Shake Shack Inc. (SHAK) Is an American-Born Premium Fast- Company Data

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Rating HOLD October 14th, 2019 Price (10/19/2019 USD) 88.49 Target price (USD) 77.85 Americas

% down from Price on 10/19/2019 12.02% Equity Research Market cap. (USD, b) 03.30 Enterprise Value (USD b) 03.24 Restaurants

Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. Target price is for SHAKE SHACK INCORPORATED (SHAK:NYSE) 12 months.

Research Analysts: Our analysis on ‘Shake Shack’ (from hereupon referred to as “Shake Shack”,

Murtaza Salman Abedin “Shack” or “SHAK”) is Discounted Cash Flow valuation-driven. Shake +852 59858568 [email protected] Shack is a growing brand with rapidly rising potential, however being a small company it still faces various growth-oriented challenges. Our Daria Yong-Tong Yip [email protected] Valuation gives SHAK a fair share value of USD 77.85 (HOLD) and this

Samya Malhotra has been calculated through a DCF valuation of the 5-Year forecast period [email protected] ranging from 2019E to 2023E.

Gerald Akhmelvan [email protected] We believe the company’s primary target growth strategy of raising store Raymond Widjaja count will still be their continued method of expansion, but it will be [email protected] supplemented by technology and social responsibility driven initiatives like Siddhant Jain [email protected] the partnership with ‘Grubhub’ and an increased incorporation of technology through Project ‘Concrete’. Additionally increased consumer

Data Analyst: tourist traffic in high-concentration franchise regions like the Middle East

Mandeep Singh and Japan, due to events such as the UAE EXPO 2020, and the Qatar FIFA [email protected] World Cup 2022, should also act as a key driver of growth.

These expansion plans, however, will be impacted by challenges faced from

increased revenue cannibalization, intense market competition from the likes of unlisted competitors like ‘Five Guys’, and listed ones like ‘Wingstop’. In

addition to this, falling global consumer spending trends and the potential

for a global economic downturn could impact SHAK’s share value, due to

capital reallocation to more stable and established equities.

For our Discounted Cash Flow model, we have assumed that SHAK revenue growth will be derived from a mixture of an expansion in international licenced store operations and increases in self-operated stores. We have also used an effective tax rate of 28%, which is slightly higher than the company forecasted rate of (26%-27%).

SHAK Stock Price Graph Key Financial Metrics

120 in USD$ (Mn) 2019E 2020E 2021E 100 Revenue 63 4.35 79 6.80 97 4.66

80 EBIT 43 .67 54.71 66.80

EBITDA 87.67 110.12 13 4.70

E C

I 60 R

P Net Income 31.08 39.03 47.73

40 Revenue Growth 38.11% 25.61% 22.32% Cash Flow from Operations 87.47 111. 76 13 4.25 20 Total Stores 265 32 4 3 87

8 8 8 8 8 8 8 8 9 9 9 9 9 9 9 9 9

8 Self Operated Stores 16 2 20 4 25 0

7 7 8 8 8 9

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

0 0 0 0 0 0

2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2

/ / / / / / / / / / / / / / / / / /

/ / / / /

/ Licensed Stores

2 1 2 3 4 5 6 7 8 9 0 1 2 1 2 3 4 5 6 7 8 9 0

1 10 3 12 0 137

/ / / / / / / / / / / / / / / / / /

1 1 1 1 1 1

/ / 1 1 1 1 1 1 1 1 1 / / / 1 1 1 1 1 1 1 1 1 /

1 1 1 1 1 1 EBIT Margin 6.88% 6.87% 6.85% DATE Price Revenue Per Store 2.394 2. 459 2. 519

Table of Contents Company Overview ...... 5 Business Summary ...... 5 Ownership Structure ...... 6 Legal Cases and Scandals...... 7 Industry Overview ...... 7 Dubious Future Outlook : Cautiously optimistic market ...... 7 Labour Cost Inflation and the US-China Trade War ...... 8 Risk from Digitalization ...... 9 Competitor Analysis ...... 9 Valuation...... 12 Revenue Breakdown ...... 13 Regional Analysis ...... 14 Asia-Pacific ...... 15 Middle East & Europe ...... 15 North America ...... 16 South America ...... 16 Expansion and Growth ...... 17 New Markets in Asia ...... 17 Partnership with Grubhub and Online Ordering ...... 18 Project Concrete ...... 19 Growth Catalysts ...... 20 Grubhub ...... 20 2020 and Beyond Health Trends ...... 22 Environmental and Social Governance ...... 23 Social Media Presence and Customer Engagement ...... 24 Catalysts: Conclusion ...... 25 Investment Risks ...... 25

Company Overview

Business Summary

Shake Shack Inc. (SHAK) is an American-born premium fast- Company Data

casual restaurant chain that started in 2001 as a hot dog stand in 52 Week Range 40.67 - 105.84 Exchange Rate 1.00 Manhattan. Shake Shack is known for its offerings of hamburgers, P/E Ratio at 10/19/2019 178.41 hot dogs, frozen custards, shakes, beer, and wine. The company is Market Cap ($bn) at 10/19/2019 3.46 listed on the New York Stock Exchange as SHAK.N and has a Diluted Shares at (mn) 12/31/2018 29.18 Average Daily Vol (mn) 0.97 market capitalization of USD 3.669 Billion (10/18/2019). There Exchange Rate 1.00 are three major sources of revenue for Shake Shack: domestic Index RUSSELL 2000 Figure 1.1 company-operated stores (food-servicing), domestic licensed stores (franchising), and international licensed stores. In 2018, there were 34 new domestic company-operated Shacks and 15 new licensed Shacks in US and International locations opened. 2018 also saw the launch into 9 new domestic and global markets including Seattle, the San Francisco Bay Area, and Hong Kong. In total, Shake Shack has 256 locations to date in 17 countries including the US.

Shake Shack has two classes of common stock: Class A and Class B common stock. Class A and Class B both entitle its holder to one vote per share held on matters presented to shareholders. The difference between the two is that Class B common stock is held by the Continuing SSE Equity Owners on par with the number of LLC Interests of SSE Holdings they own. Shake Shack recently announced on October 7, 2019, that it would be releasing its third-quarter results on November 4, 2019, after the market closes. Some other notable events of recent include the extension of Tara Comonte’s role from CFO to CFO & President as well as adding in a ninth board member. This move was made in anticipation of the robust growth that the company foresees.

2004 2017 First full Shake Shake Shack Shack Store launches its opened application Figure 2.2

200 0 2005 2010 2015 2019

2001 Shake Shack Shake Shack Shake Shack opens first Shake Shack went Public opens its 100th restaurant outside starts as a small on the NYSE store kiosk. NYC in Miami

Ownership Structure

In total, there are 257 Institutional Investors. According to the Proxy 2019 report dated April 25, 2019 – Daniel Meyers (CEO of Unique Square Hospitality Group) owns 325,661 (1.1%) of Class A Common Stock and 4,55,320 (61.1%) of Class B Common Stock for a combined voting power of 13.1%. All directors and executive officers as a group (10 persons) own 1,749,333 (5.9%) Class A Common Stock and 6,369,610 (85.5%) of Class B Common Stock for a combined voting power of 21.9%.

Ownership Structure

Gilder Ganon Howe & Co.LLC 8% Others

Macquire Investment Management 8%

12 West Capital Management, L.P. 8%

BlackRock Institutional Trust Company, N.A. 22% The Vanguard Group. Inc 18%

Figure 3.3

The top five institutional investors of the firm are Blackrock (21.67%), Vanguard Group (17.84%), 12 West Capital Management (7.91%), and Gilder Gagnon Howe & Co. LLC (7.66%). Figure 1.4 shows the recent trading activity of company insiders regarding the purchase and sale of their shares. According to Yahoo Finance, 3.32% of shares are held by insiders.

Insider Activity

761,034 12 MONTHS AGO 204,604

524,339 6 MONTHS AGO 156,519

Time Period Time 229,625 3 MONTHS AGO 147,125

Shares Sold Shares Bought

Figure 4.4

Legal Cases and Scandals

The management of Shake Shack have a clean history. There are no specific scandals of note that are public knowledge however there are some events to note would relate to Shake Shack’s Chairman Daniel Harris Meyer. Meyer’s company is Union Square Hospitality Group (USHG). His company has been implicated in improper handling of sexual harassment allegations in the past, but reportedly pledged to improve their processes for better treatment of this sort of conduct. Meyer himself has also been involved in a lawsuit along with chef Tom Colicchio, Will Guidara and Daniel Humm of Eleven Madison Park, and Gabriel Stulman of Fedora. The suit was filed by Timothy Brown on behalf of a group of victims. The suit alleges that Meyer colluded with top restaurateurs to create “no-tipping” policies in order to raise prices and profit more at the expense of customers and waitstaff. The case has since been dismissed as the judge disagreed based off the presented evidence.

Industry Overview

"Quick Service Restaurant" (QSRs) are emerging as one of the most outperforming businesses in the market today. The industry sales statistics look fairly optimistic. However, some key factors need to be taken into account, as they may affect the future profitability of the industry.

Dubious Future Outlook : Cautiously optimistic market

According to the National Restaurant Association, the global restaurant 2018 179.87929 industry market sales are forecasted to 96 reach USD 863 Billion in 2019 and 2017 expected to keep increasing at a growth 158.04619 78 2019 rate of 3.6% annually up to 2022. The 146.89588 2016 97 restaurant industry is a highly 2015 137.89142 134.24574 01 competitive market in which the 95 consumer taste changes continuously Global CPI Average and can shift towards cheaper or more Figure 2.1 appealing options, due to the variety offered in today's market. The restaurant industry includes the QSR and fast-casual category, both of whom are amongst its largest individual sub segments.

The global food Consumer Price Index (CPI), which covers more than 170 countries, has continuously been rising as displayed by the Figure 2.1; a fact which is also in correlation with the growing food expenditure (Figure 2.2). The data illustrates that the average prices across the world have been rising steadily, mainly due to inflation, while the remaining factors are massive expansions, labour Food Expenditure cost, and technology adaptation. The 800 majority of the restaurant industry’s 780 growth has occurred as a result of 760 urbanization in the emerging market, 740 720 which will account for approximately 700

two-thirds of the global GDP. Billions $ USD 680 Furthermore, growth in restaurants 660 over the past few years from 2015 2016 2017 2018

approximately 400,000 to over Figure 2.2 600,000 shows that people demand varieties of food more.

Labour Cost Inflation and the US-China Trade War

Despite their growth and success, one Changes in Consumer Food Price Indices of the largest issues facing restaurants 2.5 is wage inflation and the occurring 2 rising costs, as shown by the consumer 1.5 1 price index of food. There is cost-push 0.5 inflation occurring due to climate 0 % Change Change % CPI in 2017 2018 2019 2020 20 Year change, which causes crops to be more Historical Average challenging to raise and cultivate. Year Labour costs are rising faster than wage Figure 2.3 inflation to a large extent, which also causes a cost-push increase.

Labour makes up a large percentage of total costs, and wages have been on a constant rise in the last few decades. Wages have risen due to minimum wage reforms and union pressure on companies, and government laws and regulations placed on the treatment of workers.

Risk from Digitalization

The increase in digital technology usage has disrupted the restaurant industry on a large scale, especially customer experience. Online reservation sites, new customer interfaces, and digitally-enabled delivery services are examples that could redefine the way the industry operates and runs and who dominates the market.

The Digital leader (best in class digital usage restaurant) has outperformed the S&P median by 9% annually. With that, restaurants could utilize digital online services to sustain their market and improve brand recognition in the future. ‘Open Table’, ‘Door Dash’, and ‘Grubhub’ are some of the well-established online food-service applications which are redesigning the food industry.

Competitor Analysis

Market Cap Name of Brand Stock Price Revenue in Store Count (Million ($)) 2018

Shake Shack 98.04 459 3,660 253

Chipotle Mexican 840.47 4,900 23,300 2,500

Denny's Corp 22.76 630.2 1,350 1,700

Wingstop 87.28 48.1 2,570 1,250

Noodles and CO 5.66 457.8 249 410

Potbelly 4.36 372.8 103 474

Private Five Guys 531.3 N/A 1,500 Company Private Smash Burgers 13.1 N/A 370 Company

Private In-n-Out Burger 575 N/A 347 Company

Chipotle Mexican Chipotle Mexican is a casual American fast food chain founded over 26 years ago by Steve Ells. The company has over 2500 locations worldwide and has a revenue growing at 9.86% on average over the last four years.

Denny’s Corp Originally opened as a coffee shop under the name of ‘Danny’s Donuts’ in the year 1953, by Harold Butler and Richard Jezak. It now has up to 1700 stores worldwide.

Wingstop ‘Wingstop’ is an aviation themed casual fried chicken restaurant. It was founded almost 25 years ago in 1994 by Antonio Swad and Bernadette Fiaschetti.

Noodles and CO ‘Noodles and CO’ is a fast food chain founded in 1995. In 2010, a majority interest was bought by an investment group led by Catterton Partners. The chain currently has 410 stores worldwide and experienced growth threefold from the financial crisis until 2013.

Potbelly A fast food chain that specializes in sandwiches and has over 474 stores across the world. Founded by Bryant Keil in 1977 it has been in the market for over 40 years, and listed in 2013 in order to raise 75 million dollars from its IPO.

Five Guys ‘Five Guys’ is a privately-owned business which was co-founded by Jerry and Janie Murrell, around 33 years ago. They now have over 1500 locations and revenue upwards of 800 million dollars.

Smash Burgers Founded in 2007, ‘Smash Burgers’ has grown at a rapid rate to 370 stores, and continues to expand. The company is privately owned and was co-founded by Rick Schaden and Tom Ryan. It was acquired by

‘Jollibee Foods Corp’ completely in two separate buy ins, one in 2015 at 40% and the second in 2018 at 100%.

In-N-Out Burgers ‘In-N-Out Burgers’ is an American regional chain of fast food restaurants which currently has 347 stores. The company is privately owned, and was co-founded by Harry and Esther Snyder. It was the first ever drive thru hamburger stand in all of California, which allowed customers to order via a two way speaker communication system.

Valuation

Figure 3.1 Our DCF valuation of Shake Shack Inc. Shake Shack DCF Valuation summary (Figure 3.1) gives us an implied share price US 10 year Bond (risk free rate) 2.80% of 77.85 USD for the forecast period CAPM Cost Of Equity 6.8% ranging from 2019E-2023E. The revenue Tax rate 21.0% After Tax Cost Of Debt projections are driven by strong industry 1.90% WACC growth prospects and aggressive internal 5.8% Perpetual growth rate (Post 2022) 4.2% and external expansion projects in the Terminal value 2,731,953 American & Asian markets. We have Enterprise Value 2,206,039 applied a WACC of 5.8% and perpetual Equity Value (Market Cap) 2,271,539 growth rate of 4.2%, which remains Diluted Shares outstanding 29,179 constant. The perpetual growth rate was Fair Value Share Price USD 77.85 assumed to be relatively high due to the fast food industry’s growth rate averaging roughly at 5.2 % until 2030 and expected to remain at a similar rate for the expected future.

The consistently high year-on-year revenue growth, averaging roughly 30% over the past 6 years, for Shake Shack also demonstrates high long-term growth potential, but according to our DCF forecasts it is overvalued, so the company has thus achieved a valuation less than its current share price. Although the company is almost debt free and has an extremely rapidly growing customer base, it faces the risk of revenue self-cannibalization, intense competition entrants and high regional revenue concentration risk. Currently, SHAK is trading at USD 88.49 and the 52-week range is from USD 105.84 - USD 40.67.

Free Cashflow Valuation (in Thousands of USD$) 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Total Revenues 118,530 190,592 268,475 358,810 459,310 634,346 796,800 974,660 1,167,720 1,375,980 Less Total COGS + SG&A (115,387) (183,839) (240,670) (324,997) ( 427,599) (590,679) (742,089) ( 907,862) (1,087,821) (1,281,966) Total EBIT 3,143 6,753 27,805 33,813 31,711 43,667 54,711 66,798 79,899 94,014 Less: Tax (EBIT * Tax Rate) (662) (3,304) (6,350) (8,791) ( 8,862) (12,087) (15,179) ( 18,563) (22,232) (26,184) Less: Capital Expenditures (28,515) (32,117) (54,433) (61,533) (87,525) (95,000) (105,000) (115,000) (125,000) (135,000) Add: D&A & Non-Cash Expenses 5,809 10,222 14,502 21,704 29,000 43,999 55,406 67,900 81,480 96,146 Change in working capital and other 5,288 11,675 13,171 14,624 25,917 5,218 9,976 10,900 11,832 12,763 Free cash flows to the firm (FCFF) (14,937) (6,771) (5,305) (183) (9,759) (14,202) (86) 12,035 25,979 41,740 Years to discount 0.21 1.21 2.21 3.21 4.21 Cost of capital 5.8% 5.8% 5.8% 5.8% 5.8% Discount factor 0.99 0.93 0.88 0.83 0.79 PV Free Cash Flows to the Firm (FCFF) (14,037) (80) 10,626 21,680 32,924

Revenue Breakdown

Shake Shack expanded its store count starting from 208 in 2018 with a CAGR of 35% to 256 stores to-date world-wide, among which 173 (67.18% of the total store count) are domestic stores i.e. American, and 83 (32.81% of the total store count) are internationally operated stores. By 2019, Shake Shack was expected to open 122-125 domestic company-operated stores and 85-87 licensed stores. In the first quarter of 2019, there has been an evident increase in the company’s total revenue by 33.8% to $132.6 million. The 2020 year-end goal for this company aims at increasing its store count to 320 as well as doubling its revenue to $700 million through aggressive store expansion.

System Wide Domestic Self Domestic International Operated Licensed Licensed

208 124 12 72 159 59 90 10 114 64 7 43 5 27 63 31

2014 2016 2017 2018 2014 2016 2017 2018 2014 2016 2017 2018 2014 2016 2017 2018

Figure 4.1 Figure 4.2 Figure 4.3 Figure 4.4

Shake Shake’s Total Revenue over the past 5 years has increased from $119 million in 2014 to $459 million in 2018 (28% growth rate). Its System-wide sales have increased to $672 million with an over-all CAGR OF 33%. In 2018, the System-wide Shack sales grew by 31% to a total of 208 stores; 124 company-

Shake-Shack Sales Growth Store Distribution 16% 14% Americas 12% 58% Middle 10% East 8% 23% 6% 4% 2% Asia- 0% Europe Pacific 10% -2% 9% 2014 2015 2016 2017 2018 Figure 4.6 Figure 4.5 Copyright © CityU Student Research & Investment Club 13

operated, which yielded a growth rate of 38% and 84 licensed shacks with a growth rate of 22%. Combined with a 33% increase in licensing revenue generated from international locations and airport restaurants that are franchised out – revenues increased by 34% year over year.

The System-wide sales grew by 34%, however, with the increase in expenses, it translated into a 13% growth in operating profit. Due to numerous stores opening in the same cities, weekly sales per shack have also declined from $96,000/shack in 2016 to $84,000 today.

By the Fourth Quarter of 2018, the Same-Shack Sales increased by 2.3% versus Same-Shack Sales growth of 0.8% in the fourth quarter of 2017 as a result of a combined increase of 0.6% in price and sales and offset by decreased guest traffic of 0.3%. SSS (Same-Shack Sales) as of 2018 grew by 1%.

As of now, there has been an improvement in the Same-Shack Sales with an increase of 3.6%. Shake Shack’s goal for 2019 includes increase in licensing revenue to $16 million, by increasing the number of franchised outlets across the world. For the year 2019, the firm aimed at opening 36-40 domestic company- operated outlets along with 16-18 Licensed outlets – a goal which it is well on its way to establishing. The average annual sales volume for domestic company operated outlets are targeted to be $4.1 million with an over-all Shack-level operating profit margin of 24%.

Regional Analysis

Shack Shake has evolved commendably over the past few years, due to its multi-format strategy. As ambitious as the past 2 years have turned out to be, its city-focused nature has been quickly dissipating. The restaurant’s establishments in the United States, along with Asia Pacific, have increased at a rate faster in comparison to Europe and the Middle East.

The 2020 goal of the company is to establish 450 stores worldwide. Currently, the company has a global presence of 256 stores. Analysing the historical store expansion, Shake Shack on average expands by 30 stores per year. Therefore, optimistically, the company will be able to reach its goals by the said year.

In terms of franchise locations opening up, Shake Shack opened up 16 new locations all over the world and their plans to expand has clearly been portrayed through their aggressive store openings in various countries in the world.

Asia-Pacific

The demand in the Asia Pacific is evidenced through examples such as the opening of a single store in Singapore's prestigious airport, along with numerous openings in Japan in the last year alone. It also grabbed the chance to expand its licensing with 16 new openings across Japan, Korea and a few other places in 2017.

After its expansion to Tokyo in 2015, with a future growth prospective of 10 new locations by 2020, Shack continued expanding across Seoul and intends to open 25 new stores across South Korea. In 2018 alone, they added 49 stores across the world, and in certain locations such as Hong Kong the success of a single store, meant that Shake Shack had more store openings.

Over the past year, Shake Shack has undertaken agreements to open more stores in Macau, Shanghai and Hong Kong with an estimate of about 40 stores in the next 10 years. Currently Shake Shack aims at opening its first international office in Hong Kong, and is still looking forward to see the growth aspect in Mainland China (Shanghai).

‘The Chairman’, the first Chinese cuisine restaurant in Hong Kong which made it to the world’s 50 Best Restaurants List, was to collaborate with Shake Shack on its limited-edition burger meal as of July.

Looking into Shack’s future growth plan, it plans to widen its horizon and open 14 new outlets in Hong Kong and Macau by 2027, with eventual plans of increasing the store count to 25 across East China and Shanghai by the year 2028. Shack Shack’s expansion through Asia is fuelled by a licensing agreement with Maxim’s Caterers, which also operates Cheesecake Factory locations in China.

Middle East & Europe

Shake Shack’s goal for 2016, was to open 16 new stores in the Europe and Middle East. The Middle East has the biggest share of Shake Shacks internationally, and the annual report clearly states the success of these restaurants. Shake Shack’s biggest demographic success is due to its acclimatization of the country and regions it is opening up in. In the Middle East, Shake Shack has provided Halal meat, which shows its ability to be flexible in order to gain the trust and taste of the consumer.

The Alshaya Group operates all the licensed shacks across the Middle East and through third party sub licensees operates all of the international shacks, with exception of the Tokyo shack as of 2015. Alshaya delegates the supply functions to third party logistics providers in which Shake Shack has limited communication for the prevention of control being exercised.

The success of the Alshaya Group’s licensed Shacks has come through its ability to maintain good and healthy relationships, which involves a great deal of communication and feedback with licensees. The Alshaya Group has exclusive rights on a Shack license, which allows them to open new Shacks in certain new countries.

Shake Shack has 41 stores in the Middle East region, with 11 situated in Kuwait and 11 in Abu Dhabi. With plans to open more stores the Middle East, this region has the greatest Shake Shack presence worldwide. In comparison to the rest of the international licensed shacks, those in the Middle East make up nearly 50 percent or 41 out of the 83 international shacks.

North America

Since 2017 Shake Shack has been expanding its footprints in New York City, Mid-Atlantic, Midwest, and Texas among others. In the past year, Shake Shack has also entered markets including Charlotte, North Carolina and Seattle, but more than 80% of their stores are located in New York. There are currently about 7 Shake Shacks at the airports in the U.S., as a result of Shake Shack’s perception of a growth opportunity in airport spaces.

As big as 2018 turned out to be for Shake Shack, 2019 also promises to top it with about 36-40 new company restaurants in places including Salt Lake City, New Orleans, Ohio and Columbus. It has also opened its first premium food court location in Miami recently, and has come up with the authentic food-truck concept in New Jersey and Atlanta.

South America

Shake Shack Plans to open its first location in Store Count Latin America in Mexico City. The menu is 200 planned to feature items in partnership with the 180 160 140 local retailer Grupo Toks. It will also mark the 120 100 first of its 30 planned locations over the next 9 80 60 Store Count Store 40 years. The plan is to open in premium locations 20 0 such as Mexico, Santa Fe, Bosque de las Lomas Asia Middle Europe United South Pacific East states of America and Polanco in Mexico City. The Cancun and Los America Cabos airports are among them. Regions Figure 5.1 The firm’s plan is to achieve success through catering to local tastes by including local twists and variations such as Oh Ma-Mey, Lemon and Piloncillo piggy cookie, and shark attack. The outlets will all be run by

the General Manager of Grupo Toks. Grupo Toks operates in the Retail, Service and Real Estate sector in Mexico and runs numerous restaurants such as ‘Beer Factory’, ‘Panda Express’, and gourmet Chinese food restaurants.

Expansion and Growth

As of 2018, Shake Shack (SHAK) has opened 208 stores, with 136 shacks in the U.S. and 72

international shacks. As of 2nd Quarter of 2019, they have 237 stores opened, which means that they have been on track and have not diverted from their original expansion plan and goal of having 320 shacks (or stores) by 2020. The firm seems to be focusing more on international expansion, particularly the Asian and South American markets. SHAK’s biggest franchise partners include Alshaya in the Middle East and Sazaby in Japan. The firm is planning to open 15 new stores in Japan, and has similar plans for both South Korea and Mexico. Additionally, there is room for growth in the Middle East, where there will be large events in the 2020s, such as the FIFA World Cup 2022 and UAE Expo in 2020. Burgers and sports events are seen as complements, because fans may get hungry during or in

between games. Figure 5.2 (where 2019 is the 2nd Quarter of 2019 in actuality) shows the gradual increase in their total shack counts per year since 2014.

As of the 2nd Quarter of 2019, SHAK opened 29 new Figure 5.2 company operated and licensed shacks in total. International expansion gives the firm some diversification and allows it to spread risks geographically, as a few years ago most of their company-operated shacks were in New York. The outlook seems positive, as the firm is in line with its growth and expansion strategy. However, the increased geographic spread puts SHAK under pressure to always perform well. If one restaurant does not live up to its expectations, SHAK can expect their brand image to be damaged globally, which may impact future sales.

New Markets in Asia

There are a few interesting locations in Asia that will be discussed in the following paragraphs that may benefit SHAK. Firstly, the firm is opening a store in Gran Seoul, Korea. A busy office district, this location presents an opportunity for SHAK to target employees working there, more specifically young employees in that district, given the high volume of co-working spaces and start-up offices in the said district.

Another interesting store opening is also located in Asia, namely their Shinsaibashi (most famous for the GLICO neon sign) shack in Osaka, Japan. It is a bustling and well-known tourist spot, a shopping district that brings in a lot of traffic, millennials and tourists alike. Tourists typically find McDonald's in other countries as a ‘safe’ option during situations where they are unable to decide on where to eat or are still unfamiliar with local cuisines, as they cannot go wrong with their choice in terms of taste and price. By opening in Shinsaibashi where there is a massive inflow of tourists, SHAK may replace consumers’ choice of McDonalds’ being their safe meal, as SHAK also provides a similar safe option and has a good brand reputation that consumers are aware of.

More recently SHAK has expanded its operations and opened up additional shacks in airports, most notably their store opening in Jewel Changi Airport. This opening made headlines and a sea of people gathered outside to try the new restaurant. Expanding in airports opens up the possibility of increasing margins. This enables SHAK to sell at a premium price as consumers in airports are less price-sensitive and generally the demand for restaurants in airports is price inelastic, given the limited options of dining in airports.

Partnership with Grubhub and Online Ordering

Figure 5.3 In August of 2019, SHAK announced its partnership with ‘Grubhub’ (GRUB) – a company that provides a platform that enables users to order food online, similar to ‘Uber Eats’ and ‘DoorDash’. As of 2Q19, GRUB has accumulated 19.9 million active users and is one of the most popular applications consumers use to order food online. SHAK is testing its partnership with GRUB in 4 different locations in the US. The areas for testing include New York, Chicago, Connecticut and New Jersey. Figure 5.3 shows the number of GRUB active users per year and its growth.

Grubhub has its own ‘Just in Time’ delivery mechanism that alerts drivers to pick up the order when the order is about to be finished, allowing them to provide customers fresher food and faster delivery time. Such features are particularly appealing to millennials as they are more interested in and gravitate towards things that are instantaneous and quick.

The partnership with GRUB will give SHAK access to tools to analyse and track customer behaviour and spending patterns. SHAK can see which of their products are most popular and use this information to come up with new marketing strategies. Combined with the redesign of their mobile app, customers’ online ordering experience may be more personalized as SHAK takes the steps necessary to increase engagement, such as having their order history so customers can quickly order things they love.

However, SHAK needs to consider the rising costs affiliated with its paper and packaging. Their partnership with GRUB and the redesign of their mobile app potentially brings more digital sales, thus SHAK cannot overlook this trend. GRUB’s delivery fees may also be an issue to consumers and may increase the prices

of the food. GRUB’s partnership will be fully realized and integrated in 1st Quarter of 2020, as right now it is still in the testing stage.

Project Concrete

SHAK announced that it will be initiating ‘Project Concrete’, under which the firm will be implementing new enterprise systems and upgrading existing ones in order to increase efficiency, by eliminating laborious administrative tasks and moving towards automation. This will allow SHAK to achieve and gain a competitive edge that will help differentiate it from competitors. The table below shows a similar initiative between SHAK and MCD, a larger and more well-established competitor. The company has stated that they are going to incur capital expenditures in a range of $4.5-5 million and SHAK are going to finance it through internal retained profits and are not looking to issue new shares or undertaking of debt.

We believe that adding and installing more self-service kiosks should not be their number one goal, and instead they should focus more on customer retention. SHAK received heavy backlash when they first implemented a fully cashless shack, with only self-service kiosks in Astor Place, New York. Customers were left agitated as they were adamant on paying with cash and the store only accepted cashless payments, such as debit or credit cards.

As seen from the Figure 5.4 on the bottom left, SHAK’s labour costs increased continuously at a higher rate than their revenue after 2015. This data may could be a reflection of the minimum wage hike and labour inflation in the U.S., where SHAK operates a majority of their stores. SHAK is therefore subject to higher wages that the U.S. is legislating. The figure on the bottom right shows the gradual increase in minimum wage policies in California and New York, two states that they have the most operated stores in, 17 and 33 respectively. The data shows that minimum wages in both states have shown an increasing trend, with New York’s legislation escalating the minimum wage at a higher and more rapid rate than California, from $9

per hour in 2016 to $16 per hour in 2019. Project Concrete may alleviate labour costs in the long-run but the extent of its impact depends on how much it will reduce labour costs.

Company Initiative FigureTargets 5.4 Figure 5.5 SHAK announced that they will be initiating a project called ‘Project Concrete’ where they will be implementing new enterprise systems and upgrading existing ones in order to increase efficiency by eliminating laborious administrative tasks and SHAK Project Concrete moving towards automation. The upgrade includes self-order kiosks, redesigned counters for table service, menu Experience of the boards with better lighting, special parking spots for customers that order through MCD Future redesign mobile, and an improved McCafé with more counters.

Growth Catalysts

Grubhub

On August 5, 2019, Shake Shack announced an integrated partnership with online and mobile app food delivery service ‘Grubhub’. ‘Grubhub’ currently has a network of over 20 million diners and is expected to slowly roll out nationwide over the next 2-3 quarters. We expect that this will be a beneficial partnership for Shake Shack for a variety of reasons, the first of which is ‘Grubhub’s “Just-In-Time” technology where the drivers pick up the order as soon as it is finished. This ensures that the food quality is preserved and is fresh for the customer. As a company that is conscious of the ingredients used in its burgers, such as 100% all-natural Angus beef with no hormones and no antibiotics, this style of delivery service is reflective of Shake Shack’s commitment to high-quality food servicing. It is also the perfect complement to Shake

Shack’s current ecosystem, which will allow them to reach existing and new customers conveniently without compromising the customer experience. We expect that this innovation will contribute to a potential increase in revenue in the long-run and possibly more stable earnings as the weather cools in wintertime. In fact, after the partnership was announced, Shake Shack also upped their fiscal year revenue from $576M - $582M to the $585M - $590M range. FactSet’s outlook on the revenue was around $598.1M.

Another reason we expect this will be a beneficial partnership is the access to customer intelligence information and new horizons of marketing initiatives and data sharing that will come as a result of this collaboration. ‘Grubhub’ offers a robust support team for operations and customer service, and already expects to integrate into joint-partnership marketing initiatives with Shake Shack in order to push order frequency for existing customers and generate new leads. This partnership will also provide data on the most popular products with CRM capabilities, insight on consumer trends, and insight into consumer behaviours with POS integration. In turn, we expect this information will be a large part of future marketing strategies that the firm pursues.

Finally, according to an article published by Restaurant-Dive, experts have found that consumers are increasingly purchasing more through delivery than they are purchasing in- store. Millennials are a large component of the demographic using delivery services – and the target audience of Shake Shack. The article quotes, “the most frequent delivery app/site users are between Figure 6.1 18- and 29-years-old (63%), followed by 30- to 44-year-olds (51%). People with income under $10,000 ordered via online delivery the most at 51.6% compared to any other income bracket”. Morgan Stanley also states that approximately 40% or $220 billions of restaurant sales will be from delivery orders by 2020. These statistics all point to an increase GrubHub Network vs Competitors of delivery as a large portion of revenue in the millennial target demographic of UberEats 500 220000 Shake Shack. In leveraging ‘Grubhub’s 1500 DoorDash 200000 extensive network, Shake Shack will

2400 have access to 2400 cities for deliveries. GrubHub 125000 Even if Shake Shack is not currently in 0 50000 100000 150000 200000 250000 that specific city, this may drive # of Cities # of Restaurants Figure 6.2 expansion towards the cities that are in

‘Grubhub’s reach. We may also see joint expansion plans between the two companies to keep the synergy of delivery availability of Shake Shack. In addition to that, investment bank UBS echoed the sentiment and made a strong case for increased food delivery orders globally. UBS forecasts delivery sales could rise annually more than 20% worldwide to $365 billion from $35 billion.

In conclusion, we expect that one of the upcoming large catalysts of the growth of Shake Shack will be its partnership with Grubhub thanks to the consumer intelligence Grubhub can provide, the increasing consumer trend of buying through delivery services, and the market outlook and optimism towards this partnership.

2020 and Beyond Health Trends

Another catalyst that we believe will positively affect Shake Shack’s operations, is the consumer pursuit of health trends expected to continue in the next few years.

Overall, Shake Shack has been responsive to trends in consumer preferences as shown with the introduction of its Veggie Shack in April 2018. For example, the Veggie Shack caters to gluten-free and vegan customers as a gluten-free bun can be substituted and the cheese can be removed to make the burger entirely vegan. According to an article in the Economist, 25% of 25-34-year-old Americans identify as vegetarian or vegan. It also mentions that in June 2018, vegan food sales rose ten times faster than total food sales, indicating a rapid shift in dietary preferences. This rapid shift in dietary preferences can become a competitive advantage if Shake Shack is one of the first adopters to cater to it. We believe that Shake Shack’s customization-friendly menu and quick turnaround regarding consumer trends are progressively important to today’s customers. As consumers lean more and more toward a healthier diet, we predict seeing consumers substituting fast food for healthier fast-casual options such as Shake Shack’s selectively sourced ingredients. We also see from an article from Restaurant Business Online that beyond 2020, consumers will be on the lookout for foods that are part of a healthy diet that will “promote physical, mental, and emotional health” such as collagen, CBD oil, and turmeric.

We also believe that as millennials age and some start families, operators can better cater to millennials who have children by providing antibiotic-free dishes with natural ingredients and kid-friendly portion sizes of regular menu options. The fast-casual options serve as a balance between convenience and quality; in Shake Shack’s case, we can also see the options to select foods based on dietary preference on top of that.

We may also see a partnership with Beyond Meat on the horizon, should the interest and fervour surrounding it continue. In the past, Shake Shack’s CEO, Randy Garutti, stated that they had “no intention” of adding Beyond Meat to the menu at the time, citing that he wants to wait and see if the numbers continue to outperform expectations. Should Shake Shack pursue a partnership with Beyond Meat, we may see the

same fervour investors had for the Grubhub collaboration reflected as a jump in stock price thanks to the bullish outlook many large industry players have on it, such as Tim Hortons who incorporated it into its menu. To elaborate on the optimism surrounding Beyond Meat, recently, McDonald’s released the PLT, its unique Beyond Meat burger to test customers’ interest in plant-based alternatives. As a company that has been a late adopter on the incorporation of Beyond Meat to its menu, we see this as a signal that McDonald’s sees this as an endorsement in a plant-based future that Beyond Meat will be a part of. This was also highlighted by CEO Steve Easterbrook’s previous statement that the company has to weigh the benefits and costs to introducing plant- based menu options. If Shake Shack decides to pursue this plant-based partnership, we could see the release of a new menu item that would generate great excitement and a boost in short-term profits, like KFC had when it partnered up with Beyond Meat and sold out within hours in one store in Atlanta. In light of all these exciting innovations to shock the food industry, we expect to see Shake Shack come ahead in identifying long-running and popular dietary trends and incorporating it in its menu based off its previous history of doing so to come out ahead of the competition.

Environmental and Social Governance

SHAK ensures that all its ingredients are ethically sourced and capitalizes on their large number of followers on Instagram (October 2019: 656,000) to endorse themselves and to enhance their brand image among the ethical consumers, which have been on the rise. They showcase their ethically responsible actions in their highlight album titled ‘SFSG’. Their album shows viewers how their products are sourced and videos, such as of grass-fed cows. SHAK posts at least once a day on their Instagram, and therefore the highlights are not drowned by the many posts they have. These practices are parallel with the consumer trends of eating more ethically sourced foods.

Figure 6.3 SHAK does not require customers to tip and even discourages tipping, as they already pay their employees higher than the minimum wage. SHAK has vowed to reduce plastic use and has taken steps by using compostable plant-based straws. Abandoning plastic straws has been a popular trend among restaurant businesses. Consumers nowadays lean towards companies that are using their influence to drive constructive change and deliver messages that can raise awareness on environmental issues. We believe that consumers are more likely to purchase a company’s product if the company supports and advocates causes that are supported by their target customers. Figure 6.3 shows SHAK’s S&G (Social and Governance score, which measures how ethically responsible a company is.

Social Media Presence and Customer Engagement

Shake Shack tries to actively engage with its customers. It participates in a variety of causes and events, such as supplying students the materials needed for the #MarchForOurLives movement, participation in pride month, and encouraging customers to tag SHAK in their posts to be featured on SHAK’s account during the annual music festival Coachella where they also had a pop-up store. By involving themselves in causes or events that its target audience cares about, people realise that they share the same sentiments as SHAK and are thus are enticed to try it.

SHAK has opened food trucks, and has catered for people’s weddings. This increases their engagement with customers outside of just social media, as SHAK is involved in a major event in their lives. If SHAK successfully cultivates and moulds this, it may increase SHAK’s sales and improve its brand image because people are attached to things that are personal, heartfelt and sentimental. SHAK includes things in their social media that are close to peoples’ hearts such as pets photographed alongside SHAK’s burgers, and aesthetically pleasing photos that attract customers and entice them to buy their products. SHAK posts on their Instagram at least once a day, and when they post during the time that people are thinking about lunch, they may increase their sales and conversion.

In comparison to its competitors, SHAK has lower Instagram followers than ‘Chipotle’ (CMG) but higher than ‘Denny’s’ (DENN). This is because the three of them focus on different social media marketing strategy, and the reason why CMG has more followers is that CMG posts viral web content that resonates with millennials. The figure on the right shows the followers' comparison on Instagram. Figure 6.4

Catalysts: Conclusion

The points above are based on our own opinion of what could possibly lead to a positive movement in the stock price of SHAK, selected from our view of its importance and perceived degree of influence towards a movement. Three out of four of the catalysts that we have chosen are things that resonate with millennials and teenagers, which parallels what they believe and stand up for the most, namely ESG, Health Trends, and Social Media Presence. Millennials are more concerned about the environment and the ethical aspect of businesses, invoking the need for businesses to be more aware of how they source their food, or if their menu (for restaurants) includes vegan choices, for example.

Investment Risks

Shake Shack Inc (SHAK) is currently priced at a premium, given that it has a relatively smaller number of operating units than most competitors, raising its spread risk. SHAK now has no hedging position on commodities and are highly exposed to foreign exchange risk, due to the volatility of the market.

At this point, SHAK bears a high competitive risk as competition from other fast-casual restaurants will remain steady ahead. ‘Five Guys’ and ‘In-N-Out’ IPOs in the future could drastically reduce Shake Shack market share. Also, the recent IPO of ‘Beyond Meat’, could pose a severe threat to Shake Shack if the industry shifts towards plant-based meat.

Following the multi-market expansion, it would be a risk to support the current operating unit. The general income level is decreasing, and the labour costs are increasing; both affected by the economic recession in the US. Supply chain risk is emerging as well, as the US-China Trade war escalates.

On the other hand, new taxation and accounting rules IFRS 19 could affect SHAK performance in the book. They are also exposed to brand risk, such as management scandals and insider trading, that could significantly reduce their brand image and lose consumer confidence.

The assumptions are valid on the date of publishing. However, there are evolving risk and uncertainties from the market, for example, the industry conditions, competition, future regulation changes, firm instability, and legal risks, which cannot be addressed extensively

Appendix

A. Income Statement

B. Cash Flow Statement

C. Balance Sheet

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