Shotgun $SHAK?

by Dan March 7, 2016 2:20 pm • Commentary• Trade Ideas

Event: Shake Shack reports Q4 results after the close, the options market is implying about a 10% one day move in either direction. I would note that in the 4 quarters the company has reported since going public, the average one day post earnings move has been only about 3%, the last three being sell-offs, and the first out of the gate being a 2% gain.  

Price Action / Technicals: The stock is up 4.5% on the year, up 38% from its 52 week low made in mid -January, but down 58% from its all time highs made in May 2015.  The chart below shows the very slight technical support in the low $30s, but the post IPO low of $30 would obviously be a target on the downside, while the 200 day moving average near $40 could serve as moderate technical resistance:

[caption id="attachment_61959" align="aligncenter" width="600"]SHAK since Jan 2015 IPO from Bloomberg SHAK since Jan 2015 IPO from Bloomberg[/caption]

For a stock like SHAK with nearly 60% of the float sold short, the notion of technical support seems flimsy at best if the stock ever had a reason to rally.

Fundamentals: In a post on the, my co-contributor Guy Adami highlighted the recent improvement in operating margins, and shareholder focus on expansion:

Their operating margins for the third quarter reported on November 5th was 30.4% That was up from 25.1% in the third quarter the year before. Will margins continue to improve? The street may give them a pass on operating margins if revenue growth continues to expand. But it had better be one of the other.

Next I will be looking for restaurant growth. As of September 30th there were 75 Shake Shacks. What will that number be now? What is their plan for international expansion?

It appears these will be the key issues to watch, but with valuation when it comes to SHAK (trades 100x expected 2016 earnings, higher on a GAAP basis), a good part of the value ($1.5 billion market cap) may be related to what a larger competitor would consider paying for the brand.  SHAK’s expected sales in 2016 of about $240 million is 1% of McDonald’s (MCD) expected sales of $24 billion.  MCD’s sold in three days last year what SHAK did in an entire year.

My View: Full disclosure, I have single handily done my best in the last 6 months to make sure these guys hit their numbers, especially since the launch of their Chicken Shack sandwich a couple months ago. But that’s here nor there, competition in the fast causal space, especially for burgers is heating up, as regional players like Smashburger, LarkBurger, BareBurger, Five Guys and In-N-Out expand, but the likes of MCD appear to be going upstream a bit on the burger front and who knows that the impact of all day breakfast is having on consumer behavior after such a short trial.

With less than 70 stores, I suspect the runway for SHAK is long, but the road to profitability will be long as the company will need to achieve a certain level of scale that may not be consistent with the quality of their product.

If SHAK were to have a sort of come to Oprah moment, as expectations got reset lower, I would consider dipping my toe in back towards the lows. In the meantime, I see few catalysts that are likely to send the shares sharply higher above $50.  With a stock as expensive as this I think it’s important to separate the product and the brand from the reality of current competition and the market for value proposition vs quality.

So what’s the trade?

Stock Alternative:

So for those that are long, or those considering a new long, it might make sense to do so with defined risk as the hopes and dreams of the valuation still hinges on some pretty extraordinary execution by the company.  Call Butterflies look interesting targeting the implied move, but defining your risk to $40 on the downside.  You would only do this in place of long stock is you do not think there was a strong likelihood the at the stock would outperform the implied move to the upside:

In lieu of 100 shares of SHAK ($41.35) Buy the March 40/45/50 call fly for 1.35
  • Buy 1 March 40 call for 3.20
  • Sell 2 March 45 calls at 1.10 (2.20 total)
  • Buy 1 March 50 call for .35

Rationale – This call fly targets the implied move to the upside and only risks 1.35 in case the stock craters on the event. (the most that can be lost with the stock lower is 1.35 vs unlimited risk to zero in the stock) The breakeven (at 41.35) is basically where the stock is trading so you’re not spending a ton of extrinsic premium on the trade. The risk to the upside is important though. This targets the implied move in the stock. If there’s a massive short squeeze and the stock is up near $50, this could actually be a loser, so it is threading the needle a bit on the upside and looking for sellers to show up on a 10% move higher.


Yield Enhancement for Existing Longs:

For those that are already long stock there’s an interesting way to try to collect some premium (add yield), but this entails being willing to sell the stock up 10%+ and buy more down 10%+:

Against 100 shares of SHAK (41.20) sell the March 11th weekly 41 straddle at 4.50
  • Sell 1 March 11th 41 call at 2.35
  • Sell 1 March 11th 41 put at 2.15

Rationale – This is selling the move. Basically, you collect yield against your long stock as long as the stock isn’t 4.50 higher or lower on Friday. This is a high probability trade of making at least a little but there is an outside chance of being put stock down 10% or selling your long up 10%. This is not the trade for those unwilling to add to the position lower or for those that are waiting for a short squeeze higher towards 50 as this position would mean being called away in the stock at 45.50.


Straight Overwrite against long Stock:

If you did not want the added risk of buying more lower with the put sale in the straddle detailed above, I might consider merely selling out of the money call like the $45 strike and make it a straight over-write. For instance with the stock at $41.35, the March 11th weekly 45 call can be sold at $1.05.  If the stock were below $45 on this Friday’s close the call seller would collect the $1.05 in premium against their long stock, or about 2.5% of the stock price.  If the stock were $45 or higher the long stock would be called away, but effectively at $46.05.  Again a holder would not want to do this if they thought there was a strong likelihood the stock could go much higher after results.  This overlay is take advantage of high options prices in what could be a dull move.