This article was originally published on Action Alerts OPTIONS on Aug. 19 at 12:32 pm.
NEW YORK ( TheStreet) -- If you like burgers and milkshakes, chances are you've heard of Shake Shack(SHAK) - Get Report. Started by well-known chef and restaurateur Danny Meyer and run by Randy Garutti, the company describes itself as a "modern day 'roadside' burger stand." In addition to their all-natural burgers and hot dogs (no hormones or antibiotics) they also serve frozen custard, shakes and, importantly, beer and wine. A couple decades ago it might have seemed daunting to enter a business dominated by McDonald's (MCD) - Get Report Burger King, Wendy's(WEN) - Get Report, Jack in the Box(JACK) - Get Report and the like. But it is clear that information moves much more quickly now. When Shake Shack opened their store on South Lamar in Austin, TX, there was a long, long line on the first day.
In some respects, the world is going through a 1950s/1960s type of renaissance. The post-war era transformed the economy and the nation as many returning GIs went to college and migrated to cities. Now, companies that seemed invulnerable due to their size and scale, such as McDonald's, are viewed as outdated monoliths as some consumers are no longer satisfied with fast food, but also want good food. Combine that with modern-day viral marketing and a hot dog stand in Union Square can be transformed into a business valued at $2 billion dollars in just over a decade.
Of course Shake Shack didn't create the trend, it was riding one that had been started earlier by other burger joints that focused on better burgers rather than speed, cost and advertising, such as Five Guys, In-n-Out and Fatburger. They aren't the only new arrival either. Denver-based Smashburger has joined the fray and already has 300 stores (Shake has 71) and in foodie-culture towns such as Austin, where Shake Shack opened to much success, they are challenging Austin's already successful answer to In-n-Out, P. Terry's.
Comparing a Shackburger with a glass of wine to Big Mac value meal and one begins to see why investors might get excited. I can tell you which I'd rather have.
Investors gobbled up the limited float with as much enthusiasm as they eat the burgers, imagining that Shake Shack may be to burgers what Starbucks(SBUX) - Get Report is to coffee and that they may one day become as ubiquitous. But looking more closely at SHAK as an investment opportunity means we need to take a look at their financial statements and for owners of the stock that may be about as appealing as looking at the nutritional information from their menu. By the way, a single burger and fries (no cheese) will be 780 calories, respectively. Let's assume that's the minimum. A double SmokeShack burger, cheese fries and a Shake would be up to 2,460 calories, essentially my entire daily recommended caloric intake, assuming I am moderately active. Here are some other statistics you might find interesting.
-- Enterprise Value of Shake Shack is about $2.1 billion and McDonald's is $103.4 billion.
-- The number of locations added over the most-recently reported quarter: Shake Shack added five locations added for a total of 71. McDonald's added 78 locations added for a total of 36,368
-- Revenue per location (here SHAK shines over MCD). Shake Shack has more than $4.3 million annualized and McDonald's has more than $2.4 million. In both cases company-owned locations have higher revenues than franchise averages (greater than $5 million for SHAK and greater than $2.7 million for MCD.)
These latter numbers are not particularly surprising. SHAK's menu items are substantially higher priced than MCD's and SHAK has the advantage of beer and wine sales, a de minimis number of McDonald's sell alcohol. In any case, the current valuation of SHAK is about 30 million per store and they added five locations in the past quarter. The current valuation of McDonald's is 2.85 million per store and they added 78 locations last quarter. Hmm.
Options markets have been highly skeptical of SHAK stock since it first became available for trading, and this is largely due to the limited float.
Last Friday, for example, if you bought the January 2017 47.5 calls on the offer or ask price and sold the January 2017 47.5 puts on the bid price, you would have executed that trade for a 10-cent credit. Given the large bid/ask spread, it's entirely possible that one could have gotten an even larger credit. If you are long the 47.5 calls and the stock is above that level, you would exercise the calls and be long the stock at the strike price, or $47.50 in this case. Because you collected a dime credit to do the trade, the net purchase price would be $47.40, substantially lower than the level at which the stock was trading. If the stock finished below the $47.50 strike price, the calls would be out of the money, but the puts you sold would be assigned and you would purchase the stock at $47.50, again net of the dime credit the effective purchase price would be $47.40. Effectively entering into this trade would be a commitment to purchase the shares at $47.40 in January 2017.
Why would it be possible to get long the stock synthetically at such a discount to where it is currently trading? Because the limited float made the stock hard to borrow and those who would short the stock have to pay to borrow the shares. In other words, the demand to borrow stock to short is high and the availability of stock to short is very low. So what happens when the supply of stock available to sell increases? It's simple economics and the options markets suggest that the price of the shares may fall.
So what is the takeaway here? If you are inclined to purchase the stock, the valuation is a bit heady here and perhaps you should wait until the supply and demand for those that would sell the stock has normalized.
At the time of publication, neither Action Alerts OPTIONS nor Khouw held positions in any of the securities mentioned.