Cypr prus Valu alue In Investor r Con onference John M. Zolidis - - PowerPoint PPT Presentation

An n Unhe nhealt lthy Addi ddictio ion to

• Units

nits Cypr prus Valu alue In Investor r Con

• nference

John M. Zolidis

• Oct. 2019

This presentation was given on Sept. 23, 2019 at the Cyprus Value Investor Conference

Presentation Outline

2

Speaker Credentials Slide 3 Quo Vadis Capital Process Slide 4 This year’s idea: Shake Shack (SHAK) Sides 5-11 Investment Thesis Slide 12 Argument (the most important slides are #23 & 24) Slide 13-28 Investment recap Slide 29 Caveat Emptor Slide 30 Appendix (Past Performance of Hot Resto Names, Mgmt. Incentive Structure, Insider Activity) Slides 31-34 Disclosures Slide 35

Presenter Credentials – John Zolidis

3

➢Founded Quo Vadis Capital, a research boutique and Registered Investment Advisor (RIA) in 2017 ➢Analyst following U.S. consumer sector since 1999 ➢Named to Wall Street Journal’s Best on the Street list in 2005 ➢Frequently cited in the financial media ➢Education at Kenyon College & Oxford University (Mansfield College) ➢Presented at value investment conferences in Vail, CO, Klosters, Switzerland and Cyprus ➢Based mostly in Paris, France ➢More at quovadiscapital.com

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Quo Vadis Capital, Inc. : Our Process (Condensed)

4

➢Focus on Consumer sector, specialize in companies which can be analyzed by estimating and segmenting unit economics ➢Solve for ROIC and Return on Incremental Invested Capital (ROIIC) at the unit and corporate level ➢OUR FAVORITE BEARISH THEME is identifying cases when future dollars invested in a business generate lower returns than the existing

• perations. In other words, return on incremental investment is lower

than return on overall investment (ROIIC < ROIC)

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Check out this chart: Two-year return >200%

5

John Zolidis

john.zolidis@quovadiscapital.com

SHAK shares are up >200% over 2-Years… How were Fundamentals?

6

➢ Current year (2019) revenue is forecasted 67% higher than 2017 ➢ Current year EBTIDA is forecasted 36% higher than 2017 (EBITDA growth ½ of Revenue growth) ➢ Current year EBITDA margin forecasted 12.8% vs. 15.5% in 2017 (-270 bps) ➢ Current year EBIT forecasted 11% lower than 2017 ➢ Current year EPS forecasted 14% higher 2017 inclusive of tax reform Net, over two years the EV EBITDA has expanded to 39x from 15x. The Price to Earnings ratio has expanded to 134x from 55x even as margins have contracted and EBIT has declined.

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

What is Shake Shack, Inc. (SHAK)?

7

Shake Shack is a fast-casual (food made-to-order, self-service) restaurant serving burgers, fries, hot dogs, shakes, and other food and drink items. The company went public in Jan 2015. ➢ The company currently operates ~150 restaurants in the U.S. while franchisees operate 100 locations both in the U.S. and internationally ➢ EBITDA margin: 12% estimate for 2019 ➢ 2019E Capex ~$100M (16.5% of sales) ➢ Balance Sheet: $66M cash, No debt aside from operating leases, $300M Shareholders’ equity ➢ Has never generated meaningful free cash flow; 2018 OpCF was $86M ➢ No dividend ➢ Recent price $103 on the U.S. exchange, current market cap: $3.9B

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Valuation? SHAK’s EV/ EBITDA Multiple is 4x The Group Average*

8

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com *Peer group includes companies that primarily operate their own restaurants

SHAK’s EV/ Sales Multiple is >6x

9

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com *Peer group includes companies that primarily operate their own restaurants

Why are people so excited about SHAK?

10

➢ The company has a hot brand and people love the product (burgers, fries and shakes) ➢ Unit-level metrics are exceptional ➢ The company is growing units at a very fast rate ➢ It is easy to envision SHAK growing its unit base several multiples of the current business ➢ Optionality on the balance sheet

The multiple and the stock performance represent investor anticipation of the long-term growth potential, not near- term margin trends, cash flow, or earnings

John Zolidis

john.zolidis@quovadiscapital.com

The Combination of high ROIC and Unlimited Growth =

11

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Investment Thesis

12

We believe future unit openings will dilute financial metrics to a much greater degree than is reflected in analyst forecasts, generating downward revisions. We expect valuation to revert closer to the industry mean as growth slows, EBITDA margins contract, and financial metrics more closely resemble those of the peer group. Our cautious view is despite agreement that SHAK has tremendous unit growth potential and a fantastic brand. We commend management for exceptional execution of a demanding growth rate and for effective communication of the story.

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

How we propose to analyze SHAK (our process)

13

➢ Step 1: Compare key unit metrics for SHAK company-operated restaurants to those of a peer group ➢ Step 2: Review metrics of recently-opened Shacks ➢ Step 3: Quantify and forecast the future impact of yet-to-be-opened units

• n the overall company

➢ Step 4: Propose valuation for SHAK based on future profile of the company ➢ Step 5: Discuss expected catalysts for re-valuation We will show that SHAK is a company with superior metrics today that is rapidly becoming a company with very average metrics. We expect valuation to adjust over time to reflect slower growth and its less exceptional profile.

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Step 1: Compare Key Shack-Level Metrics to a Peer Group Or: Why is everyone so Excited?

14

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Peer Group Unit Metric Compare: SHAK Ranks Near The Top

15

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Source: Company Reports & Quo Vadis Capital, Inc. estimates; PLAY and CBRL use Jan YE; Period Presented is TTM Ended with 2Q19

ESTIMATED AVERAGE UNIT CASH-ON-CASH PRE-TAX RETURN RESTAURANT LEVEL MARGINS ESTIMATED AVERAGE UNIT LEASE-ADJUSTED PRE-TAX ROIC ESTIMATED SALES PER AVERAGE SQUARE FOOT

$1,359 $917 $833 $800 $780 $738 $701 $653 $652 $651 $535 $515 $487 $435 $431 $308 $266 $- $200 $400 $600 $800 $1,000 $1,200 $1,400 $1,600 28% 25% 24% 21% 19% 19% 19% 18% 18% 17% 17% 17% 17% 15% 15% 13% 12% 14% 16% 18% 20% 22% 24% 26% 28% 30% 30% 30% 28% 26% 25% 24% 23% 23% 22% 21% 20% 18% 18% 17% 16% 16% 12% 17% 22% 27% 32% 57% 52% 49% 48% 35% 33% 33% 31% 30% 30% 24% 23% 23% 19% 18% 16% 0% 10% 20% 30% 40% 50% 60%

HOWEVER: ARE THESE SUPERIOR METRICS JUST AN ILLUSION?

16

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Step 2: Extract New Unit Metrics & Examine

17

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

In Contrast, Recently-Opened Shacks Screen Below Peer Group Averages

18

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Source: Company Reports & Quo Vadis Capital, Inc. estimates; PLAY and CBRL use Jan YE; Period Presented is TTM Ended with 2Q19; New Shack-level Margin is an Estimate

ESTIMATED SALES PER AVERAGE SQUARE FOOT RESTAURANT LEVEL MARGINS ESTIMATED AVERAGE UNIT LEASE-ADJUSTED PRE-TAX ROIC ESTIMATED AVERAGE UNIT CASH-ON-CASH PRE-TAX RETURN

$1,054 $917 $833 $800 $780 $738 $701 $651 $600 $535 $515 $487 $435 $431 $308 $266 $- $200 $400 $600 $800 $1,000 $1,200 28% 25% 21% 19% 19% 19% 18% 18% 18% 17% 17% 17% 17% 15% 15% 13% 12% 14% 16% 18% 20% 22% 24% 26% 28% 30% 30% 28% 26% 25% 24% 23% 23% 22% 21% 20% 20% 18% 18% 17% 16% 16% 12% 17% 22% 27% 32% 57% 49% 48% 35% 33% 31% 31% 30% 30% 29% 24% 23% 23% 19% 18% 16% 0% 10% 20% 30% 40% 50% 60%

But Wait, Shouldn’t Newly Opened Restaurants Have Weaker Metrics and Get better over Time? Actually, in This Case, The Trend Suggests and Management’s Commentary Confirms, Future Units Should be Even Less Attractive…

19

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Step 3: Quantify Impact of New Unit Openings on Margins & Returns

20

John Zolidis

john.zolidis@quovadiscapital.com

Trend in New Unit Performance is clear: Recent Openings Tracking to $3.46M AUV, Down 31% from Peak…

21

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Source: Company reports and Quo Vadis Capital, Inc. estimates; Calculated using 24 month delay for new units to enter comp base.

TTM SALES PER AVERAGE NEW STORE ($M) SEQUENTIAL CHANGE

$4.6 $4.9 $5.1 $5.1 $4.8 $4.5 $4.3 $4.1 $4.0 $3.8 $3.7 $3.7 $3.6 $3.6 $3.5 $3.0 $3.5 $4.0 $4.5 $5.0

Jun16A Sep16A Dec16A Mar17A Jun17A Sep17A Dec17A Mar18A Jun18A Sep18A Dec18A Mar19A Jun19A Sep19E Dec19E

5% 5% 4% 0%

• 5%
• 6%
• 4% -5%
• 3% -4% -4%
• 1% -2%
• 1%
• 2%
• 8%
• 6%
• 4%
• 2%

0% 2% 4% 6%

Jun16A Sep16A Dec16A Mar17A Jun17A Sep17A Dec17A Mar18A Jun18A Sep18A Dec18A Mar19A Jun19A Sep19E Dec19E

Essentially, a small number of early stores were in AAA locations (e.g. Times Square, NYC) and produced

• versized volumes and profits

22

Future openings will not resemble these stores at all and could even produce unit level profitability below industry averages… Investors are mistakenly extrapolating from the performance of a small number of early stores, rather than more recent openings which more accurately reflect the future, in our opinion

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

What is the Impact of Aggressive Opening of Less Productive Units? Let’s do the math:

23

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Using our assumptions we estimate this could dilute AUVs by >10% and profit per unit >20% yielding consolidated AUVs of $3.7M and 19% Resto-Level Margins

FULL-YEAR 2019 2018 & 2019 2020 & 2021 CURRENT CHAIN AVERAGE STORES < 2 YEARS OLD ESTIMATE FOR STORES TO BE OPENED OVER NEXT TWO YEARS AUV $(M) 4.16 $ 3.50 $ 3.28 $ PROFIT PER UNIT 0.94 $ 0.62 $ 0.57 $ RESTO-LEVEL MARGIN 22.5% 17.7% 17.4%

We estimate SHAK will open 100+ company-operated locations during 2020 and 2021, representing 63%+ Growth

How is the Street modeling this situation?

24

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Consensus Forecasts Currently Call for AUVs to decline 10% over 2020 & 2021 and Profit Per Unit To Fall 15%; Vs. Our Estimate of >10% AUV Decline and >20% Contraction in Profit Per Unit Resetting Consensus Should Contribute to Material Downward Revisions to EBITDA and EPS Estimates

2018A 2019E 2020E 2021E AUV $(M) 4.36 $ 4.13 $ 3.93 $ 3.71 $ PROFIT PER UNIT 1.10 $ 0.95 $ 0.89 $ 0.81 $ RESTO-LEVEL MARGIN 25.2% 22.9% 22.7% 21.9% % CHANGE AUV

• 5.3%
• 4.9%
• 5.5%

PROFIT PER UNIT

• 14.0%
• 5.8%
• 8.8%

Source: FactSet, Quo Vadis Capital, Inc. estimates

Step 5: Potential Catalysts For Re-Rating

25

John Zolidis

john.zolidis@quovadiscapital.com

What Will Cause Investors to Look Past Fast Rev & Unit Growth and a big TAM?

26

We anticipate some of the following to occur, noting that 3Q19 should have peak revenue growth given easy compare and the timing of store openings Total revenues miss estimates due to weaker new unit contribution ➢ The company slows unit growth (compounding at 30% is hard to do) ➢ Execution issue (see above) ➢ Margins fall faster than Street forecasts, generating incremental downward revisions to near and long-term models

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Step 4: What is the Right Valuation for SHAK?

27

John Zolidis

john.zolidis@quovadiscapital.com

SHAK has a great brand, legitimate growth and

• ther options (B/S optionality, more franchising)

28

Nevertheless, the core business will more closely resemble the balance of the restaurant industry in just two years, according to our forecasts. In addition: ➢ The U.S. restaurant industry is highly competitive. A burger and fries may be the single most commonly available menu item(s) in the entire U.S. ➢ Labor inflation remains a threat to restaurant operators ➢ Shift in consumer preference to delivery is a challenge Accordingly, we see the multiple for SHAK retaining a premium to the group average (~12x NTM EBITDA) but given similar store metrics, we believe this premium should be modest (call it 14x-17x, a premium of 20-40%)* The high end of this potential valuation range implies >50% downside * It traded here just two years ago

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Investment Recap:

29

➢ Hot Restaurant Stock trading at 40x EV EBITDA ➢ Investors are excited by the combination of the company’s strong brand, exceptional unit economics, fast growth rate, and large TAM ➢ Management has done an excellent job managing growth and communicating the story to the Street ➢ However, current performance metrics reflect a small number of past store

• penings, future restaurants will produce lower revenues and profits

➢ We expect SHAK to potentially grow its store base by 63%+ over the next two years ➢ We estimate possible >10% dilution to AUV over this time and dilution to profit per unit >20% ➢ This pressure is not factored into analyst forecasts ➢ We see several catalysts to bring SHAK valuation more in-line with the group ➢ Returning the multiple to levels of 2 years ago (still 17x EV EBITDA) = >50% downside Shake Shack, Inc. (SHAK)

john.zolidis@quovadiscapital.com

Caveat Emptor/ Risks

30

➢ Shake Shack has a unique and very strong brand. ➢ SHAK’s management team has done an excellent job executing a very ambitious growth rate ➢ Even better than management’s execution has been the company’s communication to investors ➢ The company has tremendous growth in front of it ➢ We could be over-estimating the dilution from new units ➢ Franchising growth could accelerate ➢ Existing units could see accelerating sales growth

Shake Shack, Inc. (SHAK)

john.zolidis@quovadiscapital.com

Appendix: Past Performance of Select High Multiple Resto Stocks, Executive Incentive Structure, Insider Transactions

31

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Past Performance of Select High Multiple Resto Stocks: It has Often Been a Bad Idea to Pay for Unit Growth

32

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

• Mgmt. Incentive Comp is Based on Rev. Growth &

“Adjusted” EBTIDA Growth, not EPS, ROIC, or EVA

33

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

2017 2018 Total Revenues vs Budget 50% Total Revenues vs Budget 40% Adjusted EBITDA vs Budget 50% Adjusted EBITDA vs Budget 40% Individual Performance 20% Total 100% Total 100%

Adjusted EBITDA is defined as net income before deducting interest, taxes, depreciation and amortization and excluding certain non-cash and other items not considered in the evaluation of ongoing operating performance. Source: Company reports

Cash incentive plan for executives was based on the following criteria:

Insider Transactions Since IPO. Essentially Zero Purchases

34

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com

Year Number of Shares Market Value Chairman Daniel Meyer 2019 (375,000) $ 24,170,252 2018 (580,000) $ 30,424,114 2017 (285,000) $ 11,482,443 2016 (350,476) $ 13,307,996 2015 (2,336,710) $ 134,944,900 CEO Randy Garutti 2019 (235,000) $ 16,963,621 2018 (205,000) $ 10,059,653 2017 (99,000) $ 3,585,749 2016 (84,000) $ 3,015,830 2015 (311,456) $ 17,610,680 CFO Tara Comonte 2019 (9,500) $ 804,119 2018 (4,896) $ 315,185 COO Zachary Koff 2019 (35,000) $ 2,615,000 2018 (11,000) $ 599,940 2017 (12,000) $ 438,920 Source: FactSet

Disclosures

35

General Disclosures: Quo Vadis Capital, Inc. (“Quo Vadis”) is an independent research provider offering research and consulting services. The research products are for institutional investors only. The price target, if any, contained in this report represents the analyst’s application of a formula to certain metrics derived from actual and estimated future performance of the company. Analysts may use various formulas tailored to the facts and circumstances surrounding a specific company to arrive at the price target. Various risk factors may impede the company’s securities from achieving the analyst’s price target, such as an unfavorable macroeconomic environment, a failure of the company to perform as expected, the departure of key personnel or other events or circumstances that cannot be reasonably anticipated at the time the price target is calculated. Quo Vadis may change the price target on this company without

• notice. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from

sources Quo Vadis believes to be reliable; however, Quo Vadis does not guarantee its accuracy and does not purport to be complete. Opinion is as of the date of the report unless labeled otherwise and is subject to change without notice. Updates may be provided based on developments and events and as otherwise appropriate. Updates may be restricted based on regulatory requirements or other considerations. Consequently, there should be no assumption that updates will be made. Quo Vadis disclaims any warranty of any kind, whether express or implied, as to any matter whatsoever relating to this research report and any analysis, discussion or trade ideas contained herein. This research report is provided on an "as is" basis for use at your own risk, and neither Quo Vadis nor its affiliates are liable for any damages or injury resulting from use of this information. This report should not be construed as advice designed to meet the particular investment needs of any investor or as an offer or solicitation to buy or sell the securities or financial instruments mentioned herein. This report is provided for information purposes only and does not represent an offer or solicitation in any jurisdiction where such offer would be prohibited. Commentary regarding the future direction of financial markets is illustrative and is not intended to predict actual results, which may differ substantially from the opinions expressed herein. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. The analyst who is the author of this report does not have a position in shares of the companies that are the subjects of this report. However, Quo Vadis prohibits analysts from trading in a way that is inconsistent with opinions expressed in reports [subject to exceptions for unanticipated significant changes in the personal financial circumstances of the analyst]. This report may not be reproduced in part or in whole. Please do not redistribute this report. Reg AC Certification: All of the views expressed in this research report accurately reflect the research analyst's personal views about any and all of the subject securities or

• issuers. No part of the research analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views

expressed by the research analyst in the subject company of this research report.

Shake Shack, Inc. (SHAK) John Zolidis

john.zolidis@quovadiscapital.com