(FROM THE WALL STREET JOURNAL 1/31/15)
By Ilan Brat and Kelsey Gee
It's a good time to be a boutique burger chain.
On Friday, shares of Shake Shack Inc., rocketed up 119% on their
first day of trading from their initial public offering price of
$21 each, ending at $45.90 in 4 p.m. trading and giving the
operator of 63 restaurants a valuation topping $1.6 billion.
The heavy demand for the New York-based restaurant chain's stock
-- coming days after McDonald's Corp.'s chief executive resigned
amid two years of weak sales -- reflects a stark shift in the
fortunes of the restaurant business. It also represents a bet by
investors that consumers increasingly focused on food quality and
animal welfare will shell out growing sums of money for the fancy
burgers on offer from a widening array of purveyors.
Shake Shack is among a wave of "fast casual" chains across the
restaurant industry that offer fresh, made-to-order items, from
burritos to noodles. While still tiny compared with giants like
McDonald's, upmarket burger chains have been especially hot of
late. Habit Restaurants Inc., a chain of about 100 burger
restaurants that went public in November, also priced above
expectations and still soared 120% in its trading debut, but shares
have fallen 16% from their debut closing price.
Darren Tristano, executive vice president at research firm
Technomic Inc., estimates the number of fast-casual burger
restaurants grew 10 times faster between 2008 and 2013 than
traditional fast-food burger outlets. The total number of burger
outlets grew 5.2% to 49,098 in the period, he said.
Beyond their gourmet cachet, fast-casual chains including Shake
Shack often boast meat from producers that adhere to more stringent
welfare practices and don't use antibiotics or hormones. Those
claims especially appeal to consumers in their 20s and 30s, many of
whom have grown up deeply suspicious of the established food
industry, analysts and executives say.
"My kids' generation -- they're not going to grow up eating fast
food the way they used to," said Shake Shack Chief Executive Randy
Garutti, 39 years old. "They want to know where their food's from,
they want to do it with a brand who cares and they want to do it in
a great experience."
Some analysts think investors are too enthusiastic. To take one
measure of the supersized expectations: Shake Shack's valuation
equates to nearly $26 million per existing restaurant. By
comparison, McDonald's valuation of about $91 billion equates to
$2.5 million for each of its 36,258 global outlets.
"Do I think it looks a little frothy coming out of the gate?
Yes," said Christopher Geier, head of investment banking at
Chicago-based accounting and advisory firm Sikich LLP. He added
that the company has good growth prospects, and it doesn't need to
steal much market share from companies like McDonald's to be
successful.
For now, at least, the rise of such challengers is helping to
sap the profitability of fast-food giants like McDonald's, said
R.J. Hottovy, a restaurant analyst with Morningstar Inc. Customers
who would normally order McDonald's premium offerings are instead
flocking to places like Five Guys, Umami Burger, or Epic Burger,
forcing McDonald's to depend more heavily on its value menu to draw
traffic.
Meanwhile, lower-income consumers haven't benefited as much as
wealthier ones from the U.S. economic recovery, making the
value-end of the market less lucrative.
McDonald's is becoming "basically reliant on a more economically
sensitive audience, and that group still remains very much under
pressure" financially, Mr. Hottovy said.
The fast-casual chains generally charge more. Shake Shack's
Chicago location sells a ShackBurger single for $5.19, and a basic
milkshake for $5.25. At a nearby McDonald's, a Deluxe Quarter
Pounder with cheese runs $4.69 and a medium McCafe vanilla shake is
$2.69. Many fast-casual chains, including Shake Shack, also sell
beer and wine, which generally bring higher profit margins than
food.
Shake Shack was founded by Danny Meyer, a restaurateur from St.
Louis who made his name with high-end establishments like New
York's Union Square Cafe. Shake Shack started as a hot-dog cart in
Madison Square Park in 2001 and became a brick-and-mortar fixture
of New York City by 2004. Mr. Meyer's 21% stake in the company was
worth more than $340 million as of Friday afternoon.
Shake Shack's revenue grew 41% from a year earlier to $83.8
million in the 39 weeks through Sept. 24, while net income fell by
a fifth to $3.5 million, as it opened 20 new restaurants in the
period.
Sensing a threat, traditional fast-food restaurants are
upgrading their burgers. Last month, CKE Restaurants Inc., which
owns Carl's Jr and Hardee's, launched its first burger free of
hormones, antibiotics and steroids, from grass-fed cattle. It plans
to tout the "All-Natural Burger" with a commercial during Sunday's
Super Bowl.
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