Historically, new Shake Shack units have outperformed long-term cash-on-cash return targets, CEO Randy Garutti said, but that hasn't been the case in recent years.
Pressured profitability, partly coming from elevated buildout costs, has caused new locations to fall just below these goals. Restaurants opening in 2022 averaged $2.4 million in construction costs. Some of this is due to inflationary pressures around the building market, but it's also because Shake Shake is opening drive-thru stores, which are more expensive. The fast casual expects a similar cost mix in 2023 with 12-15 drive-thru locations in the pipeline.
'We're addressing cost-savings where we can for the class of '23 and beyond," said Garutti during Shake Shack's Q4 and full-year earnings call. "We've cast our operational and construction design teams to work towards bringing down long-term average cost to build for all formats."
To mitigate costs, the brand is aiming for standardization with each store format. It's early into that process with drive-thru stores. Garutti said that with the first 20 openings, the company is "doing kind of a little bit of everything so that we can learn what we like best." Building and construction teams are analyzing whether steel or wood is used, how windows are positioned, how many drive-thru lanes to use, and how tech will be incorporated, among several other matters.
Shake Shack is also learning the right size for drive-thru units. What it's seen so far is that dining rooms are still important since they account for 50 percent of sales. The brand likes that mix and wants to continue building the drive-thru prototype to be a community-gathering place. Not one where it's drive-thru only. That may happen someday, Garutti said, but right now Shake Shack is focused on allowing customers to select from any channel they want, including dine-in.
As the company starts designing drive-thrus for 2024 and 2025, that's when it expects to "templatize" the format and lower expenses. The chain has the same mindset for its core prototype, which accounts for the most growth, and its slimmer designs that are under 3,000 square feet.
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"So, look, a lot of work to do on that," Garutti said. "I think we'll have lots of different versions that we're going to test and learn from, but we're really targeting the efficiency of our builds as we look forward."
Shake Shack will also search for deals. It may look into build-to-suit options or make smaller formats a bigger part of growth to decrease overall average costs.
"It's really one of the most important focuses of the company right now," Garutti said. "And again, we're in this elevated environment. We don't expect to reap those rewards this year. But as we look ahead towards the long-term and building back our return profile over time, we think we've got a lot of opportunity in how we build our restaurants, design them, and get more efficient for the long-term."
Store-level operating profit in Q4 was $43.2 million, or 18.8 percent—240 basis points higher than 2021. It achieved that figure through higher menu prices, stronger sales performance, labor efficiency, and positive channel mix.
CFO Katie Fogertey laid out a four-point plan for Shake Shack to see sustained improvement in profitability. The first tenet was building sales on its own channels, where it sees better margins and can communicate with guests.
Same-store sales rose 5.1 percent in Q4 year-over-year, including 8.1 percent at urban locales and 2.5 percent for suburban markets. In January, total revenue grew nearly 35 percent, including a 17 percent increase in same-store sales and double-digit traffic growth as it lapped Omicron. Average weekly sales per restaurant in Q4 were $76,000 ($3.95 million in annualized AUV), up 4 percent quarter-over-quarter.
Another focus is labor efficiency. Last year, Shake Shack filled almost 60 percent of operations leadership positions with internal candidates. Seventy-seven percent were awarded to people of color and more than 50 percent were given to women. Many stores remain below optimal staffing levels, but the system has seen improvements in hiring over the past few months.
The fast casual is hoping to reduce the strain on employees by rolling out self-order kiosks to all U.S. company-operated units by the end of 2023. Kiosks are the brand's highest-margin channel, and they allow team members to better serve guests, Fogertey said. In 2022, Shake Shack racked up nearly $500 million in combined digital and kiosk sales, mixing 57 percent. That's growth from $442 million (62 percent mix) in 2021, $329 million in 2020 (65 percent mix), and $147 million (26 percent mix) in 2019. In stores where kiosks are present, 75 percent of sales come via kiosks or digital orders.
Thirdly, Shake Shack is making progress on off-premises profitability with more discipline on packaging standards and passing on a portion of higher delivery costs to customers.
The fourth and final point is a strategic approach to menu pricing. There was a mid-to-high single-digit rise in October. The hike was necessary to address food and paper inflation in the high-single digits and investments in employees. The company is hoping food and paper inflation is at the lower end or below current expectations, but if that doesn't happen, it will take some incremental pricing later in the year.
Fogertey said these four points move the needle around building back margins in the coming years. At the same time, Shake Shack is looking at all line items for efficiencies.
"While we're pleased with our Shack-level operating profit margin progression in the fourth quarter, we know for well not every quarter will show linear improvement," the CFO said. "However, we believe addressing our profitability is one of the right priorities for our home office and our operators."
In Q1, Shake Shack projects operating profit margin of 16-18 percent. The company is tracking toward the mid-to-lower point of this range because of so many store openings being pushed to the end of Q4. It usually takes several months for a new unit to reach normalized profitability as employees and managers grow comfortable. With that said, Shake Shack is still happy with sales performances and believes this particular pressure will lower in coming quarters.
Same-store sales are projected to be mid-to-high single digits in the quarter.
The brand is planning for high-single-digit inflation in food and paper costs year-over-year in Q1, led by fries, dairy, and paper and packaging. Beef costs, the largest part of its basket, are expected to drop by mid-single digits year-over-year, but increase by low-single digits quarter-over-year.
The chain opened 35 units in Q4—the most it's ever done—including 22 company-operated outlets and 13 licensed stores. In 2023, Shake Shack expects to open about 65-70 restaurants (40 company-operated and 25-30 licensed).
Shake Shack ended 2022 with 436 restaurants, including 287 in the U.S.