Before we dive into this week’s idea, we need to close our Toast (TOST) position that broke through our stop. While taking a loss is never fun, it’s part of the game and we need to stick to the playbook.
To execute this trade you need to:
Sell your TOST stock
Buy to Close the August 24 Call.
Moving on …
Last week was the first week in what feels like months that the sellers really took control. And while it was hardly a disaster in terms of the indexes as the S&P 500 fell 1.3%, the Dow lost 1.11% and the Nasdaq declined by 2.85%, the pain was worse in individual stocks, many of which fell hard on earnings.
This week we are adding a leading restaurant play, though doing so defensively as the market has weakened recently.
The Stock – Shake Shack (SHAK)
Why the Strength
Shake Shack is a burger joint, offering very tasty burgers, dogs, shakes, fries and more, and doing a good enough job of it to gain a very loyal following. Investment-wise, there are two big attractions here, the first being the firm’s huge cookie-cutter story: Shake Shack ended Q2 with 471 total locations (both operated, which are usually domestic, and licensed, usually overseas), up 23 from the prior quarter and up a big 19% from a year ago, with another 23 openings on tap for Q3.
However, the bigger story right now is the dirty work the company is doing behind the scenes—thanks in part to an activist investor (Engaged Capital, which got some board seats in May), the firm is tightening the reins on costs and boosting efficiency, which is starting to flow to the bottom line. In Q2, the top line was up 18% (actually accelerated a bit late in the quarter and into July) while system-wide sales rose 22% and same-store sales were up 3%, but more important were the margins, with restaurant-level operating profits coming in at 21% of revenue, up from 18.6% a year ago, and that helped EBITDA come in at 13.6% of revenues, the biggest margin in the firm’s history!
And there should be more to come: New store opening costs have surged with inflation the past couple of years, but the top brass thinks it can cut those costs by 10% in 2024, while there should be continued improvement in store-level expenses (kiosks, more dynamic staff scheduling, reducing costs for to-go orders), too. Granted, it’s not all peaches and cream (traffic is flat-ish at its stores, food inflation continues to be a challenge), but the top brass did hike the outlook for the rest of the year and, big picture, the combination of controlled costs and new store openings could drive EBITDA and cash flow much higher down the road.
Technical Analysis
SHAK had a multi-month bottoming phase that ended with a very tight launching pad earlier this year. The breakout on Q1 earnings was solid (it was our Top Pick in the May 8 issue), and after a little hesitation, the stock rallied nicely to the 80 area. Then came the pullback: SHAK started to retreat normally but then had a huge initial dip on the Q2 numbers (falling as low as 70) before rebounding sharply Thursday afternoon and especially Friday … forming what looks to be a huge shakeout. Expect gyrations, but it looks buyable here. Stop — 69
The Covered Call Trade
Buy Shake Shack (SHAK) Stock at 80, Sell to Open September 77.5 Strike Calls (exp. 9/15) for $5, or a Net Price of 75 or less
Static Return: $250 per covered call (3.33%)
Breakeven: 75
Covered Call Return (if assigned): $250 per covered call (3.33%)
Please note, the stock and options prices will be moving throughout the day, so these prices are simply an approximation of prices that you should be able to achieve.
However, the important component of this equation is that the stock price paid, minus the premium received via the call sale, equals the Net Price, or 75 or less. (In this case 80 minus 5 = 75. Or another example is you could pay 80.25 for the stock and sell the call for 5.25, which also equals 75)
For every 100 shares of stock you buy, you can sell 1 call. For every 200 shares of stock you buy, you can sell 2 calls. And so on …
Open Positions
If our stop is hit, I will send an alert giving detailed instructions on how to exit the trade. But don’t get too worried about setting the stop. I will manage that for you.
The next Cabot Profit Booster issue will be published on August 15, 2023.
