Why Shake Shack And Jack In The Box Are Merely Neutral Rated At SunTrust

• Shake Shack Inc SHAK shares are down 13 percent since December 7, while shares of Jack in the Box Inc. JACK have lost 7 percent.
• SunTrust Robinson Humphrey’s Jake Bartlett initiated coverage of both the companies with Neutral ratings. The price target for Shake Shack is at $40 and for Jack in the Box at $82.
• While Shake Shack is among the best positioned restaurants, Jack in the Box may face a challenging FY16, Bartlett stated.

Shake Shack

Analyst Jake Bartlett considers Shake Shack as one of the best positioned restaurants in the industry. The stock valuation is justified since the company is in the early stage of development, with 8 percent penetration in the US.

Bartlett mentioned four key variables for the stock:

#1 - New unit volumes: “New unit AUV's are the most critical variable to valuation since they also drive new unit margins and don't have related capex. They are also difficult to estimate given that guidance is much lower than SHAK's historical experience,” the SunTrust report noted.

#2 - Total unit potential: The guidance of 450 seems conservative, the analyst said, while estimating it at 500 units. Although Shake Shack’s model is based on premium real estate, which restricts its markets. its flexible real estate model and robust new unit economics could drive upside to the SunTrust estimate.

#3 - New unit margins: Even if the company’s operating costs match SSS going forward, overall restaurant margins are expected to contract through the 20-year projection period.

#4 - SSS: Bartlett considers the company’s long-term SSS guidance of 1.5 percent appears overly conservative, and estimates this at 2.5 percent.

Jack in the Box

Bartlett expressed concern regarding FY16 being a more challenging year for the Jack in the Box [JIB] concept, although this may be partially offset by Qdoba’s repositioning “for a long runway of growth.”

FY16 headwinds for JIB include expected industry-wide average check pressure given softer restaurant demand and a promotional environment, a resurgent McDonald's (MCD, $117.58 BUY) and a challenging economy in Texas.

The analyst mentioned the headwinds in JIB that could limit JIB SSS upside:

1. QSR's check growth coming in weak
2. A “resurgent” McDonald's with geographic and product overlap with JIB
3. A challenging economy in Texas, where JIB is concentrated.

Bartlett estimates 3-year CAGR of 0.9 percent for JIB, which is at the low end of the current guidance of 1-2 percent. He added, “Factors limiting development include relatively weak new units returns, lack of development in new markets despite a seeding strategy and development incentives and roughly flat development in core (CA and TX) markets despite limited refranchising in recent years.”