflation, operating and labor expenses rose as well respectively by, 40 and 90 basis points.

Source: FactSet
My Takeaway

SHAK has been a great stock to hold for the AIM small cap fund however, it is time to capitalize on the gain. The company is in a very sensitive period as expansion and rising costs are driving the company’s margins lower affecting the stock price. The different risks connected to the company are not worth holding the stock longer. SHAK is in a phase in which results are lacking and the fact that most of the management is selling the stock is not an auspicious sign. Indeed, it should be a clear hint and confirmation that it’s time for the AIM small cap fund to get out of the long position.  

Source: FactSet