The Value of Shake Shack

The Value of Shake Shack

Shake Shack (Ticker: SHAK) is a fine-casual restaurant chain originally based in New York City. It
started as a food cart inside Madison Square Park in 2004 by Danny Meyer. Since its beginnings in
Madison Square Park it has grown to be recognized as an international brand with 63 locations across
the globe with ambitious plans for future growth.
At the end of 2014 SHAK filed an S-1 with the SEC to initiate its public offering. At the beginning
of 2015 they raised $105 million at $21/share. Currently SHAK shares are trading at over $60/share.
This IPO will be used to help the company achieve its long term goal of expanding locations to more
than 450 restaurants globally, current short term expansion plans is to open 10 new locations next year
and management has estimated that they will continue to grow at roughly this rate into the foreseeable
future. They plan and achieving this goal through slower more calculated expansion to ensure location
profitability and survivability.
Product Offering
Shake Shack started its menu from New York-style hamburgers and later expanded to
hamburgers, hotdogs, fries and its namesake milkshakes. It later introduced local wine and bottled beer
to its menu in 2004. Its common menu offerings are most comparable with Smash Burger, In-N-Out and
Five Guys while its fine-casual feel is more reminiscent of Chipotle Mexican Grill and Panera Bread.

Much of the early growth and success of the business has been attributed to its fine-casual
concept with a burger, shake and fries focused product offering along with tailor made offerings specific
to regional preferences including wine and beer offerings. This regional variability is vital as the
company operates and plans to expand in very culturally diverse markets. Currently they have locations
in North America, Middle East, Russia, and the United Kingdom.

The fine-casual concept is a hybrid of fine dining and fast-casual format focusing on high-quality
all-natural, hormone and antibiotic-free ingredients which is similar to Chipotle Mexican Grill (Ticker:
CMG) and Panera Bread (Ticker: PNRA). They then combined this with elements of the fast food format.
All combined, customers receive high-quality food quickly at a price point between fast food and casual
dining restaurants.

Fast-Casual Industry Analysis:

The restaurant industry of America is experiencing a tectonic shift, as quick service and full
service restaurants, which had dominated the industry, are being squeezed out of the market by an
emerging new restaurant subsector, fast casual dining. Fast casual restaurants, which combines fullservice restaurants focus on healthy quality food and quick service restaurants focus on price and
convenience, is being increasingly embraced by consumers. This is reflected by the fact that Americans
are now spending more on dining out than home cooking, Americans are also eating less at traditional
quick-service and full-service restaurants, as an Americans shift toward fast casual dining. Driving by the

shift in consumer preference, the fast casual dining subsector is projected to grow at twice the speed of
the overall restaurant industry.

Consumers shunning traditional fast food:

Behind the rise of the fast casual dining is a shift in American consumer food preference toward
real and natural food over processed food. In a survey conducted in 2014, 39% of Americans
reported eating less processed food vs 10% who reported eating more compared to a few years ago.
Instead, Americans are choosing healthier food options. In the same survey, 49% of Americans reported
eating more fruits and vegetables, 26% reported eating leaner proteins, and 23% reported eating more

natural protein sources1.

Americans are choosing more active lifestyle:

A strong contributing factor to the shift toward healthier food options is that an increasing
number of Americans are choosing to pursue a more active life style. In 2014, 38% of Americans
reported exercising more vs 35% in 2004. This is contributing to the rise of fast casual restaurants as
researches have indicated a clear correlation between exercising more and choosing to eat more natural
food, as 52% of Americans reported that they incorporate natural food as part of their plans to
lose/control their weight.
Consumers are spending more on food and dining:

Packaged Facts, What America Eats

The other contributing factor to fast casual restaurants rise is the median household income
has stagnated at around $51,000 since the financial crisis2, and while the unemployment rate has
continued to drop from a declining labor force participation rate, the total number of wage earning
Americans remain virtually the same since the beginning of the recovery. Facing less optimal household
financial conditions, the average American household is slashing spending on entertainment and
luxuries, and instead choosing to splurge on food instead3, and fast casual restaurants with healthy but
affordable dining options have become the ideal choice.

US Civilian Labor Force (000)

2010

Labor Force
153,650
Partcipation Rate
64.3%
Working Population
98,797
Unemployed/Nonparticipating 54,853

2011

2012

2013

2014

153,961
64.0%
98,535
55,426

155,553
63.7%
99,087
56,466

155,047
62.8%
97,370
57,677

156,129
62.9%
98,205
57,924

US Household Expenditure Analysis

2013 Avg 2014 Avg YoY Ch
Income
65,029
64,432
-0.9%
Food
6,598
6,665
1.0%
Housing
17,041
17,377
2.0%
Apparel
1,706
1,674
-1.9%
Transportation
8,999
9,104
1.2%
Healthcare
3,520
3,919
11.3%
Entertainment
2,586
2,560
-1.0%

Teens/Young adults a source for continuing growth:

In a survey of more than 1,100 young adults 4, more than 45% of interviewees reported dining
out more in 2014 than last year and that fast casual styled restaurants is rising in popularity amongst the
surveyed age group. While quick service remained as the most frequently visited restaurants, overall

FRED Economic Data

Bureau of Labor Statistics Consumer Expenditure Survey
4
Source: William Blair Teen/Young Adult Survey
3

frequency has declined from the previous year. In contrast, frequency to fast casual restaurants
increased significantly, launching casual restaurants to the 2nd most frequently visited restaurants
subsector for young adults. This has become a dependable source of growth for fast casual restaurants
as casual dining becomes a part of the young American lifestyle.

Shake Shack Company Outlook

Revenue Growth
Shake Shacks unique business concept has translated in impressive revenue growth. Such high
growth is not a surprise as Shake Shack is comparatively still a small restaurant chain with a large
amount of room for future growth.
In 2010, Shake Shack had $19.5 million in revenues that grew to $119 million over the past five
years ending in 2014. Thats a compound annual growth rate, or CAGR, of 41.8%. This is in line with 2014
and 2013 revenue growth of 42.6% and 41.4% respectively year over year. This solid double digit growth
is expected to continue at 28% over the next five years. The main sources of past and future revenue
growth is and will continue to be the addition of domestic company-operated stores, domestic licensed
stores, and international licensed stores.
Domestic and international licensed locations was $6.5 million at the end of 2014 up from $1.5
million at the end of 2012 and represented 5.4% and 2.5% of revenues respectively. This is from 32
licensed locations compared to 31 company-owned and operated locations. By utilizing a blend of
franchised and company-owned locations Shake Shack is well positioned to grow without a huge
amount of capital investments.

Average Unit Volume

5,000

4,643
4,336

4,500

3,708

4,000
3,500

3,416

3,000
2,500
2,000
1,500
1,000
500
0
2013

2014

2015e

2016e

The most important factor for future revenue growth in company-owned locations is same-store
sales. Since 2013 same-store growth has declined from $4.6 million annually to $4.3 million and is
expected to compress even further to $3.7 million in 2015 given the companys forecasted expansions
and revenue expectations. This is concerning when compared to Chipotle and Panera that are both
experiencing same-store sales growth.

Store Growth
100
80
60

40
20
0

2012

2013

Company-operated stores

2014

2015e

Domestic Licensed stores

International Licensed stores

Revenue growth in future will continue to come from adding locations and not from same-store
sales. Given that Shake Shack currently only has 63 locations there is tremendous amount of growth
opportunity when compared to more established competitors with thousands of locations. It is also

important that Shake Shack to grow at a sustainable pace and not to over extend themselves in the
name of growth.
Costs
Shake Shacks three main costs are Food, Labor and Occupancy. When looked at from the
perspective of company operated sales we can make a relevant comparison with Shake Shacks closest
peers.

Major Cost Comparison 2014

Occupancy Costs

Labor Costs

Food and paper costs

0.0%

5.0%

10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0%

CMG

PNRA

SHAK

The above graph shows the three major costs for Shake Shack for 2014 compared to Chipotle
Mexican Grill (CMG) and Panera Bread (PNRA) as a percentage of sales.
Food Shake Shack is 31.2% which is above Panera at 26.5% and below Chipotle at 34.6% which is
unsurprisingly is right between its two closest peers.
Labor Shake Shack is again in between both peers but closer to the top at 26.2% verse Panera at 26.5%
and Chipotle at 34.6%.
Occupancy Shake Shack has the highest occupancy cost by a large margin at 8.7% with Panera well
below it at 6.3% and Chipotle even lower at 5.6%.

As a whole Shake Shacks costs are right where we would expect them to be with the exception
of occupancy costs. The occupancy costs are close enough that we dont expect them to be a significant
concern due to the year over year trend.

SHAK Costs YoY

35.0%
30.0%

25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
Food and paper costs

Labor and related expenses

2012

2013

Occupancy and related

expenses

2014

Year over year we can see that Shake Shacks costs have remained relatively flat with food costs
growing moderately and occupancy costs declining moderately which is a good sign considering
occupancy costs are much larger as a percentage of sales compared to peers and is reassuring that it is
coming down to be more in line with peers.
The rise in food costs is slightly concerning especially if this trend continues as it is difficult for
management to control these costs. It can increase the menu prices, but that would only further lower
its declining same-store sales.
Multiples Valuation
In order to ascertain a fair market value for Shake Shack, given the current market conditions
and Shake Shacks respective place in the market, we used a group of comparable firms. We included
fourteen firms, among them larger firms like Chipotle Mexican Grill (CMG), McDonalds (MCD), and
YUM! Brands (YUM), as well as smaller players in the industry like Chuys Holdings (CHUY), and Papa
Murphys Holdings (FRSH). Concentrating on making a list of comparable firms that wholly represented

the fast-casual food services industry, we chose firms that we saw as being both qualitatively similar to
Shake Shack, in their menus and customer bases, as well as technically and quantitatively similar from
the standpoint of margins, capital structure considerations, and life cycle timelines.
On the first item of this list, we saw each of these firms as being similar in their margin profiles,
maintaining on average gross margins between low-20s and mid-30s, while seeing EBITDA margins
between the mid-teens and mid-20s. On the capital structure considerations, while we put less
emphasis on this measure, we see that Shake Shacks 3.6x total debt to EBITDA was in line with the
comparative company list average of around 2.5x. Finally, likely the most important consideration we
had outside of qualitative, business model considerations was that for the comparable firms position in
their respective life cycles. A fairly new firm, Shake Shack was only founded in 2004 and has seen total
revenues grow from $57 million in 2012 to over $118 million in fiscal year 2014 a growth of over 100%
in two years. With that in mind, we looked that both the comparable firms last twelve months total
revenue growth figures as well as the 3 year revenue compound annual growth rate (CAGR) numbers.
Though ranging, the comparable firms mostly saw mid teen, double digit growth in revenue last year
while seeing 3 year CAGRs in the low teens up to firms like Papa Murphys, Zoes, Chuys and Chipotle in
the mid-20s and higher obviously showing these firms are far from steady state growth periods.
With this in mind, we first compiled key statistics for each firm dealing with market
capitalization, net debt, enterprise value and other key figures.
Company
Chipotle Mexican Grill (CMG)
Buffalo Wild Wings (BWLD)
McDonald's (MCD)

Market Cap

EBITDA

Net Income

Total Equity

21,468

(758)

20,710

4,108

828

445

2,012

3,380

(113)

3,267

1,516

238

94

574

103,907

27,441

9,612

4,758

12,853
736

90,990

Net Debt

12,917

TEV

Sales

Panera Bread Co. (PNRA)

4,927

(96)

4,831

2,529

401

179

Jack in the Box (JACK)

3,490

497

3,987

1,503

274

93

258

35,040

2,766

37,806

13,279

2,781

1,051

1,613

Yum! Brands (YUM)

Domino's Pizza (DPZ)

5,527

1,493

7,020

1,994

380

163

Noodles & Company (NDLS)

579

26

604

404

45

11

(1,219)
140

Zoe's Kitchen (ZOES)

652

(6)

646

172

(10)

121

Chuy's Holdings (CHUY)

398

403

245

26

12

118

Papa Murphy's Holdings (FRSH)

288

110

398

97

24

92

The Habit Restaurants (HABT)

425

(47)

378

175

17

(0)

117

We found five different multiples for our comparable firms: price-to-sales, to-earnings, and tobook value, and enterprise value-to-sales and to-EBITDA, or earnings before interest, taxes, depreciation
and amortization. Calculating these multiples and then applying them to Shake Shacks own figures from
the previous twelve months, as reported on SHAKs 10-K, we found valuations of Shake Shack vastly
lower than the current market price of $62. In fact, given comparable firms current levels of price to
earnings, we found market prices for SHAK at closer to $9.50. When looking at both sales ratios though,
price to sales as well as EV to sales, we found market a price for Shake Shack around $25 per share. The
below chart illustrates this valuation technique, highlighting in red those stock prices representing
valuations below 60% of the current market price.
Price

Enterprise Value

Company
Chipotle Mexican Grill (CMG)

Sales

Earnings

Book Value

Sales

EBITDA

5.2 x

48.2 x

10.7 x

5.0 x

25.0 x

Buffalo Wild Wings (BWLD)

2.2 x

35.9 x

5.9 x

2.2 x

13.7 x

McDonald's (MCD)

3.3 x

19.1 x

7.1 x

3.8 x

10.8 x

Panera Bread Co. (PNRA)

1.9 x

27.5 x

6.7 x

1.9 x

12.0 x

Jack in the Box (JACK)

2.3 x

37.7 x

13.5 x

2.7 x

14.6 x

Yum! Brands (YUM)

2.6 x

33.3 x

21.7 x

2.8 x

13.6 x

Domino's Pizza (DPZ)

2.8 x

34.0 x

NM

3.5 x

18.5 x

Noodles & Company (NDLS)

1.4 x

50.8 x

4.1 x

1.5 x

13.4 x

Zoe's Kitchen (ZOES)

3.8 x

NM

5.4 x

3.8 x

111.4 x

Chuy's Holdings (CHUY)

1.6 x

34.6 x

3.4 x

1.6 x

15.4 x

Papa Murphy's Holdings (FRSH)

3.0 x

240.4 x

3.1 x

4.1 x

17.0 x

The Habit Restaurants (HABT)

2.4 x

NM

3.6 x

2.2 x

21.7 x

5.2 x
2.7 x
2.5 x
1.4 x

240.4 x
56.2 x
35.3 x
19.1 x

21.7 x
7.7 x
5.9 x
3.1 x

5.0 x
2.9 x
2.8 x
1.5 x

111.4 x
23.9 x
15.0 x
10.8 x

Max:
Mean:
Median:
Min:

Implied Valuation
for Shake Shack:

51.35
26.78
24.93
14.09

41.86
9.78
6.14
3.33

22.70
8.10
6.15
3.29

47.08
26.26
24.57
12.25

81.61
15.59
8.84
5.70

This multiples approach does leave us with one interesting discussion: should we use
comparable firm multiples present in the market today or multiples closer to each firms post IPO
multiples as in, the valuation multiples the market assigned these comparable firms two to three
months after their own IPO, being the time period in which SHAK currently sits? However, while this

approach may be more appropriate given SHAKs recent IPO, we knew that there would be plenty of
arguments against it as well. For instance, many of these firms went through initial public offerings years
ago, at times when interest rates may have been much higher than they are now or when the market
itself was simply valuing firms at different valuation multiples. For these reasons, we saw it more fit to
value Shake Shack with current market multiples from comparable firms, therefore hopefully arriving at
a value for shares of Shake Shack more in line with todays market conditions. Had we used multiples
from the time period of each firms respective IPO, we may have arrived at a bloated valuation given the
undue and irrational exuberance that follows a new and growing firm offering shares to the market; on
the other hand, we may have arrived at a lower valuation given the markets much higher interest rates
and therefore each firms higher cost of capital at the respective IPO periods. Simply put, we want to
find a valuation for Shake Shack that takes into account the markets outlook on the fast-casual food
services industry right now as well as the overarching interest rate environment of today. For these
reasons, we saw fit to use current market multiples to arrive at a fair and current market valuation for
the firm.
With this valuation tactic in mind we created a football field chart to visually represent that
maximum and minimum values from each valuation multiple.

As shown, the TEV/ EBITDA multiple produced the most wide-ranging valuations, due in part to
Zoes large 111x EBITDA valuation in this multiple juxtaposed with McDonalds lower multiple of only
10.8x. However, given the characteristics of the business model and the focus on sales volume, perhaps
at the expense of margins at times, we concluded that our two sales multiples were likely the most
trustworthy in a valuation of this very recently offered stock. Therefore, using a sales multiple equal to
2.7x, the average for our comparable firms, we arrive at a price per share for SHAK of $26 obviously far
from the current price of $62 but still slightly north of the IPO price of $21. This $26 price also implies an
enterprise value of just over 2.9x sales, in line with the average and median figures for the set of
comparable firms.
Key Take Away
The current share price of $62 commanded by Shake Shack seems to be more a product of
market hype than of actual valuation. This seems to be supported when looking at the current valuation
through multiples analysis. SHAK is trading at roughly 900x current earnings. We believe this is an
indicator that the company is currently overvalued.
Shake Shacks same-store sales has declined year over year from 2012 to 2014 and the trend is
expected to continue into the future. This is a concern as management continues to add additional
locations it can be expected that they will earn less than existing stores.
Management must be expecting future revenue growth to come from adding additional
locations on both the company-owned and licensed segments. They have given guidance that 2015 will
add ten company-operated locations domestically and 5 additional licensed stores international and
that this pace will continue for the foreseeable future.
Discounted Cash Flow Valuation and Pro-forma Projection
The top line projections consist of 10 new stores per year and assumptions about same store
growth. As previously stated, in the short run, there will be same-store declines. For 2015, the model

has a 10% decline in transaction volume and 5% decline in average ticket. These conservative
assumptions still put us at the high end of management guidance for 2015 (159 mm to 163 mm) at 162.2
mm. Food cost, labor costs, occupancy expense, and other operating expenses are classified as COGS.
These respective categories account for a relatively constant percentage of COGS, which allows them to
grow at the same rate as revenues. For the fast casual dining space, 30% gross margin is about average,
so we model flat gross margins are project for the entire 10 year period.

The figure above shows relatively flat margins operating margin and net income margin through
the 10 year projection period, with a slight uptick at the end. In new stores, Shake Shack typically has a
strong first year, and then faces a slump in the second year. In line with management guidance, we
project 10 new stores per year for the entire 10 year period. Accordingly, we expect the same store
second year slump to suppress margins, until they get to a more mature state late this decade. In
general, management thinks they can grow to a total of 450 stores before they cannot absorb the 10
new locations (2014 10K).
For a flexible fund account, we opened a short term investment fund, which earns 1% annually.
This fund peaks in 2015 with the additional cash from the IPO. Of the 112 mm proceeds, we allocated 36
mm to pay down the revolver, 8.8 mm for a special dividend (In line with management guidance that
they would issue a dividend for .273 for every dollar raised beyond 80 mm), with the residual going into

the newly created short term investment account. We modelled increasing Cap-ex requirements
through the rest of the decade, driven by an annual 3% increase in store construction costs, and store
refurbishments ramping up in 2020.
As one can see from the Cash Flow Statement in the Appendix, the model does not explain the
cash flows attributable to the IPO. This is an area for improvement, although this value does not have a
large impact on the overall valuation. We modelled the cost of debt to be that of the newly issued
revolver, which management states is 3.0% plus 3-month LIBOR rate. Overall we calculated WACC 4.4%
Capital Structure
D/V
0.04
E/V
0.96
D/E
0.04
Beta
0.46
Risk Free
1.92%
EMRP
5.50%
Ke
4.45%
Kd
3.3%
WACC

4.40%

Given this capital structure, we discounted the projected cash flows by the WACC. We modelled 2%
growth in perpetuity, for a target share price of $45.19. Below is a sensitivity table, which shows the
firms value is very sensitive to the WACC. A 50 basis point jump in the WACC causes a larger effect than
a 50 bps jump in growth. This effect is magnified as the growth in perpetuity gets higher.
Sensitivity Table
2.9%
3.4%
3.9%
4.4%
4.9%
5.4%
5.9%
6.4%
6.9%
7.4%

0.5%
51.51
40.55
32.86
27.19
22.84
19.42
16.65
14.37
12.47
10.87

1.0%
65.43
49.30
38.80
31.43
25.99
21.82
18.53
15.87
13.69
11.87

1.5%
89.31
62.67
47.20
37.12
30.05
24.84
20.84
17.68
15.13
13.04

2.0%
139.72
85.58
60.03
45.19
35.52
28.74
23.73
19.90
16.87
14.42

2.5%
316.15
133.96
82.02
57.51
43.27
33.99
27.49
22.68
19.00
16.09

3.0%
-1271.71
303.27
128.45
78.62
55.10
41.44
32.53
26.29
21.68
18.14

3.5%
-213.14
-1220.50
290.96
123.20
75.37
52.79
39.68
31.13
25.14
20.71

4.0%
-116.90
-204.66
-1171.59
279.20
118.17
72.26
50.59
38.00
29.80
24.04

Residual Income Analysis

Our residual income analysis used many of the same assumptions outlined in our DCF analysis.
The main difference from the DCF is we used the required return on equity of 4.45% to establish the
proper compensation for equity holders. This creates an initial residual income that is negative, but later
becomes positive as the firms net income grows over time. Using this method we come up with a
valuation of $36.85 per share for Shake Shack.

2015E
5,587

Net Income
Equity

2016E
6,294

2017E
7,341

2018E
9,025

2019E
11,234

2020E
13,329

2021E
15,447

2022E
17,691

2023E
20,475

2024E
26,572

139,004

145,298

152,639

161,664

172,898

186,227

201,675

219,366

239,841

266,414

6,182

6,462

6,788

7,190

7,689

8,282

8,969

9,756

10,666

11,848

553

1,836

3,545

5,047

6,479

7,936

9,809

14,724

3
485.5

4
1,542.6

5
2,851.6

6
3,887.5

7
4,777.5

8
5,602.9

9
6,630.4

10
9,529.5

Required Return
Residual Income

(595)

(168)

Present Value

1
(569.9)

2
(153.9)

LT Growth
Re

2%
4.45%

PV of Forecast RI
34,584
PV of Terminal RI
397,192
BV of Equity
12,600
Equity Value
444,376
WASO
12,060
Value per Share $
36.85

Conclusion
In conclusion, we have utilized three different valuation techniques and have created a very
wide range for share value with the lowest multiple valuation being $3.33 from a price to earnings
multiple to a high of $45.19 from our DCF analysis. Taking into consideration the growth in the fast and
fine casual dining segment and the relative small size and tremendous future growth opportunity of
Shake Shack we feel most confident in our DCF analysis valuation of $45.19 per share. Currently SHAK is
trading at $62 per share and we therefore believe the stock is overvalued from market excitement over
their recent IPO.