PFCB – Getting Closer and Closer

PFCB is one of the better concepts in the restaurant industry. It has a good management team; though it did hang around the growth camp just a little too long. Management also committed the same mistake that nearly every successful restaurant company makes - diversification. We all make mistakes and should be forgiven when we correct the sins of the past.

Over the past four years, I have always looked at CAKE and PFCB the same way. Great concepts, but both management teams were growing the core concepts too fast. Both companies unsuccessfully diversified away from their core businesses to an inferior concept and as a result, margins and returns declined. Now, both CAKE and PFCB have slowed growth and are generating significant free cash flow. Additionally, PFCB announced on its 3Q earnings call that it would immediately close 10 underperforming Pei Wei units, which it expects will improve the concept’s restaurant margins by 70-80 bps in 2009. Management is extremely focused on cost saving initiatives at Pei Wei and expects its project evolution initiatives to benefit margins by 200 bps by 2008 year end on top of the 100 bps of labor savings it expects to realize from its new labor scheduling tool, which will be fully implemented by the end of 1Q09. So the company is working to improve margins while slowing growth, which should help to reverse declining returns at its inferior concept.

Neither company has a balance sheet issue, but PFCB’s average ticket is in a precarious spot (Management has said that it has no plans to increase prices at either of its concepts in 2009). Like CAKE, PFCB’s core store base is located in the most economically challenged housing markets in the US, so we know same-store sales are going to be challenged. Co-CEO Bert Vivian confirmed this view when he presented at an investor conference back in early January and provided colorful commentary on business trends, saying, “Yesterday, RUTH reported that comparable sales declined over 18% for the fourth quarter. Don’t be surprised by these types of numbers. Whatever numbers you are expecting for the industry should most likely be ratcheted down” (please refer to my January 13, 2008 post titled “PFCB – New Co-CEO Provides a Dire Outlook for Casual Dining”).

Both concepts will benefit from lower YOY commodity price increases as we progress through 2009. Importantly, there is a real possibility that in the next 3-6 months same-store sales trends will look less bad, which is a positive. So why is the short interest on PFCB 33% and CAKE 6.5%? I guess the easy answer is that over the past six months EPS estimates have only declined 2% for PFCB versus 20% for CAKE and 8% for all full-service restaurants. Given that PFCB management has not yet provided 2009 EPS guidance and Co-CEO Bert Vivian's rather dismal view of the industry, either he is a big “sand bagger” or guidance will be below the consensus view. Even in the aftermath of lowered guidance, we would be far more constructive on PFCB.

The Research Quantitative Edge

Looking at the Research Edge quant models, PFCB is bearish from both a Trend and Trade perspective, but just barely. It looks like a very high-risk situation for the short sellers at this stage of the game. The model says that basically both Trend and the Trade momentum lines are starting to converge at $19.18 and that is a bullish sign. Essentially, this means that the range is narrowing as volatility is dampening. Importantly, if the market gets a sniff of better than expected or “less than toxic” news, the shorts are going to get eaten by the $19.18 SHARK LINE. From the SHARK LINE, there is no resistance until $23-$24. On the downside, if the stock fails to overcome that line, $17.15 is support unless there’s a disaster in the making here. PFCB looks like a lot of broken growth names, as it’s setting up to continue to make higher lows vs. November when the stock went to $15 and short interest was at 28.6% of the float.

It does not appear that there is a big payday being short PFCB. There is no insider activity of consequence. It is, however, important to note that the holder list has a high concentration factor, which could be a liability for the bulls if one or two of these big holders flinch. Under that scenario, the stock goes to the $17 level, expeditiously.