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Why Shake Shack's Stock Could Soar

Even though quick-service restaurant chain Shake Shack Inc. (NYSE:SHAK) has gained 75% over the last year, its strategy suggests it has further growth potential.

The company is diversifying internationally, ramping up its investments in online delivery and has a pipeline of new and increasingly innovative restaurants.

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Innovative strategy

The company's innovative strategy could differentiate it from rivals. For example, in the second quarter, Shake Shack added menu items that incorporate ingredients that can be bought from local sources, providing greater representation to the local community and reducing its environmental impact. This should resonate with customers since 87% of consumers have a more positive opinion of companies that support social and environmental issues.

Shake Shack is expanding the range of restaurant formats it operates. For example, during the quarter, it opened its first 24-hour roadside restaurant. The company has also expanded its presence at airports. Its increasingly innovative approach to restaurant locations could provide it with a relatively captive audience that is less price-sensitive due to a lack of alternative options. This may enhance its margins and improve its long-term financial performance.

Investing for growth

Shake Shack entered a delivery partnership with Grubhub (NYSE:GRUB) in August. The deal follows the company's successful implementation of an extensive delivery pilot phase that provided it with a large amount of data on customers' ordering habits and how effectively it's restaurants managed to balance their online and physical presence.

This should mean it has a deep understanding of its customers' preferences and the logistics involved in its delivery service. It will also change the layout of its new restaurants in order to make them as efficient as possible for an increasingly online-focused quick-service restaurant industry. This should enhance its competitive advantage in a market that is forecasted to grow at an annualized rate of 10% between 2019 and 2023.

In the first half of fiscal 2019, Shake Shack opened 21 company-operated restaurants. It plans to open between 38 and 40 restaurants in total this year, which will increase the size of its total addressable market and could boost its sales performance.

Potential challenges

The company's financial outlook could be negatively impacted by rising costs in the U.S. In the second quarter, for example, Shake Shack's labor-related expenses increased 90 basis points to 27.2% of total sales.

The restaurant chain also recorded an increase in food and paper costs, with their proportion of sales increasing 90 basis points to 29%. Shake Shack also experienced increasing food supply costs, which could continue to put pressure on margins over the medium term.

Shake Shack's international growth plans could diversify its operations and reduce its dependence on the U.S. In August, it announced a new strategic partnership to expand its operations in China following the opening of a restaurant in Shanghai in the first quarter. As part of this initiative, it will open 15 restaurants in Beijing over the next decade.

In addition, it will invest in its global supply chain and strategic partnerships. This will expand its operations into other regions after opening restaurants in the Philippines, Singapore and Mexico in 2019.

Outlook

Analysts project Shake Shack's earnings per share will grow 25% in 2019, followed by 20% growth in 2020. Although the price-earnings ratio of 194 is high, the company's growth strategy suggests it has investment appeal.

Disclosure: The author has no positions in any stocks mentioned.

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This article first appeared on GuruFocus.