2023-05-10 21:53:32 ET
Summary
- We do believe in the investing mantra that people need to eat.
- Food price inflation is coming under control and labor is next given the declining inflation trends.
- The company has passed most of its increased costs to customers.
- Reasonable valuation, with growth expected into 2025.
- Down 20% in two months, with strong EPS growth, we see a trading opportunity here.
The Cheesecake Factory ( CAKE ) has a compelling valuation in the low $30 range. Today, we believe the stock can be bought. While there is the risk of a coming recession, we fully embrace an investing theme of "people need to eat." Here is the deal. A recession will hit restaurants differently depending on what clientele they cater to as well as how well they are able to attract traffic. Higher end restaurants are likely to get hit hard. We are not talking about the best restaurants in the nation, but the more expensive "per plate" type restaurants. We think many smaller but more expensive local family restaurants will also be hit. Cheesecake Factory offers quality food at a fast-casual pace. Their pricing is rather competitive with other similar styled restaurants. We see fast casual, lower-dollar type sit-down restaurants will benefit from families still trying to enjoy a meal out but trying to stretch their dollar further. With CAKE stock up off the lows from last year, with inflation finally coming down, we think that this stock can be bought. Below we outline a trade following a 20% decline in shares in two months.
The play
- Target entry 1: $33.00-33.25 (25% of position)
- Target entry 2: $32.00-$32.25 (35% of position)
- Target entry 3: $30.50-30.75 (40% of position)
- Target exit: $38
- Stop loss: $27
- Estimated profit: 20%
- Options consideration: We like a call buying strategy with a recent pullback in the VIX, targeting 4-6 months out.
Note: This type of trade is what we lay out for members at BAD BEAT Investing week to week.
Discussion
Remember, The Cheesecake Factory is in our opinion casual dining. While it is on the higher end of the spectrum, we believe it has the pricing power to offset margin pressure stemming from past inflation. The company currently owns and operates 318 restaurants throughout the United States and Canada. While the bread and butter of the business is of course " The Cheesecake Factory", the company also operates "North Italia" and some "Fox Restaurant Concepts". The company is expanding internationally, and now has 30 "The Cheesecake Factory" restaurants through licensing agreements. Finally they also have a bakery division which operates two facilities making cheesecakes and other baked products. The company put out some mixed numbers for Q1, but we like the outlook going forward. At the same time, The Cheesecake Factory is slowly growing into a value play at these levels, despite some pressure on comps, and some signs of a slowdown, but growth is projected through 2025 on earnings. The company is also buying back shares. We think a mild recession will have minimal impact. Further, people need to eat, and the jobs data is just so strong. Let us discuss the just reported Q1 .
Sales rise and comparable sales do too
Growth in comparable sales is key for restaurants. It is something we are constantly watching. For Cheesecake Factory, overall sales fell in Q1 versus the prior year. Cheesecake Factory reported total top-line revenue of $866.1 million in Q1 2023.
These sales of $866.1 million were an increase of 9.1% compared to Q1 2022. However, this was a small miss of $6.2 million against consensus estimates . The comparable sales figure was up nicely but actually came in below the 7.1% positive consensus estimate. Cheesecake Factory saw positive comparable store restaurant sales of 5.7%. They were also up nearly 15% from the pre-pandemic year 2019.
As we mentioned inflation is mediating and this was reflected in margins. Cost and expenses were 96.1% of sales down from 96.4% last year. Food and beverage costs came in at 23.8% of sales about flat from the 23.7% last year and labor expenses are also coming down, and were 36.0% of sales which was down from 37.3% last year.
Earnings grow nicely from last year
The Cheesecake Factory margins had been under pressure from rising food and labor costs, but with pricing power, they have offset a good chunk of this expense pain as noted above. As rate hikes continue to impact the economy we expect to see declines in food inflation and labor inflation ongoing, which will be a long-term benefit for Cheesecake Factory. Putting together revenue and expenses we saw adjusted EPS of $0.61 was a nice beat of $0.02 against estimates and rose from $0.47 from Q1 2022. At these levels, with the forward view, we have a good combination of value and growth.
Valuation and shareholder-friendly policies
The valuation is attractive based on performance numbers. We are trading at less than 12X FWD earnings. That is attractive to us to wait for improvement and stabilization in the expenses line. This comes as the company is being strategic to open new shops, and watching margins tightly through pricing power and hiring practices.
Further, the dividend offers a 3.3% dividend yield. We expect dividend increases moving forward after being suspended for two years for the pandemic. While the yield is not overly impressive, an over 3% yield is always welcomed when buying a new position. Further, the company is repurchasing shares. The company bought back 341,500 shares of stock for $12.4 million, further boosting shareholder value.
Looking ahead
The balance sheet here is in good shape with only some slight leverage. The debt is high very manageable relative to cash flows. Total cash, cash equivalents and restricted cash was $116 million. The company has liquidity here too, with $239 million on its credit facility available. We like to watch debt as we are no longer in an easy money climate with rates so much higher. As such, future refinancing of debt will hit hard on interest expense lines. As we look ahead for the year, we now see EPS of $2.65-$3.00. This translates to less than 12X FWD EPS. We think this is a fair price to pay here for a company growing earnings some 85%-plus from last year.
All things considered, barring a market meltdown, we think you do some buying here and this trade will play out nicely following a 20% decline in two months.
For further details see:
Cheesecake Factory: A Lucrative Trade Emerges Following Earnings