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HOW BAD CAN PFCB BE?

P.F. Chang’s is a company with two brands under fire.  PF Chang’s China Bistro and Pei Wei have been underperforming and the investment community has not been forgiving; the stock is down almost 40% year-to-date.  Since I walked away from the PFCB investor meeting last month feeling like I was missing something, I needed to spend more time in the store to understand the issues and contrast that to the direction the company is going. 

Given the current sentiment and valuation, and our fundamental view of the company, we would hold a bullish bias on PFCB but feel that we are 6-9 months away from some initial metrics that can provide some direction.  We need a little more clarity on how the company’s initiatives are faring to gain confidence and visibility that the turn happening.  I’m positive on the long term TAIL (three years or less), but remain cautious from a TRADE (three weeks or less) and TREND perspective (three months or more).  

A successful turnaround of the PF Chang’s Bistro brand must incorporate the following characteristics:

  1. Price points: reengineering the lunch menu to a lower price point, while preserving margins (very tough call here), I imagine they need to give up some margin at lunch.
  2. Marketing/Product: P.F. Chang’s Bistro needs to start communicating more effectively with its customers and enticing people back.  The Irvine project is ground zero for these initiatives.
  3. Look and Feel: upgrading the asset base to a new look and feel is in the works with some early success, but this will take time.

Yesterday, in conversation with Brad Kaemmer, Regional Vice President at P.F. Chang’s China Bistro, we gained a lot of perspective on the depth of the issues at the concept and where Wall Street may be right and wrong on the name. 

The main takeaways are as follows: 

  1. The brand needs to reposition itself on the price-value spectrum, particularly at lunch.  Lower price points at lunch are necessary to provide compelling value to increase traffic.
  2. The concept has a marketing problem.  Part of it is solvable, part of it is not.  What the company can address is the need for improved communication around the product and food preparation.  What consumer doesn’t know (because they are not told) is that the concept ingredients used in P.F. Chang’s restaurants are fresh and carefully prepared as what we witnessed at the West New York location.  That is solvable but will require management to do a much better job of communicating with the customer.  What is not solvable, at least not in the near term, is the fact that the sparse geographic nature of the store base makes it difficult for management to improve its communication via traditional advertising media.
  3. The company fell behind in menu innovation.  For years the company had no real competition and became lazy.  The malaise that the company is feeling now is galvanizing management to make the necessary adjustments to win back customers.  Ground zero for menu innovation is in the renovated Irvine, CA store.  The key to binging traffic back into the store is to provide customers with an incentive.  I know it a restaurant cliché, but the P.F. Chang’s concept needs some “new product news” – give consumers a reason to come back!
  4. The outlook is perhaps not as dour as some fear, but the solution is not around the corner.  While a pricing adjustment may be a large part of what is needed, winning back customers that have been lost is not possible over the immediate term, especially for a company with such a geographically sparse store base.  However, some markets and aspects of the business model are performing well and we believe that the company will regain traction. 

Yesterday our visit was to a P.F. Chang’s China Bistro restaurant and, as such, our takeaways from the visit pertain primarily to that business.  The Bistro is the most important component given that the concept represents roughly 75% of total revenues. 

I hear from so many people that P.F. Chang’s is a dead brand and is uncompetitive.  The fact that the price points are not resonating at lunch is a problem.  The fact that other concepts rolling out Asian dishes in their menus makes them more likely to appeal to larger groups (where the veto vote can be a decider of where to eat) is a problem.  There are a number of different brands, however, that have encountered similar problems in the past twenty years but found a way to address the issues and thrive.

The next six months are critical to see how management addresses these problems.  The stock has been trading sideways for some time at a historically low valuation.  As we like to say at Hedgeye, valuation is not a catalyst – we’ll have to wait for evidence of that to emerge.

Howard Penney

Managing Director

Rory Green

Analyst