SHAK: Should You Flip Shake Shack Stock?

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Shake Shack (SHAK), that hip hamburger chain restaurant which serves mouthwatering, all-natural beef burgers has been on a roll, and we’re not talking about bread.

SHAK Stock - Should You Flip Shake Shack?Or are we?

Since Shake Shack stock was offered to the public in January of this year, the stock price has rallied a staggering 60%. The story of a restaurant that began as a small Big Apple-based hot dog stand and grew into a $2.8 billion company is Wall Street’s version of a Disney fairytale.

But unlike Hollywood, Wall Street has a tendency to turn happily-ever-after fairytale endings into Greek tragedies.

The question is: Which will it be for Shake Shack?

Is SHAK Worth the Premium?

There are various reasons why an investor might pay a premium for a stock. It could be a matter of stability, potential dividends or more commonly, at least in smaller stocks, a high growth potential. Of course, Shake Shack, with its exceptionally high valuation, should be judged as a growth stock.

But even premium stocks need to be fairly priced.

The first thing I check into when focusing on a growth stock is the price/earnings-to-growth ratio, which essentially adjusts the company’s price-to-earnings ratio to its growth. A PEG ratio of more than 1 means that potential growth has already been priced in by the market, more or less; a ratio of less than 1 means that potential growth hasn’t yet been priced in.

That said, I prefer to use EBITDA rather than straight earnings, to back out the inconvenient “noise.” Well, in Q1 2015, EBITDA grew 94% year-over-year; couple that with a P/E of roughly 100, and you get a PEG ratio of 1.06.

So even backing out expenses and other things, Shake Shack stock still is a little overpriced. And obviously in the real world, you can’t simply ignore inconvenient expenses like taxes, or adjust your earnings to your convenience.

Its simple PEG based on pure earnings and expected five-year earnings? A whopping 19.

Growth Per Branch

Let’s dive into the mechanics of the business even deeper — how the individual branches are doing.

According to Shake Shack’s Q1 report, “same-Shack sales” (stores open for at least 24 months) rose by 11.7% from Q1 2014. Moreover, the weekly average sales per Shake Shack branch rose to $89,000.

Those numbers look pretty tasty, right?

Well, they might not be as palatable as they seem. Shack Shake has attributed much of that growth to higher menu prices — increases that were offset by increased costs of basic ingredients such as Angus beef, which frequently suffers from tight supply lines and a congruent surge in prices.

Meaning little of that price increase has actually translated into higher profits.

Forget Profits

When it comes to a so-called premium product, the basic business model is “We don’t sell many hamburgers, but we earn more per sale.” After all, what’s the point of making a premium product if it’s not very profitable?

How is Shack Shake doing on that front? Unfortunately, not very well.

Let’s look at a head-to-head comparison against Chipotle (CMG) — another “premium” fast-casual chain. A Chipotle branch makes, on average, $47,538 per week of sales or roughly half that of Shack Shake’s $89,000 per branch. So far, so good.

Here’s where it gets sticky: A Chipotle branch generates roughly, on average, $250,000 of annual net profit after taxes. Comparatively, a Shack Shake location earns, after some adjustments to “one-time costs,” $241,000 … and that’s before taxes.

In other words, Shack Shake is not leveraging its premium price into premium profits.

In fact, if we were a little less generous in our calculations and actually used no adjustments, the company’s operating in the red.

That’s a long way of showing that, simply put, Shake Shack is losing money.

Good Luck With the Middle East

Did you know that Shake Shack concentrates its franchising efforts overseas? That’s probably not a surprise; after all, many U.S.-based chain restaurants do.

What might surprise you are the specific locations. Shake Shack has franchises in the U.K. and, believe it or not, the Middle East. Yes, that’s right, the Middle East — the single-most unstable region in the world, with countries falling into chaos one by one.

While it might be that the Middle Eastern countries in which Shake Shack currently operates haven’t crumbled, what about in the long run? In this world, while nothing is ever certain, that much uncertainty makes it difficult to understand Shake Shack’s rationale for basing so much activity overseas.

Ready to Be Grilled?

The bottom line is that Shake Shack is highly priced, even for a well-run company, and at the moment, indicators suggest SHAK isn’t all that well-run.

The burger business and the fast-food business might have a great run, and there are some terrific stocks in that space. But if you’re planning to ride it with Shake Shack stock, and hoping for some juicy profits, you might get grilled in the end.

As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/06/shak-should-you-flip-shake-shack-stock/.

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