To summarize our current thesis on CAKE, we believe the company’s three year run of improving margins is coming to an end. Specifically, we believe the decline in food costs, labor costs, and other costs have run their course.
To what extent has the decline in these expense lines since fiscal 2010 contributed to the recent traffic declines? That question is difficult to answer and even more difficult to pin on one factor. But, we do know that, collectively, all three can have an impact. We point to DRI and PNRA as other current examples of companies needing to reverse course.
The declining traffic trend suggests that we could see an increase in food, labor and other costs as the company reinvests in store operations. Below are a series of CAKE operational observations from a consultant within the Hedgeye restaurant industry network.
From these observations, there is a lot the company can do to improve traffic, but it will take some time and incremental investment which could pressure operating margins over the near-term.
FOOD AND BEVERAGE
- Food menu hasn’t really changed in 10 years so the restaurants are unlike others who adjust seasonally and can offset certain food cost increases with new less costly items.
- Also no limited time only items that can be used to move people to less costly food items.
- Beverage is not promoted and the drink menu is too confusing.
LABOR
- Labor is high because meals and drinks require too many steps to complete.
- No call ahead seating (different than reservations) allowed – costing them potential customers.
- Trouble seating large parties because of too many booths.
MARKETING AND LOYALITY
- No marketing at all!
- No focus groups.
- No loyalty programs.
- They don’t market their “to go” menu.
- They are not engaged at all at the local level.
OTHER
- Mall locations mean they are very dependent on mall traffic.
MANAGEMENT
- Overton is a tyrant who doesn’t listen to anyone and makes all the decisions.
- Potential health concerns and close to 70.
- Struggles to travel.
The last point about management is certainly not lost on us. David Overton, Chairman, President and CEO, controls and owns 6.6% of the company. As a result, he could decide to sell the company at any given time. But with the stock currently trading at 9.0x EV/EBITDA, we view that possibility as highly unlikely.
Howard Penney
Managing Director