You may look at the title and expect this article to be about eating out, but in fact it is all about money. The three food items I have listed all have experienced bubble type activity in the past decade. The reason I bring this up is to explain how and why the burger bubble is about to pop. I will use history to show how hamburgers are experiencing similar activity to frozen yogurt and cupcakes. You may be surprised food items can reach bubble valuations. This often happens when a food item the restaurant sells becomes wildly popular. At this point investors are willing to pay outrageous valuations to get a piece of the action.
Looking at the Google Trends data is a great way to see what search items are popular. It allows you to visualize the collapse froyo experienced a few years ago. The Google trends data shows an enormous spike up in searches for froyo in 2011, only to collapse lower once the fad ended.
There aren’t frozen yogurt public companies to examine. All of them are too small or are private. The reason why so many companies over expanded at the top of the market is the misrecognition of what fad is and why they aren’t sustainable. There was a misconception that consumers wanted a healthier desert option and liked the ability to make their own creations. This was faulty logic. The price for froyo was way too high and the mass consumer didn’t care about health when eating a dessert. Humans are fickle. They like things for a short-time especially food and clothing items. There is no differentiation or competitive advantage that froyo has over other deserts.
Although there aren’t any public frozen yogurt companies, I did find Google trend data for the term “red mango.” Red Mango is, of course, the South Korean frozen yogurt company. The chart below is a good proxy for a stock chart. Every year since 2011 the peaks from the searches in the summer get lower and lower.
The next bubble I will review is the cupcake bubble which lasted from 2010 to 2012. The expansion in cupcakes was the most obvious fad out of the three. As I’m sure you’re aware, cupcake shops in all shapes and forms began opening. There were small cupcakes sold at Baked By Melissa, large cupcakes at Crumbs, and gourmet cupcakes at stores such as DC Cupcakes. Even though this trend seemed like it was destine to fail from the start, it is important to recognize how many people did not see this coming. Cupcakes clearly weren’t going away as a desert item, but the nation’s obsession with them reached ridiculous proportions including being the focus of multiple TV shows on the Food Network.
The poster child for the bubble was Crumbs which did a $66 million IPO. The company ended up suffering from over-expansion. Management thought it was a good idea to expand throughout the Northeast. When sales declined it tried to expand its lunch offerings, but that went outside the company’s core competency. The lunches ended up not tasting great which spelled the end of the firm. The management was terrible, but it is difficult to fight against a dying fad. The main problem they had was they actually believed a national rollout was even feasible. The chart below shows the death spiral the stock has been in the past few years. The lesson to learn about the Crumbs case study is when fads end companies in the industry can and will go bankrupt. The firms which are the best at managing costs and innovating are able to survive. After all, there are some cupcake shops and froyo locations still in business.
The entire point of this article was to use the history lesson of past food bubbles to look into the better burger bubble which we are currently in. As the adage goes “those who don’t know history are doomed to repeat it.” The better burger bubble is more complex than the other situations because it involves two separate trends. The first is the fast casual trend which is taking the place of fast food. The best example of a successful fast casual company is Chipotle. The reason for the success of fast casual restaurants is consumers are willing to pay a premium price for food high quality food which is cooked quickly. Fast-food originally became popular because of the convenience factor. Since fast casual restaurants have quick service, fast-food companies have lost their main differentiating factor.
The second factor in this better burger bubble is the demise of McDonald’s. McDonald’s is the largest hamburger restaurant in the world, so any loss of market share can cause a small restaurant company to have huge percentage increases in revenues. The McDonald’s brand is declining because of mismanagement as it has failed to get rid of its reputation of selling pink slime. The change in the consumer’s taste have been the main reason for its decline in market share as competition from firms such as Chipotle have made consumers question why they eat fast-food.
There is a health component to the decline of McDonald’s as well. Popular brands such as Shake Shack (NYSE:SHAK) and Chipotle aren’t healthy, but their using anti-biotic free meat has given them a positive brand image. Even though McDonald’s has recently jumped on the bandwagon of antibiotic free meat, consumers mistrust the brand which is something which will be difficult to combat. If you take a look at the comment section of any video they post on YouTube, you can see the skepticism consumers have for McDonald’s. The chart below shows this situation playing out as Chipotle has had positive same store sales and McDonald’s has experience weakness.
The poster child for this better burger bubble is Shake Shack as the company has experienced lines out the door and a stock price which isn’t close to reflecting the fair value of the company. It calls business model “fine casual” instead of “fast casual”, but the concept is basically the same thing. It sells hamburgers which taste great, while having fast service. The company is taking advantage of the problems McDonald’s is having. When I visited one it was packed and the McDonald’s across the street was empty.
The reason why it is difficult to figure out exactly how this story will end is because Shake Shack’s management has a high pedigree as Danny Meyer, the founder, is an award winning restaurateur in Manhattan. The expansion plan is not at break-neck speeds which means it is sustainable. The means there will be no loss in quality and service at the new locations. The problem the company faces is the hype it has is unsustainable. The lines out the door won’t last. After all, Crumbs had a great tasting product and it didn’t succeed. To understand how well the companies’ 14 Manhattan stores are doing, you can look at the guidance for same store sales growth of low single digits. The stores in Manhattan simply cannot sell more burgers; this is why the growth projections are so slow.
The business model is sustainable because the fast casual trend is real, but there will be some push-back from McDonald’s as it institutes its turnaround plan. The Create Your Taste initiative gives customers the personalization they crave. It also offers better quality burgers at higher price points. McDonald’s is ironically copying Chipotle which it actually owned a few years ago.
Where the bubble really is able to be seen clearly is in the stock price, as you can see in the chart below.
The stock trades at a price to earnings ratio of over 1,000. To those who are unfamiliar with the stock market, the average stock trades at a price to earnings ratio of 16 and growth companies often have P/Es in the 30s. A $2.5 billion total valuation for 63 stores is a sign of an impending bubble burst. Besides the factors explained above, the market for the stock is also causing the stock to move to insane heights. Because it is a recent IPO it can’t be shorted, meaning investors can’t bet against it. Shorts allow for the stock to reach a more reasonable valuation because they inject a healthy amount of skepticism into the market. The stock also is still in its lockup period which means some of the original stock owners cannot sell their shares. This period ends in July. With only half of the float (shares available to trade) outstanding, the stock can be manipulated by momentum investors.
The take away from this article is to avoid Shake Shack stock as well as some of the other expensive fast casual stocks. It will be fun to watch this scenario play out. Now you can tell your friends you predicted this fad would end. Don’t worry, you don’t have to mention this article. Take all the credit for yourself; I don’t care. Thanks for reading.