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Damian Illia
Damian Illia
Articles (175)  | Author's Website |

The Cheesecake Factory: Too Sweet for the Competition?

March 12, 2014 | About:

When it comes to desserts, The Cheesecake Factory Inc. (NASDAQ:CAKE) is indeed one of the first places to think about, with a menu including more than 40 varieties of cheesecake and other desserts. But this baker isn’t just a cake maker — it operates a casual dining restaurant chain with more than 200 menu items that range from appetizers, pizzas and salads to seafood, steaks and burgers. Working under the Cheesecake Factory name, with more than 155 units across the U.S., it also operates 14 Grand Lux Cafes and a RockSugar Pan Asian Kitchen restaurant. Baking since 1972, The Cheesecake Factory operates 181 full-service casual dining restaurants, and also offers its products to other foodservice operators, retailers and distributors.

The weather hit the restaurant industry and affected the company's last fourth-quarter results. For The Cheesecake factory sales rose 2.2% to $475 million, but were below the consensus estimate. Furthermore, despite earnings and revenues going up year over year, they failed to meet the analysts’ estimates. Nevertheless, the firm's expense management improved in the period, seeing a reduction in total operating costs of 320 basis points, and keeping EPS at $0.57, in line with expectations despite weather impact.

Rather than the climate, it seems as if the company should be worrying about its Grand Lux Café chain, as its soft performance resulted in a 1.1% fall in comparable sales. Indeed consumer spending and food cost inflation are hitting the restaurant industry, and although the underperformance of Grand Lux Café segment might affect the company’s numbers for 2014, the focus is being put on the expansion plans and new locations opened by the company in international markets, such as Saudi Arabia.

Market Snags

The Cheesecake Factory has a solid position within the niche casual dining segment, and the brand has a strong recognition in the U.S. market. The company’s restaurants tap all dining preferences, from lunch and dinner, day to mid-afternoon and late-night, providing stable guest traffic. With high-quality locations as well as an extensive menu, comps remained positive in all the quarters of 2013, and the company is likely to sustain steep same-stores sales.

Although the cake baker indeed has an appealing menu, the restaurant industry never ceases to pose snags and might limit the company’s ability to garner a competitive advantage. Between the intense competition and the food cost inflation, the chance of a rise in menu prices might take a bite out of this restaurant’s profits. Controlling its operating costs in order to keep prices appealing for customers seems to be the challenge. Moreover, the increased competition put up by new fast-casual dinner restaurants which focus on selling high-end ingredients at low prices — Chipotle Mexican Grill (NYSE:CMG) with its green-menu, or Panera Bread (NASDAQ:PNRA) with its special salads, for instance — may result in reduced traffic, and might take share away from casual and upscale casual diners like Cheesecake Factory.

Nevertheless, the fierce competition has not slowed the company’s organic growth, which has posted strong positive same-store sales the last three years. This indicates the company’s concept remains appealing for customers, an important sign of a prospective business, especially for the restaurant industry and in times where consumers’ preferences are switching and discretionary spending is volatile.

Expansive Mode

New store openings are planned by the company for the near term. A huge demand led to three new restaurants openings during fourth quarter of 2013. Overseas expansion started in August 2012, venturing into Dubai. Through an agreement with a Kuwait-based firm, the Cheesecake Factory enables this company to develop 22 different recipes of its restaurants, and new units are expected to be opened in the Middle East. The Cheesecake Factory will receive royalties from these restaurants, and expand its brand recognition internationally, but won’t see immediate additions to the top line. Keeping the innovation and expansion strategy, the company should be able to battle inflation and higher food costs. As far as the domestic market is concerned, the management is developing new formats of sizes and scales in order to cater to local demand through smaller units.

Bottom Line

The Cheesecake Factory is one of the most productive restaurant chains in the U.S., and has been delivering optimistic results the past three years. With continuous innovations on their menu and an expansion plan on the watch, analysts think this stock is worth taking a bite of.

Moreover, its cash deployment strategy is appealing to shareholders, seeing continuous returns via dividends and share repurchase. Approximately 4.5 million shares of its common stock were repurchased at a cost of $183.7 million in 2013, building investors’ confidence.

Nevertheless, others think the company’s lack of strong intangible assets and the fierce competition in this industry might hurt the firm’s profits for the mid-term. The continuous underperformance of its Grand Lux Café’s restaurants might be a weakening point for the company.

On top of that, restricted consumer budgets continue to pressure the margins, and the rising food costs pose a threat to the company’s earning projections. However, GAAP earnings per share were $0.62, up 55.0% year over year, and revenues increased 2.2% year over year to $475.1 million driven by positive comps.

Disclosure: Damian Illia holds no position in any stocks mentioned.

About the author:

Damian Illia
A fundamental analyst at Lonetreeanalytics.com constantly looking for value and income investments.

Visit Damian Illia's Website

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