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Given the recent volatility in the commodity markets, particularly with milk and cheese prices up approximately 48% and 36% year-to-date, respectively, I decided to take a closer look at the CAKE model.  As of the company’s fourth quarter earnings call on February 10, CAKE had contracted 60% of its food needs, including “virtually” all of its proteins.  The company is still exposed, however, on its dairy, fresh fish and some cheese requirements.  All in, management guided to 3% cost inflation for the year, up 4% in 1H11 and up 2% in 2H11.  This guidance includes the expectation that some of the current price levels on its non-contracted items will abate as the year progresses.  Cheese prices fell 10% last week, but with prices still up about 44% year-over-year and milk up about 53% year-over-year, there remains significant risk to the company’s full-year commodity cost outlook, particularly during the first half of the year.

We already know that top-line trends suffered early in the first quarter as a result of bad weather, which management said impacted first quarter comp trends by 1%.  The company guided to flat to +2% comp growth in 1Q11, below the full-year expected run-rate of 1-3%.  This softer start to the year will only magnify the commodity pressures during the first quarter.   Management implemented a 0.7% price increase during the February/March time-frame, which will result in a 1.4% price impact by the end of the quarter relative to only 0.5% of price during the fourth quarter.  This higher pricing should help to offset some of the increased margin pressure during the first quarter but negative mix has worked against the company’s pricing initiatives recently; though average check did improve sequentially during the fourth quarter. 

Management guided to $3 to $5 million of additional savings, primarily on the labor and operating expense lines, and tighter G&A controls to offset the expected incremental $0.05 per share of commodity costs relative to the company’s prior guidance and as a hedge against higher than expected commodity costs going forward.  To that end, management’s full-year EPS guidance of $1.55 to $1.70 seems achievable.  I am currently at $1.64 per share (the street is at $1.65 per share). 

The first quarter, however, could be a little rough given the negative weather impact and tough commodity environment.  I am currently modeling $0.31 per share, below the street’s $0.33 per share estimate but within management’s 1Q11 EPS guidance range of $0.29 to $0.33.  I am expecting restaurant-level margins to decline about 90 bps during the quarter.  The company is facing its most difficult restaurant-level margin comparison during the first quarter on a YOY bp change basis.  Although I think the company will continue to get leverage on the labor expense line, it will likely not be enough to offset the sharp increase in commodity costs.  It is important to remember that about 90 bps of the company’s fourth quarter labor expense favorability as a percentage of sales was due to one-time items that will not repeat during 1Q11. 

CAKE should continue to face commodity pressures during the second quarter and for the balance of the year, but the YOY comparisons get a little easier as we progress through the year.  Cost of sales as a percentage of sales declined 70 bps during 1Q10 and then increased 20 bps, 50 bps and 100 bps in 2Q10, 3Q10 and 4Q10, respectively.  These easier comparisons, combined with my expectation for the company to achieve leverage on the labor and other operating expense lines for the year, should translate into higher restaurant-level and operating margins for the balance of the year.  This YOY margin growth relies on continued same-store sales improvement, but given recent industry trends as measured by Malcolm Knapp, the company’s full-year comp guidance of 1% to 3% does not seem out of reach; though it does assume a sequential acceleration in two-year average trends.






Howard Penney

Managing Director