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Shake Shack's Business Model Is Not Scaleable

Summary

Business model targeting upper income millennials and building restaurants in high traffic urban locations is not nationally scalable.

Competition in the burger market is much more fierce than for other fast casuals.

Overvalued on a P/S basis compared to both burger and fast-casual comps.

SHAK's business model targeting upper income millennials, and building in high traffic urban locations is not scaleable nationally at the same performance levels of current stores

Shake Shack (NYSE:SHAK) is successful because it is willing to invest in prime real estate locations that other burger chains may not be willing to invest in. For this reason, Shake Shack with its current portfolio of locations is able to successfully target the higher income urban customer better than peers.

However, I believe this business model is not scaleable on a mass scale. Currently, over 33% of Shake Shack's locations are in high traffic New York City locations with 7 of these being located in prime Manhattan locations. The majority of non-New York locations are located in downtown urban centers, or are near high-traffic urban shopping destinations. As Shake Shack expands, it will be forced to put restaurants in mid-tier locations that will bring the chain's overall average unit volumes down. Average unit volume is defined as sales divided by the number of stores open. Shake Shack even hints at this in the latest 10-K filing.

Additionally, many of our current domestic company-operated Shacks are located in urban markets. As we expand, this percentage will decline and as a result we may not be able to maintain our current average unit volumes ("AUVs") and Shack-level operating profit margins and our business, financial condition and results of operations may be adversely affected.

Lower average volumes per unit should compress operating margin as fixed costs are deleveraged over lower sales per store numbers. At the J.P. Morgan Conference in March, management admits to this by projecting new restaurants to...


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