Market Overview
Despite a concerning start to the week for the bulls, Friday’s big rally provided some hope that the market could get back in gear. By week’s end the S&P 500 had lost 0.8%, the Dow had fallen 1.24%, and the Nasdaq had gained 0.07%.
This week we are adding an earnings season winner, though doing so via a “safer” in-the-money call sale.
The Stock – Shake Shack (SHAK)
Why the Strength
Shake Shack is basically an international roadside burger stand, with 456 locations around the world serving very tasty burgers, chicken sandwiches and nuggets, sausages, fries and dogs, along with shakes, lemonade and the like.
Demand has never been a problem, with management rapidly increasing the restaurant base from its New York City roots, spreading across the U.S. and making a push overseas, with both company-owned and licensed locations; sales have been kiting higher for years and the restaurant count at the end of March was up 13 from the prior quarter and up a whopping 17% from a year ago.
However, all that growth was offset by huge costs, which mostly kept the bottom line in check (and, except for the occasional run of a few months, capped the stock, too). Now, though, one of management’s priorities is to increase margins, and progress is happening—in Q1, food and paper costs as a percent of revenue fell a full percentage point (to 29.4%), while labor expenses and G&A also came down, leading to store-level profit margins of 18.3%, up from 15.2% last year ... and the top brass sees this figure getting back over 20% (it was even higher in the past) as soon as this quarter!
Meanwhile, the expansion plan remains in fifth gear (20 new openings planned in Q2 alone, both company-owned and licensed) and demand is strong (same-store sales up more than 10% in Q1), which has Wall Street goosing estimates—EBITDA is solidly in the black, and analysts now see the bottom line following in the near future. There are still some holes in the story (new location economics are just OK), but if the top brass can keep a lid on costs, there’s no reason earnings can’t surprise on the upside for many quarters.
Technical Analysis
SHAK cratered from 140 in early 2021 to below 40 in June of last year as inflation crimped what was already an iffy cost situation. And from there, the stock didn’t really stand out, with a modest summer rally, a retest of the low at year-end and a January 2023 upmove that only lasted a couple of weeks. However, SHAK’s action from there was notable, with lots of tightness and volume really drying up, and last week’s earnings move (biggest weekly volume since November 2021) was powerful. Stop — 56
The Covered Call Trade
Buy Shake Shack (SHAK) Stock at 66, Sell to Open June 65 Strike Calls (exp. 6/16) for $3.75, or a Net Price of 62.25 or less
Static Return: $275 per covered call (4.41%)
Breakeven: 62.25
Covered Call Return (if assigned): $275 per covered call (4.41%)
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 62.25 or less. (In this case 66 minus 3.75 = 62.25. Or another example is you could pay 66.25 for the stock and sell the call for 4, which also equals 62.25)
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 May 16, 2023.
