CAKE: RISK PROFILE RISING

Takeaway: From Bull to Bear, we briefly run through our short thesis following our conference call.

We added CAKE to the Hedgeye Best Ideas list as a SHORT yesterday at $47.51 per share.

 

Click here to access the presentation: NEW BEST IDEA: SHORT CAKE

 

 

IT’S BEEN A GOOD RUN

We have been bullish on CAKE for the better part of the past two years, but in this industry nothing lasts forever.  In full disclosure, CAKE is a strong company with a good management team, so we will be disciplined with this short call.

 

The bottom line is that 2014 is setting up to be a difficult year for the company.  To summarize our thesis, we believe the company’s three year run in improving margins is coming to an end.  Specifically, we believe the declines in food costs, labor costs, and other costs have run their course.

 

Traffic has declined for four straight quarters, a trend that management must address soon.  This suggests that 2014 could see an increase in labor and other costs as the company reinvests in store operations.  Factor in the minimum wage increases and the ACA, and it is clear that incremental pressure is beginning to build.

 

 

LOOKING AHEAD TO 4Q13 EARNINGS

CAKE is scheduled to report 4Q13 EPS on 2/12.  Current consensus estimates suggest the company will report 2.0% same-store sales at the Cheesecake brand and 1.9% on a consolidated basis.  This would represent a slight slowdown in 2-year same-store sales trends of 30 bps.  We believe that those estimates are aggressive and have not been adjusted lower during the quarter despite sluggish industry sales trends.

 

On the 3Q13 earnings call, the company gave fairly aggressive guidance for 4Q13, due to the easy comparisons from a year ago.  The 0.9% comp from last year was the lowest of the 2012 and was impacted by the Presidential debate, Election Day, and Hurricane Sandy. 

 

Management commented on the 3Q13 call: “The housing market continues to recover, the stock market is up, there really doesn’t appear to be any negative calendar issues or holiday shifts that are impacting the fourth quarter.  I think that Thanksgiving and Christmas, there’s one less week between Thanksgiving and Christmas.  We don’t really think that’s going to impact us.”

 

However, one less week seemed to have an impact on a number of retailers this holiday season.  We are unsure why CAKE would be immune to these trends.

 

Consolidated revenues are expected to grow 4.1% in 4Q13 vs 3.5% in 3Q13, but we believe these numbers may also be aggressive given slower than anticipated 4Q13 trends.

 

Furthermore, the company is guiding to EPS of $0.57-$0.60 in 4Q13, based on a range of same-store sales between 1.5-2.5%.  The street is assuming the company delivers at the high end of the EPS range, currently registering at $0.59.  The current guidance for 2014 is for EPS of $2.29-$2.41, based on a range of same-store sales growth between 1-2%. 

 

 

FOOD COST INFLATION WILL BE AN ISSUE IN 2014

In our opinion, the largest issues the company will face in 2014 is food inflation.  This becomes an even bigger issue considering management has limited pricing flexibility given the decline in traffic over the past four quarters.  Can they protect margins without perpetuating the recent decline in traffic?

 

Management is guiding to food cost inflation of 4-5% in 2014, driven primarily by shrimp and, to a lesser extent, salmon.  The company estimates this could impact 2014 by as much as $0.07-$0.10. 

 

As management stated on the 3Q13 earnings call: “We believe that we will be able to offset some of this pressure with slightly higher pricing, balancing our need to protect guest traffic and protecting our margins.  As a result, we factored in a net of about $0.04 to $0.07 into our 2014 earnings per share sensitivity.”

 

However, management failed to account for the spike in milk and cheese prices we are seeing early on in 2014.  In our opinion, this will add significant incremental pressure to the food cost line and will force management to lower their 2014 earnings guidance.  We run through this thesis in our presentation, including more thoughts on the topics, our earnings sensitivity analysis and the notion that management will be “in a box” in 2014.

 

If you haven’t already, we encourage you to read through the slide deck.  As always, we are available to talk.  Please feel free to call any questions. 

 

CAKE: RISK PROFILE RISING - 1

 

CAKE: RISK PROFILE RISING - 2

 

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CAKE: RISK PROFILE RISING - 5

 

 

Howard Penney

Managing Director


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