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    MARKET EDGES

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We were cautious on The Cheesecake Factory’s prospects for 2011 for much of last year.  Approaching 4Q earnings, we think expectations are in line. 

The Cheesecake Factory has been downgraded by several sell-side firms in the last few months.  Our bearish stance on the stock hinged on two factors: overly optimistic company outlook on commodity costs in 2011 and consensus estimates being too high for the year.  During the third quarter, both of those factors changed as management revised its guidance on commodities and the street lowered expectations.  Sentiment duly followed the stock price but, at this juncture, we believe that the fourth quarter is likely to be strong for the company.  Furthermore, the likeliness of commodity inflation surprising the Street has been reduced; we believe that on the short side heading into earnings, the risk outweighs the reward.

CAKE: LOOKING AHEAD TO 4Q EARNINGS - cake sentiment

One chart we would like to highlight pertaining to the top-line is below: CAKE system same-store sales versus the ICSC Chain Store Sales Index.  The correlation between the two data sets is +0.8.  Given that consumer metrics in general, not only the ICSC Chain Store Sales Index, have been indicating quite healthy levels of spending, it is difficult to be bearish on CAKE’s top-line prospects.  CAKE is a beneficiary of traffic in malls and the strong dollar as much as any other player in the space.  Our firm’s macro call has been Strong Dollar = Strong Consumption and that applies to CAKE as well.

CAKE: LOOKING AHEAD TO 4Q EARNINGS - cake comps vs icsc

Another strong aspect of CAKE’s top-line story is its growth profile.  The smaller format of restaurant that the growth is weighed towards is offering higher returns and productivity (north of $1k/square foot).  From a guidance perspective, we expect continuing positive tone around this point.  

While our estimate for 4Q EPS is coming in slightly below the Street’s at $0.51 versus $0.52, we believe that the top-line will overshadow any other concerns.  The company continues to generate free cash flow (~$130m through the first three quarters) and is using the majority of that to buy back shares.

Howard Penney 

Managing Director

Rory Green

Analyst