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CAKE reported 1Q earnings after the close Wednesday, announcing diluted EPS of $0.34 versus consensus at $0.33 and guidance of $0.29 to $0.33. 

The Cheesecake Factory reported 1Q earnings after the close Wednesday and, while the results were in line or slightly above expectations, the commodity outlook – and the question of company’s ability to pass it along to consumers – is causing uncertainty.  This uncertainty weighed on the stock Thursday as CAKE traded down 3.9%. 

Comparable restaurant sales came in at +1.6%, or +2.4% excluding weather, which implies a sequential increase in two-year average trends of 220 basis points.  The street was expecting comps to come in at +1.2%.  Exiting the quarter, CAKE had +1.4% of price on the menu.  Grand Lux did experience negative comps during the quarter, coming in at -3.8%, but management attributed that weakness to a difficult compare (+4.0%) versus 1Q10 and volatility in sales at the Las Vegas locations. 

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In terms of ROP Margin, CAKE’s performance was less reassuring.  Cost of sales increased 70 basis points year-over-year.  With 60% of its food cost basket contracted, management anticipates inflation of approximately 3.5% for 2011.  The prior guidance was for inflation of 3% in the food basket.  Tellingly, management now forecasts the commodity impact on EPS for 2011 to be $0.11 from $0.05 prior.  Along the lines of my post on CAKE in February, titled “CAKE – PUNT AND HOPE”, management is betting the ranch on food inflation falling off a cliff in the back half of the year.  While that may happen, on a year-over-year basis, it is less than certain and does not jive with much of the agriculture news at present which point to disappointing harvests in grains and produce and increasing feed costs supporting protein prices.  Despite having protein costs locked, to the extent CAKE has to renegotiate contracts with suppliers in 2011, the overall cost of its commodity basket could increase further than the general rate of food inflation.   The company is guiding to 2.5% inflation in 2H11, with 1.5% in 4Q11, as compared to 4.5% inflation in 1H11. 

In order to address this inflation, management maintained that pricing would be taken, if necessary, to absorb cost pressure.  As I stated before, price was +1.4% at the quarter’s end and, with 0.7% in price rolling off the menu at the end of summer, the company anticipates taking 0.7% in the 2011 summer menu change to maintain the 1.4% price.  Management also underlined its willingness to take price closer to 2% with that menu change if the commodity environment required it.  G&A/labor efficiencies will also contribute to offsetting inflation, according to the company.

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EPS guidance was raised at the low end, from $1.55-$1.70 to $1.58 to $1.70 (full year consensus EPS is $1.65), despite the incremental $0.06 of pressure from food costs that management is expecting.  This full-year earnings guidance is based on a comparable restaurant sales forecast of 1.5-3.0%.  For the second quarter, EPS guidance is at $0.39 to $0.41, which is below the street at $0.44 and will result in a shift in EPS from 2Q to 2H, absent a reduction in full year consensus expectations.  I would not be shocked if 3Q inflation, which could well be as bad as, or worse than, 2Q, prompts an additional shift in EPS expectations to 4Q!  Whether or not CAKE has sufficient pricing power to absorb the coming inflation will be the key question from here.  I do not believe that CAKE has the ability to price its way through the inflationary period ahead.  There is a significant risk of full-year EPS being reduced from here, especially given the lop-sided sentiment around the stock of late.

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Howard Penney

Managing Director