Shake Shack's high valuation will be tested as the burger chain expands beyond its hometown of New York and into areas where the brand isn't as well known, according to Bloomberg Intelligence.
Even after a 13 percent drop from its record high last week, Shake Shack traded at a higher multiple than Panera Bread and Chipotle Mexican Grill. Shake Shack's forward price-to-earnings ratio was 773 at Friday's close, compared with an average of 64 for other fast-casual restaurants, according to Michael Halen, an analyst at Bloomberg Intelligence.
Shake Shack's challenge will be generating the same high profit margins outside of New York that it achieves in the city, where locally renowned restaurateur Danny Meyer founded it as a hot dog kiosk in 2001. Not only are the chain's most loyal customers in New York, Wall Street investors and analysts also are familiar with the brand, which may be fueling the valuation.
"If they go to a Shake Shack, they're constantly seeing lines out the door -- that definitely plays into investor psychology," Halen said. "Their perception of Shake Shack's brand awareness and potential could be skewed by seeing those long lines."
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Shake Shack priced its initial public offering at $21 and more than doubled on its first day of trading in January.
Shake Shack's New York locations still attract long
lines for its burgers, fries and shakes. The company's seven restaurants in Manhattan posted operating profit of 31 percent of revenue in the 39 weeks to Sept. 24. By contrast, locations outside of Manhattan had an operating profit margin of 21 percent, according to a regulatory filing. Sales volumes also are higher at Manhattan locations.
The chain has fewer than 70 restaurants and plans to open 10 new company-operated stores in the United States each year.
The first six to 18 months of a new restaurant location often are marked by rapid employee turnover and high labor costs, Halen wrote. In addition, Shake Shack may face challenges setting up its supply chain when it enters new markets.
"Investors are expecting this company to grow into its valuation," Halen said. "They're willing to pay up for a chain they think can provide growth."