Shake Shack (SHAK) is an casual restaurant chain based in New York City featuring designer shakes, burgers, and other quick-style food. As an investment, it has traded at a premium valuation for some time, and is currently in the middle of a 52-week range:

(Click on image to enlarge)

Source: Yahoo Finance

What we like about the name is that it has expanded its menu to attract new customers. It has really turned into a tiny operation, which began as a simple food cart inside Madison Square Park in 2004, and as its popularity steadily grew, moved into physical locations. The growth is looking impressive over the next five years.

Shake Shack is a growth/expansion play. Management is actually targeting 450 domestic company-owned locations, up from the just over 90 It has now. With these restaurants, it is targeting $700 million in revenue, up from just $359 million in 2017. The question is, can you buy the stock here? Or are you simply chasing revenues at the expense of other metrics?

Revenue growth continues to Shake Shack because it is continuously expanding. In the most recent quarter, revenues were higher on the back of new stores being opened, but did not get much help from same store sales. Same store sales were positive, and we were looking for -0.5% to 0.5% growth on this metric. Same store sales came in at 0.8% for quarter. This is down substantially versus 1.5% growth in the fourth quarter last year. This is the most important indicator that we look for.

It is tough to justify getting behind a new growth name when same store sales are this weak. Some will argue that the growth of the company offsets this issue. Others will argue that these comps are tough to gauge given the little time new shops have been open. Still, we maintain that declining comparable sales are due to a combination of lower weekly sales volumes per stores, in addition to flat traffic. That is a problem, regardless of the new shops being opened. While this was partially offset by higher prices and better sales mix, this is very disappointing. Keep an eye on this metric going forward.

Now, again, sales are up with authority. Expenses however need to be kept in check. Total operating income did jump 17.0% to $5.8 million for the fourth quarter of 2017 from $5.0 million in the same quarter last year. However, operating income margins decreased 70 basis points to 6.1%. Be that as it may, the stores are insanely profitable. Store level profit increased 30.3% to $23.5 million in Q4 from $18.0 million in the same quarter last year. However, the cost of sales is rising because as a percentage of sales, operating profit margins decreased 20 basis points to 25.2%.

The decline in margins was primarily due to increased labor and related expenses resulting from increases in hourly wages. Taking it all in and considering tax reform, net loss to the company was $14.4 million, or $0.55 per share, compared to net income of $3.9 million, or $0.15 per share for the same period last year.

Of course, we need to adjust for this tax impact on earnings, among other items. On an adjusted basis earnings per share was $0.10. This was up just $0.01 from last year’s $0.09. That is not enough growth for our tastes.

Shake Shack will continue to grow and expand over the next few years, driving up revenues substantially. However, we care about critical metrics, and ultimately profitability. To that end, the fundamentals have us on the sidelines.