Yesterday, Shake Shack reported their fourth quarter and 2018 results. It was very much as management had predicted, reflecting modest same store sales gains, cost pressures at the store level as well as continued high administrative expenses to support very rapid expansion.
New locations, heavily weighted in the fourth quarter, opened at strong levels, which held the year's average unit volumes (AUV) of domestic company operated locations at $4.39 million per store, down from $4.598 million, about $100,000 higher than the guide. We should interject here that this "beat" might have been at least partially the result of heavy openings (17 out of 34 for the year) in the fourth quarter, including the honeymoon effect of 17 out of 120 total stores in the year's AUV.
Rather than dwell on the fourth quarter, which followed the trends of the individual quarters, the full year's result is probably most informative. 34 domestic company stores were opened against a base of 90. Same "Shack" sales were up 1.0% and traffic was down about the same. Shack level profit (EBITDA) was 25.3% of sales, down 130 basis points year-over year. AUVs were down 4.6% to a still impressive $4.39 million.
For the year, Cost of Goods Sold was down 10 basis points to 28.3%. Labor was up 110 basis points to 27.4%. Other Operating Expenses were up 130 basis points to 11.6%, partially offset by Occupancy Expenses which were down 80 basis points to 7.3%. G&A expense was up 60 basis points (not "leveraging" yet), and depreciation expense was up a noteworthy 30 basis points to 6.3%. Pre-opening expense was constant at 2.7%, averaging about $360,000 per store. Pretax Operating Income was down, $31.7 million (6.9% of revenues) vs. $33.8 million (9.4% of revenues). Diluted EPS was $0.52 per share, not comparable to last year (with its adjustments).
Following the above numbers, management presented "adjustments", which brought the "adjusted pro forma net income" to $0.71 per share.
Rather than itemize the adjustments, we think it is more productive to focus on the store level operating metrics. New stores are, as predicted opening at levels closer to $3 million than the current $4.4 million domestic company AUV. Store level EBITDA of new stores is closer to 20% than the 25.3% of 2018. Accordingly, management is guiding, for 2019, to AUVS of $4.0-4.1 million, with store level EBITDA of 23-24. %. This guidance could prove to be conservative, but realistic expectations relative to past years is lower. This is a result of guidance, including total revenues up 28-29%, SSS of 0-1%, including 1.5% price. There will be a continued aggressive opening pace (36-40 new company openings plus 16-18 licensed), G&A of $66.4-$68.2 million, up 26-29% (leveraging slightly against the revenue gain), depreciation expense up 40% or more (higher investment per store?), pre-opening expense of $13-$14 million (a constant $350-$360,000/store).
Relative to the fourth quarter of 2018 and 2018 as a whole, and implications for 2019 and 2020, our bottom line is that, based on cost expectations at the store level, and the corresponding lower store level margin, it will be hard for SHAK to show improvement in net income per share.
More importantly, our contribution to the dialogue is that, while the revenues per store have been, as management predicted, coming down, the investment per store is going UP. The following three short paragraphs are copied from the 2016, 2017 and 2018 10k filings.
Construction 2016 10K
A typical Shack takes between 14 and 16 weeks to build. In fiscal 2016 the cost to build a new Shack ranged from approximately $1.2 million to $3.4 million, with an average near-term build cost of approximately $1.8 million, excluding pre-opening costs. We use a number of general contractors on a regional basis and employ a mixed approach of bidding and strategic negotiation in order to ensure the best value and highest quality construction.
Construction 2017 10K
A typical Shack takes between 14 and 20 weeks to build. In fiscal 2017 the cost to build a new Shack ranged from approximately $1.1 million to $3.3 million, with an average near-term build cost of approximately $1.7 million, excluding pre-opening costs. The total investment cost of a new Shack in fiscal 2017, which includes costs related to items such as furniture, fixtures and equipment, ranged from approximately $1.6 million to $3.7 million, with an average investment cost of approximately $2.2 million. We use a number of general contractors on a regional basis and employ a mixed approach of bidding and strategic negotiation in order to ensure the best value and highest quality construction.
Construction 2018 10K
A typical Shack takes between 14 and 20 weeks to build. In fiscal 2018, the total investment cost of a new Shack, which includes costs related to items such as furniture, fixtures and equipment, ranged from approximately $1.4 million to $4.0 million, with an average investment cost of approximately $2.2 million. We use a number of general contractors on a regional basis and employ a mixed approach of bidding and strategic negotiation in order to ensure the best value and highest quality construction.
Editor's comment: With depreciation guided to increase by more than 40% in 2019, it's possible that the investment per store is moving higher still.
What Does It Mean?
You can see that, while there have been some changes in wordings (your interpretation is as good as mine), the $1.8 million investment, as described in the 2016K is a lot lower than the $2.2M investment of 2018. AUV in 2016 was $4.981 million, virtually flat with 2015. The pre-opening expense seems to have been about constant at $350,000 per location. Back in 2016, the store level EBITDA was 28.2% (down from 29.1% in 2015).
So: the store level EBITDA cash-on-cash return in 2016 (adding the $350,000 of pre-opening to the $1.8 million cost of construction) was 28.2% of $4.981 million which implies $1.4 million, an awesome 65% of the total $2.15 million investment. (No wonder the new issue went to $90 per share.) Today, however, the 23% expected EBITDA margin (at most) on new stores doing $3.3 million (at most) would be a 29.7% cash-on-cash return.
People.....this is a big difference, and this could be the best case.
More importantly, the latest information, as disclosed in the 2018 10K and management's guidance going forward, provide investors with more food for thought (no pun intended). We saw that one analyst referred to SHAK as the next Krispy Kreme, which it's not, but SHAK isn't what it used to be.