2023-03-07 17:40:25 ET
Summary
- My worry is that any price changes may not be enough to keep up with rising wages, and this could put stress on profit margins.
- The focus for the upcoming quarters will be on how CAKE will protect or regain its margin, especially if inflation continues to rise.
- CAKE's share price may come under pressure from margin narrowing and investors' rebasing of expectations if inflation remains high.
Description
As cost inflation continued to be a drag on margins in the 4Q22, The Cheesecake Factory's ( CAKE ) results were slightly below expectations across the board. The Adj EPS of $0.56 was nonetheless in line with expectations. As for the positive performance so far in 1Q23, while the top line looks good, I expect margins to come under further pressure as we move through the fiscal year, primarily due to cost inflation resulting from wage increases. As a silver lining, CAKE has promised more price changes for this month. My main worry is that the price increase won't be enough to keep up with rising wages, which could put stress on profit margins. Thus, I believe the primary focus for the upcoming quarters will be on how CAKE will be able to protect or regain its margin, especially if inflation continues to rise. Most estimates suggest inflation will begin to moderate in the 2H23, which sounds like good news. However, this has also meant that improvements in margin are already baked into estimates (mostly in 2H23). CAKE's share price may come under pressure from margin narrowing and investors' rebasing of expectations if inflation remains high. Especially when factoring in that the general outlook (as seen by most investors) for FY23 is skewed toward the 2H23. Because of this, I am not underwriting the full amount of margin recapture and am instead proceeding with greater caution, in particular with regard to 2H23.
For a quick background, CAKE owns and operates more than 300 restaurants and The Cheesecake Factory brand accounts for over 200 locations. Despite the decline in off-premises sales, I believe that a return to on-premises sales will have a significant positive impact on CAKE, as it has on many other brands. However, one thing that really annoys me about CAKE is how it functions: like a century-old company that refuses to change. CAKE is not like other restaurants that have streamlined their store-level or corporate-level operations, which dampens my belief in any margin improvement initiatives that management might have (note that margin is the key focus moving forward). In a normal situation, one would expect margin improvement strategies to be rolled out (and investors would probably love it). As a result of my lack of convictions and the current lack of clarity regarding the company's margin cadence for fiscal year 2023, I would advise holding off on making any stock purchases until we have more information about margin improvement.
Sales review
Cheesecake SSS came in at 4.0%, which was slightly below the consensus estimate of 4.5%, due to a dip in November and subsequent rebound due to the holiday season. This helped to more than make up for the poor weather experienced in 2H4Q22. Positively, quarter-to-date comparable sales are up 9.5%, which is a sign that the upward sales trend from the previous quarter carried over into 1Q23. Given this result, I anticipate better-than-expected 1Q comp performance. Prices are expected to go up 3.5% year-over-year in 1Q23, according to management. Moreover, what was also good to know (that would help margin) is management also mentioned that additional price action in the second half was possible.
Margins
The store margin was 13.0%, compared to the consensus estimate of 13.3%. Management anticipates 1Q23 commodity inflation of 10-12%, with a moderation to around 4% in 2H23, so we should see improved numbers then. Management has restated their target for operating margin to return to pre-Covid RLM. This is not inconceivable, in my opinion, given that, after the price adjustment, it reached 2019 levels in December 2022. However, as I mentioned before, CAKE is like a century-old corporation with no brand optimization strategies, as such, in my opinion, the other brands will still be a drain on profits.
Guidance
CAKE's unit guide dropped to 20-22 from the previous 21-24, with an anticipated 80% of openings occurring in 2H23. If this works out, it would almost double the number of available positions compared to 2022. In addition, management comments appear to anticipate a net income margin of around 4% on revenue in the range of $3.5 to $3.6 billion. Revenue is expected to be between $850 million and $880 million, with a net margin of 3-3.5% for 1Q23.
Summary
4Q22 results for CAKE were slightly below expectations due to cost inflation, but adj EPS was in line with expectations. In 1Q23, I expect margins to come under further pressure due to ongoing OPEX inflation resulting from wage increases. While CAKE has promised more price changes, the worry is that they may not be enough to keep up with rising wages and put stress on profit margins. The focus for the upcoming quarters will be on how CAKE will protect, or even regain, its margin, especially if inflation continues to rise. CAKE's share price may come under pressure from margin narrowing and investors' changing expectations if inflation remains high. Additionally, CAKE's lack of brand optimization strategies dampens my confidence in margin improvement initiatives. While sales are expected to be better than expected in 1Q23, I recommend to only invest when there is more information about margin improvement.
For further details see:
The Cheesecake Factory: Margin Improvement Is The Focus