2023-11-20 19:51:40 ET
Summary
- CAKE's recent performance shows soft business growth.
- The introduction of the Cheesecake Rewards program is driving customer engagement and may lead to more recurring consumers.
- Margins have improved compared to last year, but there are concerns about sequential declines and managing inflationary pressures.
Investment action
I recommended a hold rating for The Cheesecake Factory ( CAKE ) when I wrote about it the last time as I thought the right decision to turn bullish was only when growth and margins moved in a positive direction. Based on my current outlook and analysis of CAKE, I reiterate my hold rating. There are definitely positive signs that things are gradually getting better. But I caution investors about taking the leap of faith here, as there is still much more to be done. The normalization of seasonality in 4Q23 should be a nice boost to 4Q23 numbers, supporting near-term sentiment. However, it is not a structural growth driver. While I am positive about the rewards program, I also note that it is still relatively new. How effective the program is and its impact on financials are unknown at the moment. Lastly, while margins improved y/y, I am still wary about the sequential decline and how it would play out in 4Q23 and 1Q24, especially with the reinvestments into the rewards program.
Review
CAKE’s recent 3Q23 results have shown that the business growth is still soft, although there are positive signs for 4Q23 to be better. Despite pricing increases in the high single-digit percentage, same-store sales [SSS] came in at 2.4%. The decision to raise price has generated a mix headwind of -6% and traffic dropping by 1%. Using management 4Q23 revenue guide of $870 to $890 million, which represents a 1.4% decline, it suggests that traffic and mix are not expected to recover as much as pricing eases. Since the product mix headwind experienced in 3Q23 was attributable to both on-premise and off-premise factors, larger party sizes leading to more sharing, and fewer alcohol and appetizer orders, I believe it will persist for a few quarters. As consumers remain price conscious, I expected them to continue opting for sharing and spend less on discretionary items like alcohol.
The good news is that SSS trends in 4Q23 are encouraging. Compared to 3Q23, October's trends have improved significantly, according to management, suggesting a return to more typical seasonality. I take that as a positive sign for 4Q23, as CAKE is going to benefit from an easy y/y comps vs. 4Q22. For instance, Christmas is going to be on a weekday this year, which gives CAKE an additional 1 day of peak traffic compared to 2022, where Christmas fell on Sunday. Also, winter is expected to be warmer than average , making things more favorable for CAKE as consumers are more likely to dine out. These should help support 4Q23 growth and FY23 consensus numbers.
There are also internal drivers that may further drive 4Q23 performance. Management is pleased with how the June-introduced Rewards program is performing. I like this program because it's not the standard point system. In contrast, the rewards that members of CAKE's loyalty program receive are more of a "surprise" and will be delivered at random times throughout the year. As a result, members have something to look forward to, which drives them to revisit CAKE again. The latter is key as it allows CAKE to gather more data to analyze how to best cater to consumers' preferences. Although all of these are increases in marketing spend, I am placing my bet that this will drive more recurring consumers. That said, this is something to monitor as the reward program is still just 5 months old.
While we are just now entering our fifth month of the program following the national launch of Cheesecake Rewards on June 1, we continue to be encouraged by the level of member activity and engagement we are seeing.
I think that says something. And we're also very happy. We're able to measure NPS sentiment for rewards members versus non-reward members. And we see between a 10% to 20% higher score in overall NPS on rewards members. 3Q23 call
As for margins, while there was a sequential decline vs. 2Q23, this is progressing nicely vs. last year. Restaurant margin came in at 12.6%, an improvement of nearly 300bps vs 3Q22 but a 260bps decline vs. 2Q23. As I have mentioned previously, CAKE's ability to pass down inflation costs is a positive sign, which it did and was evident in the y/y margin increase. As management commented that commodity and labor inflation should start to ease in FY24, CAKE could see margin expansion as pricing growth for 4Q23 is expected to be 7 to 7.5%.
We are modeling net total labor inflation of about mid-single-digits when factoring in the latest trends and wage rates. Which, similar to our commodities, continue to normalize, as well as channel mix and other components of labor.
As Etienne noted, the pricing for the quarter is going to be 7% to 7.5%. And yet the inflation for wages are going to be low to mid-single-digits and the inflation for commodities are low-single-digits. 3Q23 call
Final thoughts
I reiterate my hold rating. While there are positive signs for growth in 4Q23 and margin improvement, I remain cautious given my concerns persist regarding sustained structural growth and sequential margin declines, particularly with ongoing reinvestments into programs like Rewards. Monitoring the effectiveness of the Rewards program and CAKE's ability to manage inflationary pressures will be my key focus for the next few quarters.
For further details see:
The Cheesecake Factory: Still On Wary Mode