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Be Smart and Take Your Profits on Shake Shack Inc Stock

Dana Blankenhorn

Shake Shack Inc (NYSE:SHAK) is on a similar trajectory as Krispy Kreme, the doughnut shop that wowed markets in the wake of the dot-com collapse, but eventually fell to Earth.

After what was considered a blow-out quarter, with net income of nearly $5 million, or 13 cents per share, on sales of $99 million, SHAK shares jumped 20% over the course of two days.

Now they’re falling, as smart money sells, like director Leonard Green, who recently turned about 627,000 shares into $36.9 million in cash. That’s just one-third of his stake. He still has 10% of the company, but his stake is now house money. Shake Shack has been very, very good to Leonard Green.

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The question is whether Shake Shack could be any good to a small investor.

The New Krispy Kreme

Jim Cramer says noJP Morgan Chase & Co. (NYSE:JPM) also says no.

Their opinions are based on valuation. Even with the slight comedown off Green’s sale, Shake Shack has a market cap of $2.14 billion, on trailing-year sales of $358 million. The company is expecting 2018  revenue of $444-448 million, so you’re paying almost five times sales for the stock.

That’s not hamburger. That’s gold.

Krispy Kreme had a similar run. As it grew, while tech stocks were shrinking, it attracted a valuation of about $40 per share in 2002. Eventually, however, people realized it was just a doughnut chain. It finally sold to JAB Holdings in 2016 for $1.35 billion, or about $21 per share.

History says there’s only one fat profit on a restaurant concept, and that it’s already in the stock. At the end of the day, a hamburger is a hamburger. “It’s all just ground beef on a bun, y’all,” wrote Debbie Moose of Charlotte, North Carolina, which is just 80 miles down the road from Krispy Kreme’s old offices in Winston-Salem.

Reason for Hope?

There is reason for hope in Shake Shack’s latest quarter: Same-store sales were up.

But sales were up because customers were hit with a price hike of about 6%. More price hikes are likely coming, as meat prices continue to rise. Shake Shack’s future is tied to its ability to blanket the country with stores, as predecessor chains like McDonald’s Inc. (NYSE:MCD) did, and then to generate profit through store ownership on a par with what larger companies do with a franchised model. (McDonald’s is worth $129 billion on annual sales of $22 billion.)

Shake Shack expects to open 50 stores this year, 32-35 of them company-owned and 16-18 of them licensed. (It licenses international operations and runs the domestic chain itself.) About $4.1-4.2 billion of those sales will be in the domestic chain.

Shake Shack has 12 analysts following it, evenly split among buy, hold and sell, although sell has been picking up steam as the stock price rises. The average price target is now $49.80, close to JP Morgan’s figure.

Bottom Line on SHAK Stock

Wall Street has turned thumbs down on the Shake Shack story, and the biggest profits have already been made.

But it should be said this is a good company, a well-run company. At some point the bears are going to drive the shares down to buy territory, as the general market becomes more volatile. When the big-money boys leave, you may have a good company at a reasonable valuation, which would be $30 per share or roughly 2.5 times current sales.

Shake Shack could, in time, generate fat profits by franchising successful stores to corporate partners. That would earn it a McDonald’s valuation.

But you’ll have to wait for it.

Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this story.

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