Photographer: Andrey Rudakov/Bloomberg

This Is Why Shake Shack Is Dropping Today

  • Company facing cannibalization and new incursion by Chipotle
  • Wedbush analyst downgrades Shake Shack as margins get squeezed

Shake Shack Inc. suffered its worst stock rout in almost nine months on renewed concern that the market for upscale burgers is getting too crowded.

Wedbush Securities analyst Nick Setyan cut his rating on the burger chain to neutral from the equivalent of buy, saying he was worried about the overall fast-casual category. A saturation of Shake Shack restaurants is likely to squeeze sales and margins, he said in a note on Tuesday.

Chipotle Mexican Grill Inc. also signaled its intentions to attack the burger market with renewed vigor on Tuesday. It’s hiring Richard Blais, a winner of the “Top Chef” competition, to run its Tasty Made burger restaurant. That business began with a single location in Ohio last year.

The mounting competition is coming at a time when the fast-casual industry is slowing. Pentallect Inc., an industry consulting firm, has estimated that the segment’s sales growth will decelerate to about 6 percent to 7 percent in 2017. The fast-casual field had been growing at a double-digit clip in recent years, outpacing fast-food eateries by touting fresh ingredients and sleek restaurant designs.

Shake Shack fell as much as 7.5 percent to $31.09 on Tuesday, the biggest intraday drop since January. Even before the tumble, the stock was down 6.1 percent this year.

As the broader fast-casual market cools, chains like Noodles & Co. and Pie Five have been closing locations. Red Robin Gourmet Burgers Inc., meanwhile, abandoned its fast-casual Burger Works venture.

And now Shake Shack faces the threat of Chipotle pushing deeper into the field. At the same time, lower-end fare from McDonald’s Corp., Burger King and Wendy’s Co. has regained its mojo this year.

“Fast casual is taking it from both ends,” with both casual dining and fast food putting pressure on the companies, Setyan said in an interview.

Cannibalization Risk

Shake Shack also is competing with itself: As it expands, new locations could cannibalize customers, lopping 1 to 5 percentage points off its comparable sales in 2018, Setyan said.

Labor inflation is rising by a percentage in the mid- to high-single digits, and food costs are climbing in the low-single digits, he said. And that’s expected to continue through at least 2018.

Another risk: While McDonald’s and other fast-food chains are mostly franchised, Shake Shack locations are owned by the company. That means it suffers more when profit margins get squeezed.

Setyan lowered his 12-month price target on Shake Shack to $36 from $40. He also trimmed his 2017 earnings estimate to 52 cents from 54 cents, reflecting his lower expectations from margins.

— With assistance by Leslie Patton

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