A well-known restaurant brand, The Cheesecake Factory Inc. (CAKE, Financial), has recently come to my attention. As many of us know, the company operates a casual dine-in restaurant chain that features, of course, cheesecake (70 varieties). It brands itself as offering an experiential dining service.
In its report on the first quarter of 2020, the company reported, “We currently own and operate 294 restaurants throughout the United States and Canada under brands including The Cheesecake Factory®, North Italia® and a collection within the FRC subsidiary.” FRC refers to Fox Restaurant Concepts; The Cheesecake Factory acquired it and North Italia in 2019.
For fiscal 2019, the company reported revenue of $2.483 billion, comparable restaurant sales growth of 0.8%, adjusted operating income margin of 5.2% and adjusted diluted earnings per share of $2.61.
The GuruFocus system flags the operating margin for being down in recent years. However, a look at a 15-year chart shows margins (green for operating margin, black for net margin) dropping mid-2006, recovering some lost ground in 2010 and then slipping again since the beginning of 2017. If we add the share price (blue), we see it roughly mirrors the margins:
With this trend in margins, it would be difficult to argue that The Cheesecake Factory has much of a moat or competitive advantage, despite its brand name.
Despite a consistently growing revenue per share line, EPS has been bumpy. That will be one of the reasons why its GuruFocus business predictability score is just 2.5 of of 5 stars.
Also concerning is its WACC vs ROIC (weighted average cost of capital vs return on invested capital) ratio, as shown in the bottom of the table below:
Since the WACC vs ROIC ratio is based on the trailing twelve months, results will be affected to some extent by the Covid-19 crisis. When a company has a higher cost of capital than return on capital, it could be in trouble.
Despite this spate of discouraging news, Founder, Chairman and CEO David Overton was optimistic in his latest letter to shareholders:
“Looking ahead, we expect the acquisitions, coupled with the strength and potential of The Cheesecake Factory brand, to enable meaningfully accelerated long-term annual unit growth of 7%. We believe this will be one of the highest unit growth rates in the casual dining industry, while providing diversification with respect to restaurant segment, price point, real estate and labor model.”
The Cheesecake Factory believes it can add more than 300 new restaurants in coming years, and build up its international business beyond the 26 locations now in operation.
Despite the growth plans, there seems to be no compelling case for putting The Cheesecake Factory on your shortlist. But, when we look in the "Dividend & Buy Back" section of the GuruFocus summary page for the company, we find something that could be a compelling argument.
Stock bought at the closing price of $24.28 on June 24 would earn a 5.82% dividend. Combine that with the company’s growth forecast of 7% per year (assuming unit growth translates into revenue and earnings), and we have an annual yield of nearly 13%.
Or, combine the five-year yield-on-cost of 13.43% and the anticipated 7% growth for a total of 20.43% per year. That’s before capital gains or gains from share repurchases.
The five-year yield-on-cost ratio is based on the premise that an investor buys the stock and holds it for five years, while the company continues to increase its dividends at the same rate as it did in the past five years.
The company's three-year dividend growth rate is 16.2%, which seems an ambitious level to maintain. The dividend itself seems sustainable with the 55% payout ratio.
To keep increasing its dividends, a company needs to increase its cash flow, specifically free cash flow. In the 15 years ending Dec. 31, 2019, The Cheesecake Factory has managed to average its free cash flow in a relatively constrained range since 2010:
With its acquisition of Italia North and FRC last year, the company should enjoy increased cash flows, at least after all its restaurants get back to business as usual.
Valuation
We cannot rely solely on discounted cash (DCF) flow for this price analysis, as the company's low business predictability rating means a DCF result is likely meaningless. Instead, we turn to the valuation ranking criteria.
As value investors, we take an interest in stocks available at bargain prices. The Cheesecake Factory currently gets an 8 out of 10 from GuruFocus's valuation rating.
Gurus
Seven gurus have positions in The Cheesecake Factory. Ron Baron (Trades, Portfolio) of Baron Funds held the biggest position, with 800,000 shares at the end of the first quarter. Mario Gabelli (Trades, Portfolio) of GAMCO Investors held 520,965 shares, while Chuck Royce (Trades, Portfolio) of Royce & Associates held 329,817 shares.
Of the seven who held positions on March 31, two reduced their positions while four added or made a new buy during the quarter.
Considering all gurus who have held positions at some time in the past two years, the buys and sells have been roughly even:
Conclusion
The Cheesecake Factory is an interesting case with margin and cash flow issues but also with the potential to deliver returns of 20% or more per year over the next five years.
All of that hinges on its willingness and ability to keep raising its dividend at the same rate as it has over the past five years. To have enough cash flow to do that, it will likely need to reverse the trajectory of its operating and net margins.
For those who see the glass half full, the stock is available at a bargain price. For more cautious investors, I think a low price is not enough to make this a compelling buy.
Disclosure: I do not own shares in any companies named in this article and do not expect to buy any in the next 72 hours. Thanks are owed to reader Fekafiemd for bringing The Cheesecake Factory to our attention.
Read more here:
- The Promise and Perils of Owning Pfizer
- H&R Block: A Dividend Gain Thanks to a Falling Stock Price
- Wells Fargo: A Sudden Dividend Hotshot
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
