Focus Article: The Cheesecake Factory (CAKE)

The Cheesecake Factory (CAKE) $33.14

The Company:

The Cheesecake Factory started out as a small 700 square foot store in Los Angeles when it was founded in 1972 by Oscar and Evelyn Overton. Their son David Overton launched the first Cheesecake Factory restaurant in 1978 and now serves as the CEO of a company with 173 restaurants and $1.76 billion in annual revenue.

The company operates in two segments. The bakery division produces cheesecakes and other desserts that are sold through company restaurants. The restaurant division consists of three brands including The Cheesecake Factory with 158 restaurants, the Grand Lux Cafe with 14 locations and RockSugar Pan Asian Kitchen with 1 location. The company launched its first 13,851 square feet international location in Dubai on August 16 through a licensing agreement with a Kuwaiti company and plans on expanding to other parts of the middle east including Kuwait, Bahrain, Qatar and Saudi Arabia.

When I first looked at the Cheesecake Factory last week, the company looked interesting but did not feel like a compelling purchase. Profit margins of 5.5% and valuation of 8 times EBITDA appear to be in-line with other companies in this space such as Darden Restaurants (owner of Olive Garden and Red Lobster) and Brinker International (operator of Chilis). However while Darden and Brinker each operate 2,000 and 1,626 restaurants respectively, The Cheesecake Factory only has 173 restaurants and a lot of room to grow both domestically and internationally. The other difference between The Cheesecake Factory and its brethren is that The Cheesecake Factory has no debt on its balance sheet and has managed to expand its footprint through cash generated from its operations.

The company initiated a dividend this quarter that was paid out last week. On an annualized basis their dividend works out to an approximate payment of 25% of net income and a 1.4% yield. The company also repurchased 543,502 shares at a total cost of approximately $16.7 million last quarter.

Business Statistics & Financials:

The Cheesecake Factory brand of restaurants continues to perform well with comparable same-store-sales increasing 2.1% but sales at the Grand Lux Cafe declined 2.9% in Q2 2012. Overall comparable sales grew 1.7%, largely driven by a 2% increase in menu prices. Traffic was essentially flat with a 0.5% increase. Revenue increased 5.6% to $454.7 million in the second quarter. Earnings increased by double digits, up 21% year-over-year, driven by an increase in both gross margins and operating margins.

The company also raised its full year fiscal 2013 earnings guidance to a range of $1.87 to $1.93 per share and expects same store sales to increase between 1.5% to 2.5%. The Cheesecake Factory also expects CapEx to be lower than expected to a range of between $95 million and $105 million.

The company trades for 3 times book value, 8 times EBITDA and sports a forward P/E of 15.32.

Competitors:

Insider Buying:

One insider purchased stock on the open market over the last six months as listed below. You can view a list of all insider transactions for The Cheesecake Factory here.

Risk Factors:

1. One concern regarding the growth at CAKE is that their same store sales increase last quarter was driven by a 2% increase in menu prices and not as much by increased traffic, which was essentially flat. Traffic was negatively impacted by the Grand Lux line of restaurants. If the Grand Lux restaurants continue to underperform, the company may have to start closing some underperforming locations and take a write-down as a result.
2. The restaurant industry is very sensitive to recessions. While CAKE does not have any exposure to Europe, any weakness in domestic consumer spending will impact the company.

Conclusion:

The Cheesecake Factory has been a tough one for me. I really the story, the restaurants and the fact that one of the founders is still at the helm more than 3 decades after starting the first restaurant. However at 15 times fiscal 2014 earnings and 8 times EBITDA, the stock isn’t exactly cheap for a company that has single digit operating margins and is growing the top line at roughly 5%.