When you think of fast food burger chains, the first names that come to mind are probably: mcdonalds (MCD -0.03%). After all, this quick-service restaurant operator has more than 41,800 locations around the world. Its golden arches are one of the most iconic logos in the world, and the company is a marketing machine.
But McDonald's stock isn't the best investment option in today's quick-service burger industry — that title. shake shack (shaku -0.24%). So why does this smaller rival have more room to rise? Well, one of the biggest reasons is its smaller size.
there's a lot of room for growth
One of the biggest growth drivers for restaurateurs is adding new stores, and Shake Shack has a better chance of increasing its store count on a percentage basis than a company of McDonald's size.
Why is this important? That's because stocks tend to be valued in part on a company's growth potential, and adding new restaurants increases both sales and profits. Average sales for each Shake Shack are close to his $4 million, and restaurant-level operating margins are about 20%. This means that each company-owned restaurant generates approximately $800,000 in profits before company-level costs are deducted.
With a total of 518 stores (334 in the U.S.) at the end of 2023, Shake Shack has plenty of room to add new restaurants. While it's unlikely to approach the size of McDonald's, it could at least match the size of Five Guys, which has about 1,500 stores in the U.S. and sells premium burgers similar to Shake Shake. Combined with international opportunities, the company should be able to quadruple its number of locations over time. Given McDonald's size, that would be impossible.
Shake Shack plans to add 40 company-owned stores and 40 licensed stores this year. Company-owned stores will primarily be located in domestic markets where the company already has a presence, while licensed stores will be located in new and existing international markets, as well as domestic airports and rest areas.
Using McDonald's Playbook
Shake Shack also has a great opportunity to improve its performance by following some of the initiatives that McDonald's is already implementing. One such area is the drive-thru that McDonald's has used since his 1970s. Shake Shake is experimenting with drive-thrus at about 30 stores. The big advantage of drive-thru is that it speeds up the ordering process, allowing restaurants to serve more customers and generate more sales.
Similarly, Shake Shack has begun rolling out ordering kiosks. This is an innovation that has also benefited McDonald's. Kiosks reduce both ordering time and labor costs. Consumers also tend to spend more per visit when ordering from kiosks. Shake Shack said he is seeing a high single-digit increase in check size for orders at kiosks compared to check size at traditional cash registers.
Image source: Getty Images
Both stocks should be winners in the long run.
Over the past few years, restaurateurs have benefited from high inflation, which has allowed them to raise prices, often outweighing the increased costs they face. As a result, same-store sales increased and profits also increased. The reason for the increase in profits despite inflationary pressures is very simple. Higher prices allow restaurants to maintain their profit margins, leading to increased profits.
However, even if profit margins drop a little, profits can still increase. For example, a 20% margin on sales of $85 million results in an operating profit of $17 million, while an 18% margin on sales of $100 million results in an operating income of $18 million. Therefore, if the top line grows at a sufficient rate, profits can increase even if margins shrink, but companies typically try to keep margins stable or increase margins. Not surprisingly, the restaurant industry has done some well in this environment.
Inflation has now eased significantly, and any further price increases for both restaurateurs are likely to be smaller than in recent years. Shake Shake says it's aiming for 2.5% price increases this year, while McDonald's is talking about low-single-digit price increases. Both are expected to drive traffic growth this year. Therefore, both companies appear well-positioned to continue to drive sales growth, although the environment is not as strong as in past years.
Both McDonald's and Shake Shake should have strong long-term results. However, Shake Shake has greater upside potential given its ability to add more stores and improve operational efficiency through initiatives such as drive-thrus and kiosks.
