Shake Shack May Have a Bumpy Road Regardless of Earnings

Shake Shack (NYSE:SHAK) is scheduled to report earnings after the market closes on February 24. This will be one of the first quarter that analysts will get a chance to digest the effect of Shake Shack moving to a single digital delivery provider, Grubhub (NYSE:GRUB). After the company reported third-quarter earnings, some analysts expressed concerns that forcing consumers to use one delivery app, particularly if they do not currently use GRUB, could be an impediment to sales.

On February 21, SunTrust lowered its price target on SHAK to $79 from $82. The stock was down 1.5%. However, Shake Shack stock outperformed the broader market in 2019. Despite a large pullback in October, SHAK stock is up nearly 45% over the last year as compared to 21.6% for the S&P 500.

The company continues to open new stores

Analysts have been encouraged by Shake Shack’s plans to expand its nationwide footprint. When the company issued its first initial public offering (IPO) five years ago, the company boldly theorized it could expand its reach to 450 domestic, company-owned locations. All Shake Shack’s U.S. locations are company-owned (I.e. no franchises).  As of January 2020, the company had 151 locations and is now adding approximately 40 every year.

One reason for the company’s optimism is what CEO Randy Garutti termed “white space”. According to Garutti, the company is far from saturated in the United States. Only nine states have over five locations, leaving plenty of room – theoretically – for the company to expand.

The company is also not limiting itself to the traditional restaurant format. The company is popping up in “disruptive” locations such as airports, food courts, and event spaces (i.e. ballparks, arenas).  And as the company is expanding, they are doing so with an eye towards the expanding role of digital delivery. This is similar to how Chipotle (NYSE:CMG) is redesigning its restaurants to accommodate mobile delivery.

And, also according to Garutti, the company is not shy about cannibalizing its own locations. Meaning consumers could find a Shake Shack inside a mall food court, and see another one in a location outside the mall nearby.  However, some analysts have a mixed opinion of this strategy as they suggest that prioritizing market share ahead of revenue may work to the chain’s detriment.

Growth is a double-edged sword

For all the talk of growth, there are two significant concerns that analysts will be paying attention to when Shake Shack releases earnings. First, the company announced plans to expand its footprint in China. The company currently has three locations in Shanghai and one scheduled to open in Beijing. Garutti suggested that China represents a large opportunity.

However, those remarks occurred before the outbreak of the coronavirus. Many investors will be wondering how the virus will affect future growth plans. But they’ll also be looking to see the effect on current revenue. Although the virus will not affect the numbers for the quarter just ended, investors will be looking at the company’s forward guidance.

The second concern is that, in the third quarter, Shake Shack was already showing signs of softening same-store sales. Same-store sales are a key metric for projecting future revenue. Heading into earnings, Fact Set’s forecast for Shake Shack’s 2020 same-store sales growth is 0.7%. Analyst Jake Bartlett wrote, “As Shake Shack transitions to a single delivery partner and focuses on in-filling markets, visibility on positive same-store sales is unusually low.”

Digital delivery is getting more contentious

While there’s no question that the food delivery business is growing and thriving, it seems that some restaurants are beginning to punch back. According to Crain’s Chicago Business, a lobbying group that represents 800 Chicago restaurants is pressing the local government to impose new food-handling and cleanliness rules on food delivery services.

Additionally, the food delivery companies are facing the possibility of having to comply with legislation, such as the “gig worker” law that recently passed in California. This would require food delivery services to treat their drivers as employees, rather than independent contractors.

On the one hand, this could be good news for Shake Shack. By narrowing their food delivery companies to GRUB, they have the ability to work out a mutually beneficial arrangement. The thinking would be that having a monopoly on Shake Shack’s business should make it easier for the two sides to create a pricing structure that helps margins on both sides. And Shake Shack would be in a position to ensure that Grubhub complied with its food safety regulations.