U.S. Markets close in 1 hr 10 mins

Why Shake Shack Has Stock-Price Growth Potential

- By Robert Stephens, CFA

Plans to invest in the customer experience could boost premium burger company Shake Shack (SHAK)'s stock price performance.

To achieve this, it is increasing staff pay, while also focusing to an increasing extent on innovation. An expansion of its store estate could strengthen its financial prospects. Although the premium burger industry is becoming increasingly saturated in the U.S., the company plans to expand abroad - especially in Asia - where it sees significant growth opportunities.


Having risen 36% in the last year versus a 4% gain for the S&P 500, the stock could offer investment potential.

2035114118.png

Investment plans

Shake Shack is implementing a compensation incentive scheme for its general managers, which includes bonus potential in order to more closely align them with the company's goals. A sense of ownership among the company's staff could help to deliver a higher level of customer service. The company has also promoted 1,100 staff members in the last year, which could lead to higher morale and an improved customer experience.

The company is investing in new formats, such as a premium food court Shack in a mall in Miami. This was the first of this type of format, with the results being encouraging. It also has deployed two Shack trucks in New Jersey and Atlanta in order to serve customers in a variety of locations and events.

Investment in innovation includes the opening of its Innovation Kitchen last year. This has led to the creation of a number of new food items. Further changes to its menu are expected, with the company moving to a monthly Shake program. This is expected to maintain a novelty element to the customer experience, with the company varying its flavors with increased frequency to encourage more regular customer visits.

Evolving strategy

Shake Shack is set to continue to rapidly expand the size of its store estate. It opened in eight new major markets within the U.S. in fiscal 2018, which means that over 80% of its locations are now outside of its home city of New York. It plans to open a further 36 to 40 company-operated Shacks in 2019 and concentrate more on established markets where it intends to focus on the efficiencies that can be leveraged.

The company also expects to continue to evolve its marketing function. In the last year it has launched strategic partnerships with brands such as American Express (AXP) and Bumble, as well as a range of influencers. This has helped to broaden its customer demographic and increase awareness in new markets. It is investing capital in streamlining and automating its businesses processes. This is aimed at reducing the amount of administrative duties that are required at its locations so that staff can focus on delivering higher levels of customer experience.

Risks

Growth in the number of premium burger chains across the U.S. could pose a threat to Shake Shack's financial outlook. Although such restaurants have proved popular in recent years, the industry may be moving closer to saturation point, with the company's sales at existing stores remaining relatively flat over the last two years. This may mean that although total sales could increase as a result of the company's aggressive expansion strategy, comparable sales and margins may come under pressure over the medium term.

In response, the company is expanding internationally. Its largest focus is Asia, where it now has two locations in Hong Kong and 12 in Japan following recent openings. Further expansion is expected in established Asian markets, while it has recently opened its first store in mainland China. It intends to open further stores in the country, hoping to make it a significant part of its new store pipeline. In order to facilitate this growth, it will open its first international office in Hong Kong this year, having permanent resources on the ground in Asia for the first time.

Verdict

With a forward price-to-earnings ratio of 76, Shake Shack's value appeal may appear to be limited. Its growth strategy, though, could lead to significantly higher earnings over the long run. Plans to invest in Asia, and particularly in China, could boost the company's growth rate, as well as improve its diversity.

Innovation and an evolving marketing strategy have the potential to broaden its appeal to include a wider variety of customers. Improvements to the customer experience could also enhance its competitive position and create a wider economic moat.

Having made significant stock price gains in the last year, the company could continue to outperform the S&P 500 over the long run.

This article first appeared on GuruFocus.