Shacking Up: America’s Love Affair with Fast Casual

Shake Shack served Wall Street its IPO filling in late December 2014, with rumors about a billion dollar valuation being tossed around. The burger chain is part of a larger cultural movement towards “fast casual” dining that has overseen the subtle decline of fast-food giant McDonalds, and it seems that the sky is the limit for the Shackburger.

The growth of brands such as Chipotle and Panera Bread typifies today’s zeitgeist. Consumers are rejecting former fast-food front-runners and looking to “fast-casual” restaurants to provide them with high-quality food made with fresher ingredients and sustainable practices.

Indeed, Shake Shack proudly promotes its 100% all-natural Angus beef, vegetarian fed, humanely raised and source verified.

On the other hand you have McDonalds –unhealthy, outdated McDonalds – with their processed cheese, mass-produced beef and cookie-cutter establishments. Where the golden arch once used to represent American capitalism, even establishing a presence in Russia and thereby “defeating” communism – Shake Shack is now the playful hip alternative to Mickey D’s waning kingdom.

A crumbling empire

The 2008 recession changed the way many people approached fast food and the coveted 18-34 demographic are voting with their dollars for “healthier options”. Americans still eat fast food; it’s just called Chipotle now.

In August 2014, McDonalds posted its worst decline in sales for 10 years. Sales have been fairly flat over the past year and lower than year ago levels, and the fast food giant is struggling to address their customer’s needs. In a bid to service every customer type McDonald’s menu has ballooned to over 100 items!

Now make no mistake, the golden arches still do big business. With 35,000 stores in over 100 countries and annual revenues of they are still a behemoth.  It’s just that rising disposable incomes and increased choices mean consumers are flocking to fast-casual restaurants such as Chipotle, Panera, Five Guys and others.

Techtomic’s 2014 Top 500 chain restaurant report indicates that sales for fast-casual chains grew by 11%. In 2013 Chipotle made over $3 billion in revenues, and revenue has been growing every year since 2009.

Chipotle Mexican Grill, Inc (NYSE: CMG)

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Millions of USD; annual data; source: Google Finance

Shack attack

Shake Shack falls right into the fast casual section of the restaurant industry, even if they’re branding themselves as “fine casual”.

The New York based restaurant chain is the current darling of Wall Street. From its humble beginnings as a hot dog cart in Madison Square Park it has now grown to 53 shacks as of Q3 2014. Out of those, 31 are U.S. based and 22 are internationally licensed – most of which are located in various Middle-eastern countries. Currently they’ve expanded to 63 locations in total – 36 domestic and 27 international.

The company’s S-1 filing tells us a lot about its financials. One takeaway is that Manhattan Shacks perform way better than their non-Manhattan counterparts. Shacks based in the Big Apple average $7.4 million in sales versus 3.8 million elsewhere.

The key number to look at is that total revenue grew from $20 million in 2010 to $82 million by year end 2013. In that same time frame the company grew from 7 Shacks in two states to 40 Shacks in six states.

System-wide sales include revenue from all Shacks; total revenue is limited to domestic Shacks and revenue from franchised Shacks; source: Shake Shack S1 filing

The operating margins, how much a company makes (before interest and taxes) for every dollar in sales, are healthy as well – standing at around 30% for Manhattan Shacks and 20% for the others. This compares favourably with Chipotle which has operating margins of around 20% – i.e. it makes 20 cents for every dollar in sales.

Phew, that was a lot of numbers! Here’s a video of a super cute pig sliding around on a frozen sidewalk as a reward.

Massive growth potential

Let’s remember that Chipotle is not a direct comparison to Shake Shack. The burrito chain is a leader in the fast casual arena; after all it has over 1600 locations! However it does give us an idea of where Shake Shack might be headed.

With just 63 locations Shake Shack is very much a fast casual fetus. Five Guys has over 1000 locations. In-N-Out Burger has about 300 and as of September 2014, Chipotle had 1724! As you can see it’s not too far-fetched to see Shake Shack grow its locations by 10 or even 20x. If the burger chain can maintain its popularity who knows how many locations it could have in 3-5 years, especially considering that it has an outsize brand appeal compared to how many Shacks there actually are.

As Shake Shack grows bigger there will be accompanying challenges. It’s not easy to keep a large company profitable but in Danny Meyer, CEO of Union Square Hospitality Group, they have someone who’s going to give them a fighting chance.

Shake Shack is one of 11 brands in the USHG portfolio. Meyer’s first venture, Union Square Tavern, was ranked New York’s top restaurant for seven years. If you count all the awards and honors he, his restaurants and chefs have received…well, you’d be one short of 100. Needless to say, he’s an impressive guy.

Awards, honors, and money are nice but Danny’s business philosophy has been shaped by the experiences of his father.  The elder Meyer was a hotel owner who, unable to balance ambition and finances, ended up over-extending himself and going bankrupt at the age of 42. He would pass away only 17 years later.

The younger Meyer is desperate to avoid the mistakes of his father, and his twin pillars of business discipline and team-building have served him well. In 26 years Meyer has gone from owning the Union Square Tavern to being the CEO of a company that employs 2200 people and he doesn’t seem content to stop there.

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One thought on “Shacking Up: America’s Love Affair with Fast Casual

  1. Paradigm shift is the word of the century, though it was propagated seriously in late 20th century. All the business entities needs to remember that cycle of change is as eminent as day and night. It is the law of the jungle. Might is right. Either you evolve or perish.

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