"Altruistica": Seeking a return to full financial disclosure and regulatory oversight. A financial market analysis blog for "entertainment purposes" only by an experienced CFA seeking new hedge fund engagements for investment writing and analysis. The author has experience investing internationally, running a hedge fund, making angel investments, and helping launch five startup companies. Investors should do their own due diligence.

07 December 2006

Cheesecake Factory (CAKE) – Did I just eat all that?

Now that the Cheesecake Factory (CAKE:NAZ) has opened its 119th restaurant at Dulles Town Center, this “upscale restaurant” chain is showing signs of “wing and a prayer” guidance for investment analysts. With Taco Bell’s being shut down for e-coli concerns and Jamba Juice suffering from listeria fears, consumers have another reason to keep a tight hold onto their wallets. Despite an economy slowing into a 2007 recession, CAKE provided 2007 guidance of 18% top and bottom line growth. Are these people tippling the cooking sherry?

It certainly seems so. Due to their options scandal, the Calabasas, California-based restaurant chain delayed reporting Q2 and Q3 results until December 1st. Not only did they miss estimates, but same store sales deteriorated – slipping by 0.8% in Q2 and 1.6% in Q3. Worse, results were aided by one-time tax benefits. Yet, on the earnings call, management claimed trends were improving and announced a 1.5% price increase for 2007 to offset rising wage and food costs.

A Miss in Every Category

Q3 results missed in every category and Q4 guidance was lowered. Q3 revenue rose 10.7% to $325.3 million, $10m below estimates due to slower traffic at the company's dining outlets. For the fiscal third quarter, Cheesecake Factory earned $18.1 million, or $0.23 per share, compared with $21.7 million, or $0.27 per share, a year earlier. So profit fell by 17% and reported EPS missed by a couple of pennies, according to Reuters. Right now, CAKE’s Q406 consensus EPS estimates are $0.22-0.24, which represents an 8 to 15% decline in net income on 7-8% revenue growth –maybe that’s too optimistic.

Stuck in the Mud

CAKE is completely dependent on maintaining 20% unit growth to hit its revenue targets. But Q3 revealed increasing margin pressure and same store sales deteriorated, reflecting the sixth consecutive quarter of negative traffic. Meanwhile, the targets for opening days for new units are heavily back end loaded for Q4. Just four restaurants opened in the Q3, below company guidance of 5-6 openings. CAKE’s next warning will be to confirm that they will fail to open all 13 units planned for Q4. Even the company’s efforts to “move upscale” with the Grand Lux Cafe is not a true second concept, rather simply a larger restaurant (up to 550 seats) in more cyclical settings such as the Venetian Hotel in Las Vegas.

Other Restaurant Chains Hurting, But They’re on Half Price Sales

Research firms report that lackluster traffic trends being seen throughout the casual dining sector are representative of broader macro trends and not company-specific issues. Certainly, CAKE’s competitors such as Chili’s, owned by Brinker International (EAT:NYSE), and Applebee’s (APPL:NAZ) also had a tough November with same store sales down 2.6% and 3.1%, respectively. Both of these restaurant chains are responding by reducing unit openings in 2007, in part to enhance cash flow. According to Goldman Sachs, that makes them potentially attractive for leveraged buyouts. In addition, both sell for half the 1.6x price to sales and 25x price to earnings ratio of CAKE, which carries a slipping consensus estimate of $1.22 for 2007 earnings. The shares are likely to suffer once analysts get more realistic about their estimates for 2007 and 2008.


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