Shake Shack: Wall Street Seems Too Bullish On Q2 (NYSE:SHAK)

Juanmonino/iStock Unreleased via Getty Images Shake Shack Inc. (NYSE:SHAK) is expected to report the company’s Q2 results near the 1st of August. While the stock has recently fallen amid a weak short-term industry outlook, Shake Shack still looks to carry a weak risk-to-reward going into the earnings. I previously wrote an article on the company, titled “Shake Shack: Priced With Too Much Growth Anticipation”. In the article, published on the 6th of May, I went over Shake Shack’s long-term financial profile, including strong growth but a weak profitability. I initiated the stock at a Sell rating due to a vast overvaluation with my financial estimates. After the article was published, Shake Shack has lost -20% of its value compared to the S&P 500’s (SP500) return of 8%. My Rating History on SHAK (Seeking Alpha) Upcoming Q2 Report: Beware of Weak Industry and Bullish Wall Street Estimates Shake Shack’s Q2 report, likely being reported within the next couple of weeks, is expected by Wall Street analysts to show revenues of $314.5 million, representing a year-over-year growth of 15.7%. For the EPS, analysts expect a normalized figure of $0.27, up significantly from just $0.18 a year ago in Q2. The company guided for revenues of $308.9-314.3 million in the Q1 shareholder letter at the start of May, driven by around 10 company-operated openings and 8-9 licensed openings, and an expected low single-digit Same-Shack sales growth. Analysts seem to expect revenues to exceed the guidance. The expected profitability improvement is also significant, seemingly exceeding Shake Shack’s own guidance. The restaurant-level profit margin is expected at 21.5-22.0%, up slightly from 21.0% in Q2/2023, whereas the EPS is expected to increase by nearly 50%. SHAK Q1 Shareholder Letter Wall Street analysts’ estimates are especially high considering the current restaurant industry’s performance – slower traffic is slowing down sales across restaurant chains with a very slow expected recovery, already shown in many companies’ financials. For example, Denny’s Corporation’s (DENN) comparable restaurant sales declined by -1.3% in Q1, The Wendy’s Company’s (WEN) same-restaurant sales only grew by 0.6% in the US, and Red Robin’s (RRGB) declined by -6.5%. Shake Shack continued to perform better than the mentioned companies at a Same-Shack sales growth of 1.6%, though. Comparable restaurant sales essentially drive margins due to the high share of fixed costs, and drive revenue turbulence over the short term, making the metric critical. The strong estimates do still have some merit, as Shake Shack did communicate to have an incredibly strong 4.9% growth in Same-Shack sales in April, up significantly from Q1. The momentum was driven by flat traffic and price increases as told in the Q1 earnings call, achieved by successful, higher marketing spending to drive traffic in the weak industry despite price increases. Shake Shack communicated that the price increases’ effect on Same-Shack sales growth will start tapering off from May forward, though. I believe that investors should take the Wall Street estimates with skepticism, as they exceed the company’s own beliefs despite continued weak industry traffic. Shake Shack Appointed a New COO Shake Shack announced on the 17th of June that Stephanie Sentell has been appointed as the company’s new Chief Operations Officer. Stephanie Sentell brings 11 years of expertise from Inspire Brands, where she worked as a Senior Vice President of Company Operations among other roles. In my opinion, the appointment seems like a reasonable move to drive future growth with outside expertise, with the appointment following the prior change in CEO where Papa John’s previous CEO Rob Lynch was named as Shake Shack’s new CEO. The Stock’s Valuation Is Still Highly Unattractive While major updates aren’t due for my discounted cash flow (DCF) model, I have slightly lowered revenue estimates for 2024 and 2025 due to industry weakness, still representing the same 11.7% CAGR from 2023 to 2033 and a 3% perpetual growth afterward. I again estimate the long-term EBIT margin to be 8.0% and for the cash flow conversion to gradually improve with slower anticipated growth. For a more thorough explanation of the estimates and the drivers behind them, I refer to my previous article on the stock. DCF Model (Author’s Calculation) The estimates put Shake Shack’s fair value estimates at $37.11, 56% below the stock price at the time of writing. While the stock has already fallen, I believe that the stock still has a poor risk-to-reward unless the Same-Shack sales continue well into the future with the communicated April performance raising profitability. CAPM A weighted average cost of capital of 10.88% is used in the DCF model. The used WACC is derived from a capital asset pricing model: CAPM (Author’s Calculation) I again estimate a low 0.83% interest rate and a low 10% debt-to-equity ratio. To estimate the cost of equity, I use the 10-year bond yield of 4.22% as the risk-free rate. The equity risk premium of 4.11% is Professor Aswath Damodaran’s estimate for the US, updated in July. I again use the 1.81 beta. With a liquidity premium of 0.25%, the cost of equity stands at 11.91% and the WACC at 10.88%. Takeaway Shake Shack’s Q2 is expected to be strong by Wall Street, even exceeding the company’s own expectations. With a continued weak industry, I believe the estimates to likely be too high. The very great April growth in Same-Shack sales is expected to come down from May forward as told in the Q1 earnings call. With continued slow traffic across the industry continuing after the call, there appears to be a good likelihood for an earnings miss. The stock continues overvaluing Shake Shack’s long-term financial potential in my opinion, and as such, I remain at a Sell rating for the stock.

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