Last year was a rough one for initial public offerings, with many facing the axe from investors as the hype quickly turned to concern about fundamentals and sky-high valuations. One of the better performers has been Shake Shack (NYSE:SHAK), in spite of many underwhelming factors from a shareholder perspective. Despite the company's ambitious plans and licensing model, current global conditions and weak wage growth could eat away at potential profits for a restaurant chain with 75 branches globally. Even though licensing has so far proven a successful strategy for growing its presence and the company remains in early phases of its expanded footprint, the stark retreat from 52-week highs represents a swift correction in the irrational exuberance that has marked IPOs for the past few years.
That Escalated Quickly
Although revenues have experienced steady growth, the rapid uptick in Shake Shack's valuation in the middle of 2015 led to an equally swift spiral downwards. After falling over 65% from highs of $96.75, investors have been forced to reconsider the true value of the company, considering its core business is food service. Although some have attributed the ongoing hype and popularity as reasons to contemplate owning shares, it harkens back to the hype surrounding the initial public offering of Krispy Kreme Donuts (NYSE:KKD). Many individuals are quick to caution that Shake Shack is no ordinary burger joint; however, unlike Krispy Kreme and other potential competitors, it lacks the footprint to prove investors otherwise.
Ambitious plans to operate 450 stores within the next few years might have hit a snag with the global economy and weak external conditions. Despite plans to open 14 company-owned stores in 2016 (many international locations are licensed, not owned), the company currently expects $3.3 million revenue per location, according to projections - a number that may be reasonable for locations in major cities, but elusive as the chain branches out into numerous other locales. While indeed, the focus on creating a premium burger concept puts it at odds with other fast food chains, the question remains whether the emphasis on quality is enough to drive sustained sales growth.
Insiders Jumping Ship
One of the more worrisome aspects of the Shake Shack story has been the quick exodus of pre-IPO investors cashing out in the third and fourth quarters of the year. Considering the hype of the shares earlier in the year that at one point put the value of each and every store at $53 million, it is not hard to see why insiders have been cashing out at higher levels. With lockup periods for other investors set to expire soon, it could mean additional insider selling. Typically, insider sales are worth noting from a number of perspectives, owing to the fact that these individuals' close relationship with company and its operations offer better insights into the trajectory.
Early investors leaving in droves is just further evidence that the hype has been overdone and valuations have crossed the unreasonable threshold. Even now, with valuations having retreated in a major way, Shake Shack remains more highly valued that peers, with figures as of January assessing the value of each of location at approximately $15.10 million per store. This is nearly double the value of the location value of its nearest competitor, Chipotle (NYSE:CMG), which has a valuation that is nearly 10 times the comparable Shake Shack market capitalization and boasts more than 2,000 locations.
Even though, fundamentally speaking, the company is very sound considering its burgeoning margins and solid revenue growth, investors are still not getting a bargain when buying into the Shake Shack vision. From a balance sheet perspective, the company is very strong, especially after using IPO proceeds to pay down debt taken on before the public listing. Cash levels have also continued to grow, while capital expenditures have been mostly stable on a quarterly basis near $8.50 million. In another optimistic sign for the company, free cash flow has climbed into positive territory, especially with a substantial gross margin of 40.90%.
Although Shake Shack has been able to impress investors with steadily growing earnings that have beat consensus the last four quarters, the upcoming March earnings report is not expected to show the same type of explosive gains experienced earlier in the year. Due to the relative scale and newer nature of this chain, it becomes challenging to compare it to other casual dining companies such as Chipotle or Panera Bread (NASDAQ:PNRA). Current expectations are for $0.07, and although strong outperformance in earlier quarters may be a sign of the company's staying power, it does not necessarily indicate that Shake Shack will be immune from headwinds and growing pains as it finances its ongoing expansion.
Traders are increasing bearish when it comes to Shake Shack stock, as evidenced by a short interest of 3.98 million shares, representing 52.54% of the total float and over 25% of the total number of shares outstanding. Moreover, recent analyst upgrades have provided an additional selling opportunity for company insiders and the filing of a Form S1 back in November to offer for sale an additional 26.2 million shares. This is likely to keep pressure on shares over the near term, with buyers at current levels attempting to pick up pennies in front of a rapidly approaching freight train without getting hit.
Interesting, But Not Value
Revenue growth has undoubtedly been strong since the IPO and beat expectations by a large margin, providing longer-term investors an incentive to keep holding out as the company transforms itself into a global brand. However, as a point of caution, the strong outlook does not necessarily translate to value at current levels for the share price. Targeting 52-week lows at $30 and $25 is not unreasonable considering high-flying store values that exceed those of one of its most talented competitors by a wide margin. Earnings that fail to match expectations could also dent sentiment even further, adding to bearish woes.
The stock is likely to continue taking a hit over the coming weeks and months as the Shake Shack vision is grounded back in reality and returns to fundamentals. Although a great longer-term setup, short-term investors are likely to be punished by market currents and insider sales. Until insiders start filing to buy more shares, investors would be cautioned against buying into the long-term Shake Shack dream. While it may be among the better-performing IPOs of 2015 and may outperform its class in 2016, the company has a long way to go to prove it can sustain its current hype.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.