Shake Shack (SHAK) Seen as 'Overpiced'; Morgan Stanley Downgrades to Underweight

(Updated - July 7, 2015 9:29 AM EDT)

Morgan Stanley downgraded Shake Shack (NYSE: SHAK) from Equalweight to Underweight with a price target of $38 (unchanged). Analyst John Glass said the stock was overpriced and pointed out technical market dynamics supporting valuation, including the stock's illiquidity and its expensive borrow, get resolved after lockup expires.

Glass explained, "We are downgrading SHAK to UW from EW on valuation, while maintaining our $38 PT, which is derived from an average of our $25 base case and a $50 bull case. At ~$59, SHAK trades at >15% premium to our upside case, which gives SHAK ample credit for exceeding its initial unit expansion and margin goals. While fundamentals near term are likely to remain strong, that outcome is likely already more than compensated for in current valuation."

"On '17 estimates, SHAK trades at nearly 80x our EBITDA and a lofty 325x P/E. Its total market cap of over $2B implies SHAK trades at just under 9x 2017 revenue. This compares to a high growth peer average of 17x '17 EBITDA and 65x P/E. Based on this we find SHAK a poor relative value to the group. Even using our long term (25 yr) DCF, which provides more credit for margin maturation, we arrive at $50 bull case (assumptions described on page 2), and a base case of $25, giving full credit for industry leading volumes and margins (in fact our bull case has AUVs over time reaching close $7.5M and store margins near 30% - even after building out over 800 domestic units)," continued the analyst.

Glass continued, "In our view there are a few contributing factors, including 1) illiquidity of shares, as there are only 5.75 shares trading in the float currently out of the ~37 million in the total share count; 2) expensive “borrow” and limited on stock (~2.6m short shares, 47% of float, and borrow rates north of 150%), making it extremely difficult for investors to express a view on valuation by shorting the stock and 3) brand-related euphoria, driven by high profile locations and media attention surrounding the IPO process. Some of these contributing factors, such as liquidity and ability to borrow get resolved when more shares become available in the market, likely after lockup expires (180 days post IPO)."

For an analyst ratings summary and ratings history on Shake Shack click here. For more ratings news on Shake Shack click here.

Shares of Shake Shack closed at $59.00 yesterday.

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