IPOs: Don’t Buy The Shake Shack Hype

This installment of IPOs of the Week is special. Arguably the most exciting IPO of the year took place today.

In last week’s IPO update, I primed you for the almighty Shake Shack (NYSE: SHAK), noting, “The burger chain is expected to price between $14 and $16 a share. With just $5 million in income over the last 12 months, it’s almost guaranteed that Shake Shack will be trading at over 100x earnings when it debuts.”
Well, Shake Shack’s IPO priced at $21 a share. And the stock is soaring. Shares are up 130% as I write this.
The Shake Shack IPO is a pivotal moment for the burger industry, long thought to in demise at the hand of fast-casual companies like El Pollo LoCo (NASDAQ: LOCO), Potbelly (NASDAQ: PBPB), Noodles & Co. (NASDAQ: NDLS) and Chipotle (NYSE: CMG).
I’m sure Shake Shack needs no introduction, but in case you missed it, the “burger stand” serves premium burgers, fries, hot dogs, shakes, beer and wine.
Granted, McDonald’s (NYSE: MCD) remains the undisputed leader when it comes to burgers. There are still some parallels between McDonald’s and Shake Shack, despite the fact that one does $28 billion in revenue and the other just $100 million. McDonald’s got its start in 1948 as a self-service stand, offering just nine items.
Now, the real question on everyone’s mind; should you buy Shake Shack?
Well, the short answer is no.
With a $1.7 billion market cap and just $100 million in sales, Shake Shack trades at 17x sales.
Think about that for a moment. That’s the same price-to-sales ratio of Facebook (NYSE: FB), a company that does nearly $3 billion in income, compared to Shake Shack’s $5 million.
Its current market cap values each owned store at over $60 million and it trades at over 300x earnings.
Wall Street is falling all over itself to get into Shake Shack because it is a New York City brand. It’s a brand that many big money investors have personally experienced.
But we’ve seen this before. Recall Fairway (NSYE: FWN), which is the New York grocer that went public in 2013 and quickly traded to nearly $28 a share. The stock now trades at less than $5 a share; the premium grocery store that excelled in the New York market was a bust in other markets.
And there are already tell-tale signs: Shake Shack’s New York City stores generate nearly $7.5 million in revenue a year, but the other stores are only pulling in $4 million on average.
And there’s no shortage of fast-casual restaurant choices flooding the market. The likes of El Pollo LoCo, Potbelly, Noodles & Co. and Habit Restaurants (NASDAQ: HABT) have all completed their IPOs in the last year or so.
But all peaked shortly after their IPOs, with stock prices down 20% or more from all-time highs. And last week, all the rage was about Box (NYSE: BOX). The stock price of the cloud storage stock soared from its $14 a share IPO price to nearly $25 on the first day. The euphoria has since worn off and Box is trading just over $19.
Habit Restaurants is another fast-casual burger joint that recently IPO’d. Shares started trading back in November — surging over 120% on the first day to $40 a share. But there again, euphoria wore off and the stock is now trading at $32 a share.
The valuation at Shake Shack seems rather mind boggling in its own right, but even more so when compared to its top peer, Habit.
Sales growth has been similar for the two companies, but Shake Shack’s last 12 months’ EBIT margin (earnings before interest and taxes) is nearly a percentage point below Habit, and Habit is seeing stronger comparable store sales.
Habit has 100 stores and predicts that it can grow that number to 2,000 in the U.S. Shake Shack has around 30 U.S. stores and only expects it can expand to 450.
With all that in mind, where Habit has better margins and better growth potential, shares of Habit only trade at 5.4x sales. If Shake Shack were to trade at 1.7x sales, its stock price would be $16.
In closing, be wary of the post-IPO drift. The share price of Shake Shack will likely fall in the next couple weeks as euphoria wears off and investors start to trade the stock based on its valuation — and not its food quality.

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