There’s been a lot of talk lately about the rise of fast casual dining. The era of fast food appears to be over. Well, not entirely over – odds are McDonald’s (MCD) isn’t going anywhere any time soon. The iconic burger joint will, however, be clutching to an ever-shrinking market share. The writing appears to be on the wall: American consumers – particularly younger ones – have entirely different tastes these days. It might be hard to believe, but it turns out, people want actual food now, and that’s not working out so well for traditional fast food.
Of course, any time there’s an inevitable shift in the market, you can expect a few events to follow. Firstly, there’s tremendous investor enthusiasm, as growth investors start looking for the next big thing. That means spiking stock prices for those burger plays out there. And that, in turn, means there are inevitably whispers that we’re in a bubble. A burger bubble that’s driving fast-casual stock prices through the roof.
So the question is – are we in a burger renaissance or a burger bubble? Really, it’s almost certainly both. Like most bubbles, this one is rooted in very real value, even if it’s value that’s been artificially ballooned by hysteria. That means most of these plays will likely fizzle, but the best ones will ultimately reveal themselves, and make their investors very happy in the end. Some of the companies that are currently on people’s radar WILL be the next Chipotle (CMG) , while most of them are destined to be…whatever the Pets.com equivalent for burrito restaurants would be.
With that in mind, the currently crowded landscape for growing burger chains is an exciting one. At this point, it’s just picking horses (or cows, as it were). So, about those horses…
For the time being, most of the big players remain private companies. However, two prominent names have already IPOed, giving investors a shot at the new fast casual burger trend.
Shake Shack (SHAK)
So, this horse may have already been picked. Whether Shake Shack is THE burger chain that’s going to be the next big name, the fact that, through April 20, the stock had tripled in value from its IPO price could indicate that the getting has been gotten, and it’s probably not so good for latecomers to the party.
A downgrade from Stifel on April 21 appeared to prompt a 5.73% slip, but it also could have just been a good old-fashioned pull back from a massive spike in value. Either way, this chain; which got its start as a hot dog cart in Madison Square Park in 2001, grew into a kiosk by 2004, and took off from there; appears to be a leading contender to seize control of a big piece of this space.
Habit Restaurants (HABT)
The other major contender that’s already trading publicly is Habit Restaurants. The Habit has been around a while, with the first location opening in Santa Barbara in 1969. The chain grew to prominence out of the extremely competitive burger market of Los Angeles.
Its success in that crucible, opening 23 locations in Los Angeles by 2007, led to its acquisition by private equity firm KarpReilly in 2007 and then ultimately its IPO in late November of last year. Buzz about Habit really kicked into a high gear in mid-2014, when its “charburger” was named the best burger by Consumer Reports, narrowly edging out local competitor In-N-Out Burger (but more on them later).
Habit’s stock has been a roller coaster ride during its brief existence. It more than doubled on its first day from an IPO price of $18 to just under $40, then it collapsed almost 25% to just under $30 in its first five days of trading. That was followed by an impressive spike over $40 by December 12, then another sharp retreat that has left it around the $30 to $35 a share range that it’s traded in since.
So Which is the Better Play?
Personally, I can’t get over the fact that The Habit is currently valued at just over a third of Shake Shack (market cap of $843 million to Shake Shack’s $2.25 billion) despite Habit Restaurants featuring more locations (109 to Shake Shack’s 63) and higher revenue last year ($48.35 million to Shake Shack’s $34.77 million). There might be plenty of reason to like Shake Shack more than Habit Restaurants in the long term, but the current valuations seem wildly out of sync.
It may not even be out of the question to think some of this could be attributed to an east coast bias. Shake Shack’s New York presence puts it in a position that’s much more visible to the financial industry. Could be because I live in Los Angeles, but I’m not under the impression that New York is a real “burger town.” Los Angeles, though, definitely is, featuring almost a dozen notable chains, as well as a wide variety of one-offs. Emerging from this burger battleground successfully should probably not be underestimated.
Only time will tell which chain comes out ahead, but the huge difference in valuation at the moment would make Habit appear to be the much more appealing play. Even if Shake Shack is destined to be valued at double Habit Restaurants, that would still make Habit the better buy at the moment.
Private Companies Poised to Grow
Of course, it should be noted that Shake Shack and Habit, despite being the first to IPO, are actually not even particularly large or successful burger chains when stacked up against their private competition. The market is CROWDED.
In some cases, this could indicate something about the nature of private equity vs. small-cap IPOs in this day and age. In others, the answers are more complicated. Regardless, most of these names are ones that, if you don’t know them now, you probably will.
Speaking of Los Angeles, despite being incredibly competitive, the burger market there has a clear king. Since 1948, In-N-Out Burger has remained a Southern California staple, expanding out of Los Angeles to now include 300 locations and over 18,000 employees. An absurdly simple menu and commitment to fresh ingredients has made for a simple business model that has had tremendous success.
However, In-N-Out remains privately-owned by the same family that founded it. Lynsi Torres, who currently runs the company, is the granddaughter of Harry and Esther Snyder, who founded the company in Baldwin Park, CA in 1948. With over $600 million in revenue, In-N-Out was valued at $1.1 billion by Bloomberg News in 2013. That was, of course, prior to Shake Shack clearing $2 billion in market cap, making me think that it’s probably a lot higher than that.
The Snyder family remains protective of their restaurant and its legacy, refusing to follow the normal path for company expansion. They have grown at a modest but firm and sustainable rate for their entire 65-plus years in the business, so it’s hard to see them changing things up now.
On the other end of the spectrum, Smashburger appears to have been positioning itself for an ultimate cash-in from the very start, with private equity firm Consumer Capital Partners backing it since its founding in 2007. It raised $35 million with Golub Capital just two years ago, so the IPO may still be a ways off.
Still, regardless of when it IPOs, the company’s explosive growth would appear to point to it being a part of the landscape for some time. Smashburger currently sports some 300 locations in 32 states and five countries. In fact, it’s not hard to see companies like Smashburger starting to get attention for acquisition by major players. A company like McDonald’s, which arguably should be looking for a fast-casual partner to hedge their current market share, could entertain dropping a large chunk of change on an established franchise like this one.
Virginia’s Five Guys has a pretty similar story to In-N-Out’s. Founded in 1986, it’s family-owned and has resisted selling to a big buyer in favor of slower, more organic growth. However, it has been ready to franchise, meaning it cleared 1,000 locations by 2012, including 155 reportedly owned by Shaq. Then there’s another 1,500 restaurants currently in pipeline, meaning Five Guys is poised to be larger than Shake Shack by several orders of magnitude.
And, hey, when the leader of the free world is a fan, you must be doing something right.
Like In-N-Out, there doesn’t appear to be an IPO forthcoming. The owners aren’t looking for a quick payday and, with plenty of revenue, they don’t need the cash to push their growth. With annual revenues in excess of $1 billion, the company’s valuation could be as high as $5 billion…or a lot more. Again, Shake Shack’s current market cap would seem to indicate that, on the open market, equity in a chain like this would go for a lot.
Texas-based Whataburger cleared 735 locations in September of 2012. Its 22,500 employees and 25 franchisees serve burgers to customers in 10 states. With high marks in its consumer reviews and a rapidly expanding footprint, Whataburger should be in the same class as In-N-Out and Five Guys. The company is very healthy (if not the burgers), so the motivation to seek financing by selling equity is probably pretty low. In fact, over 600 of the locations are still owned by the Dobson family that founded the original location in Corpus Christi in 1950.
In terms of size, The Counter is nowhere near some of these other players. The company, which specializes in “custom-built” burgers, is still in the “dozens of locations” realm. That said, they’re in the process of franchising, and long term plans should bump that number well into the hundreds. The company is also debuting a fast-casual alternative to its flagship, higher-end locations that could help make for much more rapid growth.
There’s a vocal minority of Los Angeles burger fans who swear by Fatburger, insisting that the fame and praise showered upon In-N-Out is going to the wrong LA burger chain. The company has over 150 locations and plans for 300 more. It’s also international, with a branch opening in Karachi, Pakistan in January of 2013.
Freddy’s Frozen Custard and Steakburgers
Kansas-based Freddy’s is relatively young and relatively small compared to others on this list. Since being founded in 2002, the company has expanded to a modest 58 locations over 20 states. That said, rapid sales growth has Freddy’s getting a lot of attention nationwide.
Butter burgers probably sound pretty odd to most of the country, but they’re popular in Wisconsin, where Culver’s was founded. The chain is also famous for its frozen custard. With almost 450 locations and over $700 million in annual sales, Culver’s is well-established with a firm footprint across the Midwest.
Who’s the Burger King? (Probably Not Burger King (QSR))
Push comes to shove, a lot of this is going to come down to whose offering is the most popular. The existence of a promising market is pretty clear at this point, and there are clearly a lot of players with the resources to aggressively expand into that market. So, which one’s will in out? It does seem as though there’s a real chance that this will just come down to whose burger is the best.
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