The easy call is to be negative on PFCB following the analyst day on Friday. It’s also easy to get bullish.
P.F. Chang’s is, in some ways, a victim of its own success. For most of its life as a public company, the company’s core concept, PF Chang’s has been a concept that has produced very high unit level economics and has operated in the Asian category without any real competition. Over time, this has led the company to become “fat and happy”. The concept’s issues can be traced back to 2007 but, the sluggish economy has somewhat masked those problems. As the economy has expanded and other concepts have seen an improvement in trends, P.F. Chang’s has lagged. If I have one criticism of management that stands above all others, it is that it does not reflect well upon them that the company is only now getting around to focusing on consumer research and the performance of its company excluding any macro drag. The excerpt below, from the transcript of the meeting, illustrates what we mean. It should not take a crisis for the company to be moving in the direction that it is now aiming for.
“One of the things that will be sort of a common theme through today's presentations is, as an organization we've moved from being, I would say, being a little more intuitive to more fact based in terms of our decision making. I mean over the years I think we've – we've tended to be, we tended to have a really good understanding of the industry, a real good understanding of the consumer and our consumer. And we are augmenting that now with a wide variety of actual fact based research studies.”
That said, if the company is heading in the right direction and the stock has been beaten down (which it has), surely it is a Buy here? There seems to be a light at the end of the tunnel but, of course, timing is everything and it is unclear how bright the light is.
Three key point to the Bullish case:
- Strong assets and balance sheet, strong cash flow and international growth opportunities
- Perennial PE target
Three key point to the Bearish case:
- EPS estimates are too high for 2012. In our view, $1.50 in EPS for 2012 is likely and 2013 could also be disappointing in terms of earnings growth.
- It is expensive to bring back the lapsed user and give food away to the loyal customer.
- Valuation (trap)
Valuation can be bullish and bearish at the same time; PFCB is a perfect example of this. From our seat, we feel that it is cheap for a reason. We would be willing to bet that estimates are too high because it’s likely going to cost more than expected to turn the ship around. It can be fixed, but just when the valuation trap will turn into a cheap valuation remains to be seen. We don’t think it happens in the next three months at least.
In the interim the key things to focus on are as follows, along with our take on each:
1. Is management on the right track?
HEDGEYE: We believe so but, again, it is disconcerting that what other industry players have been utilizing for a long time is only being integrated in PFCB’s process now. Performance of P.F. Chang’s brand will be the yardstick to measure how management is performing.
2. How long is it going to take?
HEDGEYE: We estimate two years; management says 2012 is the transition year with high inflation and “wild card” revenue. 2013 will also see a rising cost structure.
3. How expensive will it be to fix the problems, assuming they can be fixed?
HEDGEYE: Very. These undertakings are difficult to get right the first time as well.
Unfortunately there are a lot of variables that are not within their control. As management said last week the "revenue" outlooks is the “wild card” and are unsure of the outcome from the new initiatives the company is embarking on. The road to remedying what ails the P.F. Chang's brand is filled with pot holes. The brand has very loyal customer base, but uncertainties remain around how exactly the company is going to bring back the lapsed user. As we view it, the new “Strategic Platform” they laid out is all about increasing costs and there was no talk of where they might be able to increase efficiencies.
The PF Chang’s “Strategic Platform” to brand revitalization looks like this:
- Eliminate barriers to entry. No entry level pricing on the menu and pricing at lunch needs to come down.
- Elevate the guest experience. Management has added 150 basis points back to the labor line and the brand is in need of an extensive remodel program to serve good food in a clean, inviting atmosphere.
- Operate “with a fanatical focus on guest satisfaction” (same as the second point). They have opened a new store in Providence RI with a new look and feel. There will be 5-8 remodels in 2012.
- Communicate with the guest: “We want you back”. The dilemma for the company is that the P.F. Chang’s brand does not have the density to achieve a national message via television. The alternative is an increased social media exposure and a revamp of the loyalty program. The current loyalty program gives the guest a 10% discount. The company said last week they will be moving to a “surprise and delight” loyalty program (like PNRA).
One the biggest challenges that the company faces is bringing people back at lunch. There is a real price/value issue at lunch with only a 20% difference between lunch and dinner average check. As management says “people think we are serving dinner at lunch”. At dinner, customers share entrees but the lunch menu is not designed in a way that facilitates sharing. The current average check at lunch is $17 and to be competitive it needs to be reduced by $2, according to management. We contend that management is being conservative in this regard; $13 is likely a better level given that many big players in casual dining make lunch available for less than $10. So the dilemma is that with 30% of the business coming at lunch and the concept looking at a $3-$5 decline in the average check, can management menu-engineer items that can survive that type of decline?
I was shocked to learn that the loyal user of P.F. Chang’s comes four times per year; I would have thought it was much more. So, how do you bring in new customers (hopefully younger customers) while at the same time keeping the existing loyal costumer from spending less when they walk in the door?
I don’t want to discount the potential for Pei Wei but management’s strategy for this brand is very confusing. Their consumer research says that Pei Wei also has a price/value problem, and they have recently introduced “selects” with a lower price point to help the sales problem. While it’s still early, sales trends have improved, and management said there has been very little erosion in the average check.
All that being said the company’s commentary on the introduction of the Pei Wei Asian Market was confusing. The new concept (another version of Pei Wei) is geared to a have 500 bps better margins, lower price points, reduce labor costs, flexible floor plan, reduced square feet and more portable food.
The new Pei Wei concept is geared to operate with significantly less labor costs. So what does this say about the current Pei Wei concept of which, by the way, they are opening 16 new stores in 2012? All I can say about Pei Wei is watch what they do not what they say!
I don’t want to buy a cheap stock on the “hope” that I get bailed out by some PE firm. I also don’t want to short a stock that could fall prey to some activists or PE firm taking the company private. Management tried to make a compelling case but, upon reflection, we are staying on the sidelines.
The consumer is not dumb. Restaurant companies with average check issues cannot manage margins and check in such a way that allows them to execute the business perfectly. There is no reason to rush in. Mr. Federico and team still have some work to do and there is much to be learned from the P.F. Chang’s of the future to be constructed in California. The company had it too easy for too long. Now there remains a lot of uncertainty and the onus is on management to reassure investors with results going forward.