Shake Shack is Still a Short
Casual dining companies have always commanded a high valuation, but none of those valuations seem as ridiculous as Shake Shack’s (SHAK). Despite losing considerable value over the last one month, Shake Shack still commands a market cap of almost $1.8 billion. What makes the valuation even more ridiculous is the fact that Shake Shack operates less than 100 outlets. I’m not saying that the company will not grow into the valuation in the future, the stock is clearly overvalued. However, given the stock’s valuation, I think the stock is a good short.
Why still a short
Everyone has witnessed the Chipotle’s (CMG) trailblazing run over the last ten years, and this might be one of the reasons why Shake Shack had risen to over $95 from its IPO price of $21.
Stocks that are driven by momentum and hype tend to be very volatile, and even the slightest piece of bad news can push it into a downward spiral. Shake Shack is expected to post nearly $180 million in revenues in FY2015, and even a narrow estimate miss can push the stock to new lows. $180 million in revenues is very low considering the market cap of Shake Shack, however the company needs to deliver double-digit revenue growth for years to come in order to sustain its current valuation. According to Yahoo! Finance, Shake Shack’s revenue is estimated to grow only 26% in 2016 to $227 million. A 26% is definitely impressive, but given Shake Shack’s lofty valuation, it will be years before the company can justify its present valuation. In other words, investors have already priced in at least the next five years of the company’s growth.
Although Shake Shack’s balance sheet has improved considerably, the company still doesn’t have funds to expand at a rapid pace. The company has over $64 million in cash versus total debt of under $313,000. However, the company will need to open thousands of more outlets in order to grow into its present valuation, and it will definitely need a lot of cash to do that. Given that the company doesn’t have enough funds to opens thousands of restaurants, it will soon look to raise funds and considering the stock’s sky-high valuations, it’s likely that the company’s management will initiate another secondary offering in the foreseeable future.
With a forward P/E of roughly 160, Shake Shack is clearly not worth the risk despite the fact that it has a lot of room to expand its business. By comparison, Chipotle Mexican Grill is still trading at 35x forward earnings and is slowly expanding internationally. Moreover, unlike Shake Shack, Chipotle doesn’t franchise any of its restaurants so as to maintain high brand quality. Chipotle is clearly a better investment on every metric, and it still has upside potential. Investors are expecting too much from Shake Shack, and the growth expectations will likely prove difficult for the management to deliver.
Although the interest rate of borrowing Shake Shack’s stock is high, I think investors should short the stock and invest in a better and more established business with great growth potential like Chipotle. I don’t think Shake Shack’s management will be able to deliver the growth investors are hoping for, and the stock will eventually fall. Given the risk/reward ratio, Shake Shack is a good short candidate.
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