Friday, January 2, 2015

Shake Shack Inc. (SHAK)

Wow, it's been a long time since my last post.  This wasn't an intentional break but just one of those things where times flies before you realize it.   It's been busy around here for various things (all good / normal things; nothing bad, thankfully).

Anyway, I noticed that Shake Shack (SHAK) has filed their S-1.  I do enjoy reading S-1's even though most of the time they are a complete waste of time (as Munger put it).  Value investors seek to buy assets on the cheap, and this happens only because Mr. Market is very emotional and overreacts.

For IPO's, though, this is not the case at all.  The investment bankers and companies decide both the time and price of the offering so obviously an IPO is not going to be grossly underpriced (even though one can argue that first day price pops suggest otherwise).  Of course, the bankers try to underprice it a little bit (15%?) to 'reward' IPO buyers and to make sure the deal gets done.

But having said that, I am such a big fan of SHAK that I had to take a look at it.

Chipotle (CMG)
I do have a confession to make before I go on.  I talk about value investing here but I do, at times, do things that are totally contrary to what I believe.  I do act "irrationally" sometimes.  For example, one of my biggest winners as an investment has been Chipotle (CMG).   CMG has never been a value stock.  But CMG is a company I have followed from their spinoff and have been a stockholder on and off ever since.  I have bought and sold it over the years, usually buying the dips and selling when it got expensive.  I had a bunch towards the end of last year (2014) and sold most of it due to valuation.

Why'd I take so long to dump it as it was pretty expensive for a while?  I held on just because of the operational momentum that CMG seemed to have (closet momentum investor am I?!).

There was a lot of bear talk on CMG, but that has been the case from the very beginning.  The view was that CMG is just another burrito place.  Where's the moat?  Where's the competitive edge?

This may not be interesting to most value investors (as this isn't a value stock), but since this is relevant to other fast food and fast casual restaurants, I thought I'd mention some things I've been thinking about.

First of all, CMG does not have the best burritos.  Many New Yorkers would be able to name a bunch of places with better burritos.  One of them is Calexico, which I think started in Brooklyn (I have no relationship with Calexico other than as a big fan; make sure to get crack sauce on whatever you order there!).   There are many other burrito places in NYC that are really good.

But here's the deal.  At most burrito places, you go up and order a burrito and then they start making it after you order it.  So it takes time.  That, right there, is the big factor.

At CMG, you get your food really fast.

Fast Service
This is a true story:  I usually only go to CMG right before lunchtime.  If I can't get there by 11:30 or something like that, I don't bother.  But one time (actually more than once) I did go during the rush.  The line was really long going all the way to the front door (the line was the full length of the store).  Out of curiousity, I looked at my watch and noted the time.   I got my burrito in five minutes.

Here's another true story:  Not too long after that, I was at McDonald's (MCD) and I was second in line.  And MCD wasn't crowded; I wasn't second in line with five or ten registers open.  I was second in line, period.  There was nobody else.  And it took me TEN minutes to get a happy meal (not for me) and a chicken club sandwich meal.  How does this happen?  I have no idea.   But it happens all the time.  I remember when MCD used to give something back (food is free or something) if you don't get your stuff within a minute or two.  Now it's a disaster whenever I go (and I do go to many different MCD's quite often).

The speed at CMG is really critical.  That is the key to their high margins (via higher throughput / volumes) and also to their happy customers.   I remember the hoopla surrounding the Noodles and Company (NDLS) IPO.  I love fast food and fast casual restaurants, so I was more excited about it as a place to go rather than as an investment.  But the fact that NDLS was run by ex-CMG guys got me curious as an investment too.

Unfortunately, I didn't get to try it out until I was in Washington D.C. last year.  NDLS is an interesting idea, but what I noticed right away is that their model didn't work in terms of speed and throughput like CMG.  It is certainly better than casual sit-down restaurants.  But you still had to sit down and wait for your food.  They were not going to get the volumes/turnover like CMG.    That doesn't mean that NDLS won't work out; it's just not the same model.  (At NDLS, you order your food like at a fast food restaurant and then you sit down and they bring the food to your table when it's ready.  So it's like a hybrid of fast food and sit-down.   Some people seem to like it as it's a little faster than a sit-down restaurant).

Ambiance
David Einhorn shorted CMG based on new competition from Taco Bell (among other factors).  First, I have to say that I really love fast food.  I really do.   When the YouTube video about pink slime went viral, the first thing that came to mind after watching the video was, damn, I want a Big Mac!

I love Taco Bell too.  One bummer about living in NYC is that we are often the last to get a chance to try out some of the new restaurant concepts.

But anyway, I do spend a lot of time at these places.

Having said that, when Einhorn said what he said about CMG and Taco Bell, I wondered if he ever actually ate at these places.  As much as I love Taco Bell, it is usually a nightmare of a scene.  You go at lunchtime and it's a totally chaotic mosh-pit.  When you get your food, you are basically climbing over people, fighting for a seat.  And then you have to squeeze between a bunch of slobs (like me) to get into a cheap plastic chair.

I love their food, but their premium and 'better' burritos still tasted like microwaved airline food (but I still like that sort of thing too).

Compare that dining experience with CMG.   CMG lines may be long, but it's a single line and usually pretty fast.  I usually get stressed at those MCD/Taco Bell mosh pits trying to get into a line and not getting cut out, and worried that someone else will take my food (after ordering it; where are we supposed to stand while we wait for the food?!) and I will have to reorder again.  Not to mention that they usually forget something and then you have to push your way to the front again to demand the missing item (I don't know if it's corporate policy to cut costs, but honestly, they almost NEVER put the barbecue sauce in a happy meal even though they ask you which sauce you want when you order!).   At CMG, it's quick and easy (and yes, a little more expensive, but that's fine).

Speaking of Taco Bell, it's run by the same folks that run KFC, another old favorite of mine.  I love KFC too.  But you know, it's a totally different experience.  The bathrooms are usually unusably disgusting and maybe this is just NYC, but there are often homeless people sleeping somewhere inside.  Oh, and even if you go to Taco Bell/KFC when it's not crowded (which I have done too), it is just really depressing to sit in those places; just horrible interiors and vibe  (And I say this as someone who actually likes the food!).

Oh, and the simple menus at CMG is key too.  It's not just that it's easier in the kitchen.  It's also easier for the customers. When the menu is so simple, you will never get that guy just staring up at a huge menu wondering what to get.

And the other thing that made me want to hang on to CMG for a little longer (I still own some, but not that big anymore) was their new A model restaurants.  The A models are smaller than the usual restaurants.  Some of these A model stores were grossing as much as their regular restaurants and maybe in some cases even more.

While many people thought that CMG was reaching saturation (with the low hanging fruit already picked), the success of the A model stores meant two things (at least two things; there are probably other things):  Higher returns (as their return on investments were much higher than their original models due to lower initial investment and similar AUV's) and more potential store locations (less saturated than they themselves thought at one point) since they were smaller (fit into more different places).

Having said all of that, CMG is an expensive stock and I can't really defend the valuation.

Oh, and one more thing about CMG.  I went down (to D.C.) and tried out their Shophouse Southeast Asian Kitchen and really liked it.  I would love for one of those (or more) to open in NYC.  There are a lot of authentic Asian places in the city, but then again, there were a lot of burrito places in NYC before CMG came along too (and yet, the lines are still really long at CMG here).

It seems like CMG is taking forever to expand that concept.  I do like that they take their time and perfect the model before trying to expand.   Expanding too quickly is probably one of the biggest mistakes at retailers / restaurants (check out Fairway Group Holdings (FWM), a New York City institution).

It was interesting as I read the SHAK S-1 to learn that it took them five years before they opened their second restaurant.   They really wanted to get it right before opening another store. So in that sense, it's good for CMG to take their time with Shophouse before expanding quickly.

Speaking of Shophouse, I recently stumbled upon this chain:  Wok to Walk.   It is apparently a chain that started in Amsterdam and is similar in concept to Shophouse.  But the key difference is that they actually stir-fry every dish in a wok when it is ordered (right in front of you, just like street food in Southeast Asia).  The food tasted great (but again, I'm not comparing to Chinatown; I am thinking of it as fast casual food, not restaurant food).

But of course, I got to thinking that with stir-frying everything each time it is ordered is going to limit the throughput there.  Think of how quickly CMG can assemble a burrito, and how quickly and instantly they can prepare your dish at Shophouse.  And then think about these guys at Wok to Walk actually heating something up in a wok one dish at a time.

Well, they can still do well.  Not everyone has to have the same model as CMG.  That's what I was thinking as I ate there ( I gotta keep an eye on the competition, right?).

By the way, what's up with the mozzarella sticks at MCD?   That's like the randomest thing.  Why?  It makes no sense to me.  Never mind.

SHAK
OK, so back to SHAK.

SHAK too feels sort of like CMG in many ways.

Here's the blurb from the S-1:
Overview of Shake Shack
        Shake Shack is a modern day "roadside" burger stand serving a classic American menu of premium burgers, hot dogs, crinkle-cut fries, shakes, frozen custard, beer and wine. Founded by Danny Meyer's Union Square Hospitality Group, LLC ("USHG"), Shake Shack was created leveraging USHG's expertise in community building, hospitality, fine dining, restaurant operations and sourcing premium ingredients. Danny's vision of Enlightened Hospitality guided the creation of the unique Shake Shack culture that, we believe, creates a differentiated experience for our guests across all demographics at each of the 63 Shacks around the world. As Shake Shack's Board Chairman and USHG's Chief Executive Officer, Danny has drawn from USHG's experience creating and operating some of New York City's most acclaimed and popular restaurants, including Union Square Cafe, Gramercy Tavern, Blue Smoke, The Modern, Maialino and Marta, to build what we believe is a new fine casual restaurant category in Shake Shack. 
        Shake Shack originated from a hot dog cart that USHG established in 2001 to support the rejuvenation of New York City's Madison Square Park through its Conservancy's first art installation—"I © Taxi." The hot dog cart was an instant hit, with lines forming daily throughout the summer months for the next three years. In response to this success, the city's Department of Parks and Recreation awarded Shake Shack a contract to create a kiosk to help fund the park's future. In 2004, Shake Shack officially opened and immediately became a community gathering place for New Yorkers and visitors from all over the world. Over the last decade, Shake Shack has become a beloved New York City institution that generates significant media attention, critical acclaim and a passionately devoted following. We have since grown rapidly, with 63 Shacks in nine countries and 34 cities. 
        Our vision is to Stand For Something Good in all aspects of Shake Shack's business, including the exceptional team we hire and train, the premium ingredients making up our menu, our community engagement and the design of our Shacks. Stand For Something Good is a call to action to all of our stakeholders—our team, guests, communities, suppliers and investors—and we actively invite them all to share in this philosophy with us. This commitment drives our integration into the local communities in which we operate and fosters a lasting connection with our guests. We continually invest in our "Shack Team," as we believe that team members who are treated and trained well will deliver Enlightened Hospitality and a superior guest experience. Through our leadership development program, The Shacksperience, we teach our team members the principles of Enlightened Hospitality and how to live and breathe our Shack Pact, the agreement that encompasses our value system and brand ethos. Our people make all the difference, as they embody the sense of community necessary to create the complete Shake Shack experience. This vision reflects our goal to be the best burger company in the world, for the world and for our team. 

I know, I know.  This is just another burger joint.  In-N-Out Burger, Five Guys, Habit Restaurants, who cares, right?

But for us New Yorkers, this is not just another burger joint.  It is one that was created by Danny Meyer, a pretty successful restaurateur.  But so what?  It's still just a burger, right?

Well, again, as in my comments about CMG, sometimes it's not just the food.  The food is important.  So is price.  But so is ambiance and the overall dining experience.  I really do like Five Guys too.  But it does feel like you're eating in an over-sized bathroom with loud 80's classic rock relentlessly pounding your eardrums (I love rock, so it's OK.  But still...).  It's a place that I like to eat when I need fast food, but I also want to leave right away when I finish (I guess that's good for turnover!).   The service at Five Guys, in my experience, has been pretty good.  Unlike, say, MCD when most of the time I feel like I am disturbing the employees by being there.

Growth
SHAK is growing pretty quickly now, but it seems like they are growing profitably, at least.  Contrast that with, say, again, Fairway Group Holdings (FWM).  Fairway Markets has long been a NYC favorite supermarket on the Upper West Side of Manhattan.  These guys were really good.  But they were taken over by a private equity firm and started growing quickly, and so far, disastrously.  I took a good look at them when they IPO'ed, but the rapid expansion scared me.  FWM was really great when they had a few stores in NYC, but I wondered how they would do growing so fast.  

Of course, in NYC, for a long time there was no Whole Foods or Trader Joe's, so FWM was a great alternative.  It was really a no-brainer running a decent supermarket in NYC as most large chains here were just awful.  But outside NYC, even not too far out, you had those major chains like Whole Foods and Trader Joe's but also regional competitors like Stew Leonard's (in Yonkers).  I don't know for sure, but I sort of think there must be a Stew Leonard's-like store in every region; somewhat upscale and better than the national chains etc.

Anyway, FWM might still work out over time, but who knows.  One thing I noticed reading the SHAK S-1 was that they smartly separated the financials of the Manhattan restaurants from the non-Manhattan ones.  This way, investors can see that the overall decline in margins and AUV's are due to expansion outside of Manhattan.  FWM didn't do that, I don't think, so their metrics just collapsed as they expanded.  Well, of course the metrics will collapse.  The Upper West Side store had extraordinary economics that would be almost impossible to duplicate, even within Manhattan! Their sales per square foot in the original store is just not replicable.

Maybe the bankers for SHAK noticed that and that's why they separated the Manhattan and non-Manhattan stores.   Maybe not.  Either way, it's a smart move.

Check this out on the growth of SHAK:
       Of the 63 Shacks, there are 31 domestic company-operated Shacks, five domestic licensed Shacks and 27 international licensed Shacks. We open Shacks in areas where communities gather, often with high foot traffic and substantial commercial density such as New York City's Theater District, London's Covent Garden and Dubai's Mall of the Emirates. We have been able to successfully grow across a variety of locations due to our versatile Shack formats and designs that are tailored to reflect each Shack community's core attributes. During the three fiscal years ended December 25, 2013, we grew from seven Shacks in two states to 40 Shacks across six states, Washington, D.C. and eight other countries, representing a 79% compound annual growth rate ("CAGR"). In fiscal 2013, our domestic company-operated Shacks had AUVs of approximately $5.0 million, of which our Manhattan Shacks had AUVs of approximately $7.4 million and our non-Manhattan Shacks had AUVs of approximately $3.8 million. During the three fiscal years ended December 25, 2013, our total revenue grew from $19.5 million to $82.5 million, a 62% CAGR, our net income grew from $0.2 million to $5.4 million, and Adjusted EBITDA grew to $14.5 million. For a reconciliation of Adjusted EBITDA, a non-GAAP measure, to net income, see "—Summary Historical and Pro Forma Consolidated Financial and Other Data."
GRAPHIC

You can just read the S-1 for most of this, but here is a cut-and-paste of what makes SHAK different:

What Makes Shake Shack Special
        1. Our culture of Enlightened Hospitality: taking care of each other.    We believe that the culture of our team is the single most important factor in our success. We aim to recruit and develop a team with the innate "personality to please" that cannot be taught. We look for people who are warm, friendly, motivated, caring, self-aware and intellectually curious team members, or what we call "51%'ers." We use the term "51%" to describe the emotional skills needed to thrive at the job and "49%" to describe the technical skills needed for the job. Our 51%'ers are excited and committed to championship performance, remarkable and enriching hospitality, embodying our culture and actively growing themselves and the brand. Our team is trained to understand and practice the values of Enlightened Hospitality: caring for each other, caring for our guests, caring for our community, caring for our suppliers and caring for our investors. These principles have been championed by Danny Meyer throughout his career and are detailed in his New York Times best-selling book Setting the TableThe Transforming Power of Hospitality in Business; they are fundamental to the way Shake Shack operates its business. We invest in our team through extensive leadership development programs to ensure that Shake Shack remains a great place to work and an exciting career choice for team members at every level. We have built a culture of active learning and we foster an environment of leadership development throughout the entire lifecycle of employment. We seek to be the employer of choice by offering above industry average compensation in most markets, comprehensive benefits and a variety of incentive programs, including a monthly revenue-sharing program with our employees. We believe that our culture of Enlightened Hospitality enables us to develop future leaders from within and deliver a consistent Shack experience as we continue to grow.
        2. Fine Casual: inspired food and drink.    We embrace our Company's fine-dining heritage and are committed to sourcing premium, sustainable ingredients, such as all-natural, hormone and antibiotic-free beef, while offering excellent value to our guests. Our core menu remains focused and is supplemented with targeted innovation inspired by the best versions of the classic American roadside burger stands. As a result of culinary creativity and excellence, we attract continued interest from partners such as award-winning chefs, talented bakers, farmers and artisanal purveyors who want to collaborate with us in different and engaging ways. We never stop looking for the best culinary ingredients and the best partners in order to exceed our guests' expectations in every aspect of their experience.
        3. Beloved lifestyle brand.    In Shake Shack's 10-year history, we have become a globally recognized brand with outsized consumer awareness relative to our current footprint. Shake Shack is a New York City institution, a vibrant and authentic community gathering place that delivers an unparalleled experience to loyal, passionate guests and a broad, global demographic. Born in 2004, Shake Shack grew up alongside the emergence of social media and has benefited from an ongoing love affair with passionate fans who share their real-time experiences with friends. We aim to establish genuine connections with our guests and the communities in which they live. Each Shack is localized with design and menu options that we believe drive a sense of appreciation and enthusiasm for the Shake Shack brand. Shake Shack has been recognized with numerous accolades, including Bon Appétit's "The 20 Most Important Restaurants in America" (ranked #16), TIME Magazine's "17 Most Influential Burgers of All Time" (ranked #7 for the ShackBurger) and winning "Best Burger" in 2007 and 2014 at the South Beach Wine and Food Festival's Burger Bash.
        4. Versatile real estate model built for growth.    During fiscal 2013, we grew the number of our domestic company-operated Shacks by 62% with the opening of eight new Shacks, and have opened 10 domestic company-operated Shacks during fiscal 2014. We will continue to not only fill in existing markets such as New York, Boston, Philadelphia, Washington, D.C., Atlanta, Chicago and South Florida to leverage operational effectiveness as we cluster in high-density markets, but also enter new markets, such as Austin, where we have signed leases. Although we currently have only 63 Shacks around the world, we have identified many attractive and differentiated markets for the Shake Shack experience. In major metropolitan areas, we seek locations where communities gather, often with characteristics such as high foot traffic, substantial commercial density, reputable co-tenants and other traffic drivers such as proximity to parks, museums, schools, hospitals and tourist attractions. For every potential domestic company-operated Shack we consider, we apply rigorous financial metrics to ensure we maintain our targeted profitability. We measure much of our financial success by analyzing Shack-level operating profit margins, cash-on-cash returns and payback periods. Our flexible model allows us to design our Shacks so that we can pursue a variety of property types. We have successfully launched different layouts and sizes of Shacks in varied locations throughout urban high density areas, suburban in-line and pad sites, regional malls, lifestyle centers, ballparks, airports and train stations. Each design is critical to the Shake Shack experience and we blend our core brand identifiers with features specifically designed for each Shack to be of its place and connect directly with its neighborhood. With a disciplined approach to new Shack development and a successful track record in site selection, we are positioned well for future growth.
        5. Shack-onomics.    Our brand power and thoughtful approach to growth have resulted in strong Shack performance across a variety of geographic areas and formats and during both strong and weak economic environments. Our Shack model is designed to generate attractive Shack-level operating profit margins, strong cash flow and high returns on invested capital. We have notable AUVs at both Manhattan Shacks and non-Manhattan Shacks. In fiscal 2013, our domestic company-operated Shacks had AUVs of approximately $5.0 million, of which our Manhattan Shacks generated AUVs of approximately $7.4 million with Shack-level operating profit margins of approximately 30% and our non-Manhattan Shacks generated AUVs of approximately $3.8 million with Shack-level operating profit margins of approximately 22%. Historically, our domestic company-operated Shacks have delivered an attractive average cash-on-cash return of 65% and payback period of 1.5 years, of which our Manhattan Shacks generated an average cash-on-cash return of 82% and payback period of 1.2 years and our non-Manhattan Shacks generated an average cash-on-cash return of 31% and payback period of 3.2 years. Since the vast majority of future Shacks will be non-Manhattan locations, we are targeting AUVs in the $2.8 to $3.2 million range, Shack-level operating profit margins in the 18 to 22% range and cash-on-cash returns in the 30 to 33% range.
        6. The Shack travels abroad.    With 27 licensed Shacks outside the United States, we believe that we have proven to be an internationally desirable restaurant concept. Our track record of opening successful Shacks in both the United States and overseas demonstrates the global appeal of Shake Shack and validates our belief in our significant whitespace opportunity internationally. We currently have license agreements for four major international territories, with Shacks operating in eight countries. The Middle East has been our most prominent growth market with 20 Shacks in operation, followed by Turkey with four, Russia with two and the United Kingdom with one. In fiscal 2013, our international licensed Shacks had AUVs of approximately $6.1 million, which resulted in license fees of approximately $3.5 million. In addition to license fees, we also receive exclusive territory fees, which help us fund further domestic growth.
        7. Leaders training future leaders.    Our team is led by passionate and experienced senior leaders, balanced with professionals formerly from USHG's fine dining operations and industry veterans from larger restaurant companies. Randy Garutti, our Chief Executive Officer, combines strategic multi-unit leadership experience with fine dining expertise. Randy has worked in restaurants since he was 13 and joined USHG in 2000 as General Manager of Tabla, followed by Union Square Cafe, and later took on the role of Director of Operations overseeing all USHG restaurants, prior to launching the first Shake Shack in 2004. Randy has led the development of the Shake Shack concept from its earliest stages and guided every aspect of the business. Jeff Uttz, our Chief Financial Officer, brings valuable experience managing high growth restaurant concepts drawing from his 22 years of restaurant finance experience, most recently as Chief Financial Officer at Yard House Restaurants. Jeff led the expansion of Yard House from three units when he began to over 40 units when Yard House was acquired by Darden Restaurants, Inc. Randy and Jeff are supported by a talented executive leadership team that has deep experience in operations, culinary arts, supply chain, finance and accounting, training and leadership development, people resources, real estate and design, construction and facilities, information technology, legal, marketing and communications.

 Here are some unit metrics to get a feel for the business:

Fiscal year ended Thirty-nine weeks ended
(Dollar amounts in thousands)
December 26,
2012
December 25,
2013
September 25,
2013
September 24,
2014
Other data:
Number of Shacks

21

40

33

53
Domestic company-operated          
13211626
Domestic licensed
3445
International licensed
5151322
Same Shack sales growth

7.1

%

5.9

%

5.5

%

3.0

%
Average unit volumes

 

 

 

 
Domestic company-operated Shacks          
$5,367 $5,017
Manhattan Shacks
7,0347,387
Non-Manhattan Shacks
3,7913,840
International licensed Shacks(5)
9,6656,077
Shack system-wide sales(5)

$

81,048

$

139,903

$

98,931

$

156,080
Shack-level operating profit margins(6)

25.6

%

26.0

%

27.2

%

24.7

%
Manhattan Shacks
29.0%30.3%31.7%31.2%
Non-Manhattan Shacks
19.8%21.9%22.8%20.8%
Adjusted EBITDA(7)

$

9,998

$

14,459

$

11,417

$

14,063
As a percentage of revenue          
17.5%17.5%19.2%16.8%
Capital expenditures

$

11,036

$

16,194

$

10,359

$

17,885
  
Labor Cost
And check this out.  I know this will be used by labor activists to try to boost the minimum wage, but I find this very interesting.  This reminds me of Costco (COST); they pay their employees well and they make plenty of money because of the higher quality of their work force as a result.  This is the opposite of many fast food chains and retailers that try to keep labor costs as low as possible (they pay for it in higher employee turnover (higher costs of training) and poor service (employees that don't care and treat customers as a nuisance (so often, I find myself resisting saying things like, "Excuse me, when you finish that game on your iPhone, can you take my order please?".  This never seems to happen at CMG or SHAK).

Labor and Benefits Costs
        At our domestic company-operated Shacks, we have historically provided a starting wage that is above the minimum wage in place for that particular state. For instance, in Manhattan Shacks, we start our new employees at $10.00 per hour even though the minimum wage in New York is $8.00 per hour. We believe that this enables us to attract a higher caliber employee and this translates directly to better guest service. Our desire is to continue to do so and, as such, there can be no assurance that we will generate same Shack sales growth in an amount sufficient to offset increases in minimum wage or other inflationary pressures. 

Good to Great to Gone
And by the way, I recently finished a great book;  Good to Great to Gone: The 60 Year Rise and Fall of Circuit City.   We've talked about the books Good to Great and Halo Effect here, so naturally, I had to read a book about one of the "Good to Great" companies that actually failed.  This is not just any old business book, by the way.  It is written by the son of the founder who actually ran Circuit City for many years.  Obviously, because of that, it may not be a totally objective, unbiased look at what happened.  But it is still very interesting.

It's not only a book about the history of Circuit City, but also sort of a history of the electronics retailing industry (which I always thought was very unstable and fast-changing.  We New Yorkers all remember Crazy Eddie, and then Nobody Beats the Wiz etc... )

So why do I bring this up?   Well, all of this stuff (Good to Great, Halo Effect) is always somewhere in my mind  when reading about businesses.

SHAK seems to have a great culture, and I can confirm that as a customer from my frequent visits to various locations (the food is great too, but I know I have no credibility as a food critic as I have already admitted to liking MCD and KFC food!).  I have also known about the reputation of Danny Meyer for years and have been a customer at his various restaurants over the years, so I know there is consistency in execution and getting the culture right.

But at the end of the day, I still think it's really about the people.  The big deal to me is that SHAK (although Danny Meyer is not the CEO of SHAK) has Meyer behind it.   Meyer is a passionate food guy and he has been executing amazingly well for decades.

I think this is why CMG is doing so well too; It is run by a real food guy, not some corporate guy.

PBPB
For example, Potbelly (PBPB) is another great idea; I do like the sandwiches there and think it's a cut above Subway.  I love that they heat the sandwiches, and the ambiance is definitely much better than a Subway (which tends to be pretty depressing if you eat-in there).  And it's much cheaper than Panera (PNRA).  I don't follow PBPB too closely, but I always scratch my head; how hard can this be?  Just open up a bunch of stores near PNRA and Subway; get the people who want something cheaper than PNRA (and maybe with a shorter line) and the people who want to upgrade from Subway.  Maybe that's what they are doing; who knows.

But the point here is that PBPB is not run by the founders anymore (they haven't been for years), and is now run by some corporate guy (a former Sears Holdings CEO, in fact.  OK, so he was with YUM Brands for a long time, but that sort of counts more as a "corporate guy" than a "food guy" in my book).

This is not to say that PBPB can't work out over the long term.

But for me, as an investor, it really makes a difference to me who runs an operation.  And it goes beyond just the culture (unless the culture has been proven through generations like at Goldman Sachs).

So What to Do with SHAK?
Well, first of all, we all know this is going to pop up a lot on the first day, especially since this brand is well-known to Wall Street (there is a Shake Shack, in fact, right across from the Goldman Sachs headquarters).  And Danny Meyer has been known for decades on Wall Street because of his restaurants.   Everybody is going to want a piece of SHAK.

I said I've owned CMG for years on and off, but I have to say that it is a rare growth stock investment for me.  I don't usually do growth stocks.  My only other high P/E stock at the moment is Costco (COST).

I will invest in high P/E stocks every now and then, but all the pieces have to be aligned; it has to be a really awesome company with awesome products and incredible management.  I have to constantly be impressed with both their financial performance, management, products etc.  It really has to check on all of those things.  And then of course, the price can't be that crazy.  I never paid 50x P/E for CMG (but have owned it at that level).

SHAK to me comes close to checking all the boxes in that sense, so it would be a potential rule-breaking investment.  I would temper the valuation risk by buying only a small amount if it looks crazy expensive.  Maybe I wouldn't touch it if it got insane.

So anyway, this is not some big overview of this sector.  There are a bunch of other companies out there like Habit Restaurants and Zoe's Kitchen, but as interesting as those places sound I can't comment on them as I have never been to any of their restaurants.

These are just some random thoughts that came to mind as I read through the SHAK S-1 (and sort of an excuse to make a post about something to break the silence here).

Oh yeah, and Happy New Year!



22 comments:

  1. Obviously you have a fast food obsession. No wonder you don't post often.Ever put the fork down? I am long CMG HABT PNRA DRI CBRL and CAKE but would be caught dead in any of them. absolute garbage. Thinking about SHAK after the IPO frenzy subsides.

    ReplyDelete
    Replies
    1. I used to eat mostly junk food (especially in college) but now it's a much smaller percentage of my diet. My BMI is normal, blood pressure and cholesterol are low etc...

      Believe it or not, I do pay like Marion Nestle and I love Michael Pollan so it's not like I am a total fast food junkie. I do balance that with a lot of veggies and non-processed foods most of the time.

      Delete
  2. REdanny Meyer..he's nothing more than a pretentious self promoting lesser known Bobby Flay wanna be.I remember when he opened the Union Square Cafe hoping to capitalize on it nearness to the farmers market,stealing a page off Alice Water's playbook. Plus he's chummy with snake oiled Cramer and helped him launch his cheap Mexican joint.He doesn't impress me at all.The trick to eating in NYC is finding the gems before the crowd and the NYTimes does. The tiny tapas bar on Elizabeth street opened by two very eager to please, authentic no bullshit, generous and talented Portuguese cooks who just landed in NY fresh off the streets of Albuferra.

    ReplyDelete
    Replies
    1. Yeah, that's the way I view most of these restaurateurs so it's no surprise you feel that way. I can only say that I have had good experiences with his productions and usually hear good things from others too. Of course, there is always some people that say he is overrated, overpriced etc... But I do think he runs quality operations. SHAK for sure is really well run and my experience there has always been really good.

      As for a relationship with Cramer, it doesn't matter. It's not a factor to me, unless he's getting food advice from him. If the advice is going the other way, who cares.

      And about eating in NYC, I agree. I tend to like local ethnic places (when I'm not at CMG or SHAK), and I am addicted to street cart food (mystery meat!), but don't get me started...

      Delete
  3. I too am a fast food fan and I'm not ashamed of it. Here are just a few observations:

    First - Amazing that Credit Suisse is not on the deal… the original Shake Shack is right there! What a slap in the face

    Second. SHAK is not really fast food.. Its throughput time is nothing like Chipotles - in my experience more like Noodles (from order to finish, not counting time waiting spent on line). The lines tells me there's a bit of brand prestige at work here - you certainly won't see people willing to wait 1 hour in line for Chipotle or McDonalds

    Third. If you say the market positioning for SHAK is quality and a little bit of prestige, then the question is can this really be scalable, and is it really wise to for them to go for scale? Why should this company even be public? According to the S-1 they've had the same butcher for NYC, MidAtlantic and Northeast Shacks from the beginning. I imagine it'll be a hard finding a consistent source of quality meat supply as you expand. Already, in Manhattan I think some of the stores have slightly different quality ( the Grand Central one is not as good for example), and I think if they're going with licensing/franchising strategy abroad, quality will be even harder to sustain.


    Finally, I agree the street will eat this up. This will easily trade at 20x EBITDA if not more. I think a fair price would be $500-600mm enterprise value, although people are already talking about $1bn valuation..

    ReplyDelete
    Replies
    1. Hi,
      Yeah, CS is right there at the park.

      And yes, I was not very clear; I realized that after posting. I didn't mean that speed and throughput is a big factor at SHAK. It is at CMG, but SHAK is not like that. But there are other things at the SHAK that is definitely better than others and the price is still very reasonable.

      As for scalability, I think they should be able to scale. They say they can do 450 stores domestically, but who knows about these figures. Might be more, might be less. Don't forget, they started as a hot dog stand so they can probably come up with varying models for different sites (when they have to). As for the price range and quality, I think people were concerned about CMG's growth too as being more upscale than the other fast food and they grew fine. Their supply challenges were significant too (antibiotic free meats etc.). But they were able to do it.

      As for quality as they expand, you are right. This is always a risk. We shall see if they can maintain their standards over time.

      We'll see how it goes.

      Delete
  4. A number of good things about this:

    - Nice write-up, as I didn't know much about SHAK, and will follow.
    - Really good to read (for me) that someone else had about the same thesis for CMG as I did. In addition to what you mentioned, I remember reading about how popular CMG was with college kids. That made an impression on me because they were going to be eating out for a long time. Finally, I actually thought it was a good value at a few points. I looked at it on an expectations basis to see what I thought was implied in the price, and felt they were not too high and that it could outpace the implied growth rate I felt people were placing on the future.
    - Finally, and the best thing about this write-up, is that you, as an institutional investor, identify yourself as a non-foodie, non-pretentious actual normal eater. The investors on twitter post more about food, wine, and what they are going to eat (all highfalutin stuff, mind you) than they do about investments. I really think you should take to twitter, anonymously of course, and start posting about your in-depth plans for dinner and then post a follow along with really high quality foodie type pictures of big macs and fries, etc.

    jw

    ReplyDelete
    Replies
    1. Hi,
      Thanks for the comment. And that's a great idea about twittering about food. I would love to make something contrary to what's usually out there in terms of food and wine. But that would be another time sink for me; I don't want to get involved with that...

      And by the way, most of the junk I eat is for lunch. I usually eat home-cooked for dinner (unless I'm on the road and there's nothing else; even I don't want to do MCD for dinner unless I have to!).or at an actual restaurant. The funny thing about restaurants is that nothing really beats cooking at home.

      Oh, and I am not currently an institutional investor.

      Thanks for dropping by!

      Delete
    2. I figured you didn't eat this stuff all the time, but at least you admit to actually stepping foot in these establishments. I'm telling you, really high quality, foodie pictures and stories about dining experiences at these places would be funny. If you get a bunch of free time, you have to do it, if, for nothing else the contrarian angle.

      A point about Noodles. I actually think their serving model (order and they bring the food, they clean-up, no tip) has promise, but probably not with them. It appeals to people with kids, who don't want to do dishes (Panera), etc. If someone could get a very efficient ordering "system" going with decent food, I think the turnover could be increased and lead to some success.

      Not an institutional investor? You must have been previously, right?

      jw

      Delete
    3. Hi,

      Yeah, I agree it would be a great blog/twitter material. Kind of like the Onion, even, but for real, lol... (people will think it's a joke, but it's not!).

      I think NDLS is OK and might do well over time, but also definitely not another CMG.

      I have worked on the street for many years, but not in any conventional value fund or anything like that (mostly proprietary/trading oriented).

      Delete
    4. My thoughts on NDLS are the same. I think if someone used the broad model and tweaked it, something in that format could do well. I am kind of amazed at comments about certain companies being the next CMG. Just one visit to each will tell the difference. My first visit to a Chipoltle made me almost giddy and the spidey sense kicked in without even comparing the food to other places. I thought: they can churn so many dollars/customers through here so fast that no one can match or compare.

      Interesting about your background. Do you invest long-term or trade more now?

      jw

      Delete
    5. Hi, sorry for the late response. I am mostly focused on long term now but if I see an interesting trade opportunity, I'll trade. But I want my long term investment decisions to be the primary determinant of my performance and trading p/l to be minor.

      Delete
  5. Hi KK,

    Have you read Danny's book Setting the Table? I thought it was a great book that gave some good insights into the restaurant world. The things talked about are pretty applicable to business as well.

    ReplyDelete
    Replies
    1. Hi,

      I just started reading it and am enjoying it.

      Delete
  6. What do you think about LOCO? SHAK seems a lot better than that dud of a company which has been dressed up to be the next CMG, but with more than 20 years of operating history available, has gone no where with what's a weak USP (IMO).

    ReplyDelete
    Replies
    1. Hi,
      I did take a look at that, but the thing with these food/retail companies is that it's really hard to judge without actually going to the stores/resturants (even though I would invest if there were other good enough reasons). So I have no idea about it. And the management there is recent so it's definitely not an owner/founder situation like CMG.

      Delete
    2. Maybe a little bit of topic, but if valuations of these things are so high (someone mentionet 20 EV/EBITDA), why not invest in QSR instead? You would have 3G as an owner operator, Buffett, Ackman on board, already we know that company can grow global, is hi quality business model and with a proven track record. And it seems that their story is just beginning?

      Delete
    3. Hi,
      I actually do own QSR. I guess that's a growth stock too. I forgot to mention it. I don't consider QSR a growth stock like SBUX, CMG etc. but more of a special situation.

      Delete
  7. Thanks for the follow-up and thank you for writing, your posts are really interesting!

    ReplyDelete
  8. This is one of my favorite posts of yours ever. Thanks so much for sharing your insights with the world. I, too, am a junk food junkie. If we ever meet up in Omaha or Brooklyn or somewhere, we'll have to do it over some fast food.

    ReplyDelete
  9. Good writeup. The space is too competitive for me though, as I've followed Biglari and Steak N Shake for quite some time.

    And you don't have to lie, we all know that happy meal was for you...

    ReplyDelete
  10. Really enjoyed your analysis and writings on shak. As someone who rarely(read never)bets on the market,I did purchase shak- at an admittedly too high price (I knew it would tumble,and it has) but I'm not too worried- I'm buying for the long term and think a well run co. with good product will do very well

    ReplyDelete