Existing somewhere between fast casual and fine dining, the fast casual industry occupies a rapidly-growing space in the hospitality sector. In fact, it grew 550% between 2000 and 2014, and Americans spent over $21 billion at fast casual restaurants in 2014 alone. 

Distinguishing itself from fast food, fast casual provides consumers with fresh ingredients, customization, and superior customer service. Founded in 1993, Chipotle (CMG) is widely recognized as the cornerstone of the fast casual industry. With over 1,600 locations worldwide, Chipotle continues to grow, with revenue increasing 27.8% from 2013 to 2014.

Since Chipotle went public in 2006, investors have searched for a new company to replicate Chipotle’s success. Following Shake Shack’s (SHAK) IPO in 2015, many believe the success of the burger joint is set to mimic that of Chipotle. In its first day trading, Shake Shack's stock grew 123%, raising the company's market cap to north of $1.5 billion. However, with low profit margins and slowing growth, investors believe Shack Shack will follow a different path from Chipotle.

Fast Casual

Founded by Danny Meyer, Shake Shack started as a single Manhattan hot dog cart in 2000 and expanded to over 60 locations worldwide by 2015. Following the success of comparable fast casual establishments, Shake Shack provides higher quality food and greater customization than traditional fast food chains. At leading fast food chains, the average meal ranges from $3 to $6, whereas the typical cost for a fast casual meal ranges from $8 to $15.  

Even with greater costs, sales in the fast casual segment grew by 11% in 2013, representing a shift in consumer habits and discretionary income. A driver of the fast casual sector is a high level of customer service. Motivating employee loyalty through comprehensive training and livable wages results in employees with greater product knowledge and engagement with company goals. Shake Shack workers reportedly earn a median pay of $10.70, cited by Danny Meyers as a key component of Shake Shack's success in the hospitality industry.

Financials

Filing its IPO in late 2014, Shake Shack’s model of high quality has proven to be quite successful. With just seven stores open in 2010, Shake Shack has grown to 63 total locations with 27 operating overseas. In the same time period, revenue has surged from $19.5 million to $82.5 million, representing a 62% compounded annual growth rate.

However, the year prior to its IPO, Chipotle grossed $627.7 million in revenue with approximately 453 stores open at the time. Chipotle’s 2014 operating margins of 26.2% trump non-Manhattan based Shake Shack margins of 22%. With Manhattan profit margins estimated at around 30%, Shake Shack’s planned expansion to 450 stores outside of New York has lead investors and financial experts to believe that long term financial growth will taper off.

Risk Factors

The initial success of Shake Shack does not come without questions and risks. With only 63 stores in operation, Shake Shack's lofty goal of opening 450 stores runs the risk of over expanding and drastically lowering its profit margin. As is, Shake Shack relies heavily on Manhattan for revenue and profit margins.

Reportedly, locations in new markets are likely to be less profitable and may carry higher operating costs than existing locations. Plus, Shake Shack's expansion to new markets runs the risk of competition with similar burger establishments, including the recently publicly traded Habit Restaurants (HABT). Similar to Shake Shack, Habit Burger Grill operates in the fast casual sector with 98 restaurants and $120.4 million in revenue for 2014.

The Bottom Line

Shake Shack’s ascension to an estimated billion dollar company has come as a surprise to some investors. With 63 operating stores at the time of its IPO, the allure of Shake Shack has rivaled that of Chipotle in 2006. However, with lower profit margins outside of Manhattan, Shake Shack's expansions to new markets are expected to drive down growth and margins. Furthermore, by expanding to new markets, the company will have to establish brand recognition and compete with rapid-growth companies like Habit Burger Grill. 

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