So far this year, tiny Shake Shack is beating mighty McDonald’s on Wall Street. The fast food company’s shares have gained 87.67% YTD, while McDonald’s shares have gained 22.11%.
Both companies are beating the market average—see table.
| Company/Index | Current Price | Price Gain YTD | Qtrly Revenue Growth | Profit Margin |
| Shake Shack | $85.24 | 87.67% | 31.30% | 2.96% |
| McDonald’s | 216.13 | 22.11* | -0.20 | 28.32 |
| S&P500 | — | 15.10 | — | — |
*It doesn’t include dividends.
Source: Finance.yahoo.com 7/8/2019
Shake Shack’s big gains on Wall Street have surprised some analysts who follow the fast food service sector. John Zolidis is one of them, as he isn’t impressed with the company’s most recent earnings report and guidance.
“Shake Shack (SHAK) reported figures that were generally in-line with our expectations for upside on the top-line but weakness in margins,” he says. “The company reduced its full-year restaurant level margin target to ‘approximately 23%’ from ‘near the low end of 23%-24%’. The company didn’t justify this change, which was made concurrent with lifting the outlook for total sales. However, we believe a factor is the ongoing sequential weakening of new units, which missed our assumption for the quarter.”
What has pushed Shake Shack’s stock ahead of McDonald’s? Three things.
First is the numbers game. Shake Shack’s shares have begun their run up from a lower price than McDonald’s, and that makes large percentage gains easier to attain—see table.
Then there’s the growth game. Shake Shack is an emerging franchise while McDonald’s is a mature franchise. This means that Shake Shack has plenty of room to grow by opening new stores, while McDonald’s relies primarily on boosting existing store sales.
And there’s the hype game. Younger generations of burger lovers—usually the buzz makers in the fast food industry — crave Shake Shack’s premium burgers made from fresh ingredients.
To be fair, McDonald’s has tried to catch up with Shake Shack by introducing its own line of “Signature-Crafted Burgers” a couple of years ago. But it didn’t work, and the company removed them from its menus, sticking with its conventional Quarter Pounders.
Still, Zolidis is pessimistic on Shake Shack’s shares. “SHAK is a long-term unit growth story,” he says. “The stock is getting a valuation based on the performance of a small base of existing stores in exceptional locations and the potential for a very large number of future openings. However, the future openings are going to look nothing like the existing base.”
That’s where Shake Shack’s problem is. “The most recent performance of new stores underscores this,” he says. “We estimate new units continue to weaken sequentially both on the top-line and especially on the contribution margin line, are contributing an estimated 90-200 bps pressure on consolidated RLM in 2019. This pressure should continue for the foreseeable future.”
That’s why he sees very little upside left in Shake Shack shares.
To be fair, McDonald’s has its own performance problems with newer stores. But it has demonstrated a remarkable ability to adopt and adapt to change, re-igniting growth in its existing stores.
Meanwhile, McDonald’s pays a hefty dividend to investors who stick with its stock over the long-term.
And that makes a better long-term play for value investors.