Editor's Note: Below is a complimentary excerpt of an institutional research note written last week by our Restaurants analyst team. For information on how you can subscribe to our institutional research send an email to email@example.com.
CAKE could be an exceptional investment in the restaurants space with updated thinking around the business model; but today it’s just an average investment.
Management is expending a significant amount of effort to achieve so little - spinning one’s wheels. If you haven’t looked lately, the average age of the management team is 67 and the board of directors is 70! No wonder there is no effort to try to fix the company’s traffic problem and their solution to padding margins is raising prices and charging what consumers they have left more to eat there! It’s just a matter of time before CAKE becomes the next target for change in the restaurants space!
THOUGHTS ON THE PRINT
Last night CAKE reported mixed 4Q17 earnings results. Cheesecake Factory same-store store came in below expectations at -0.9% (-2.8% traffic, +2.5% pricing and -0.6% mix) vs FactSet -0.5%. However, in rate of change terms, same-store sales are showing a recovery, as the two-year average has accelerated by ~40bps sequentially from 3Q17. Traffic in 4Q17 came in at -2.8%, showing 150bps of sequential improvement, and 60bps of acceleration on a two-year average basis, but there is still lots of work to do!
On the recently enacted tax reform bill, the Company recorded a $38.5M benefit to the income tax provision from a revaluation of deferred tax assets and liabilities. On the heels of this tax benefit, CAKE was able to take the bottom-end of its previous EPS guidance from $2.50 to $2.64, and extend the top end of the range from $2.75 to $2.80. According to management, the tax savings will be used in various ways, with some going to investing in staff members in numerous ways, and another portion used to evaluate and move forward on some of the Company’s strategic corporate initiatives (Enterprise Resource Planning and Human Capital Management systems).
Turning to the off-premise portion of the business, CAKE’s national delivery rollout continues as planned, and delivery is now available via third-party providers in approximately ~90% of locations. With the off-premise business increasing to 12% of sales in 2017, management is confident that they will be in the 13-14% range by the end of 2018. Diving deeper, delivery is making up the biggest portion of the growth in off-premise, but with online ordering ramping up, to-go should pick up steam in due time. Online ordering is well ahead of schedule, and will be live by the end of March.
How management allocates their capital is critical to long-term shareholder returns, and we believe CAKE is misguided in its efforts to grow secondary brands. In 2017, CAKE spent roughly $120M of cash in capex and $18M in growth capital investments. In 2018, CAKE is shifting its priorities of capital spending with cash capex of $90-$105M, and $20-$25M into growth capital investments, namely in North Italia and Flower Child. We continue to contend that every dollar not going into the Cheesecake Factory will come at a lower return for shareholders!
We believe that the CAKE story still has a long way to go, as management still needs to cut deeper and go further in driving restaurant level efficiencies. As we harped on in our Black Book (October 2017), the menu size at the Cheesecake Factory is over-extended and far too complex, making for an over-complicated dining experience. Menu cuts would be a swift and relatively easy initiative that would yield incredible results, but it was not mentioned.
NOTABLE COMPANY THOUGHTS
“Our guidance range continues to assume wage rate inflation of approximately 5% in 2018. We’re continuing to move forward with more market-based pricing where the wage pressure is most concentrated to help mitigate rising labor costs,” (Matthew Clark, CFO).
HEDGEYE – Wage rate inflation is an industry-wide headwind. CAKE is proactively working to offset these headwinds in anyway it can.
“We continue to see food inflation of 3% for our 2018 market basket. This reflects inflation across most of our categories notably higher poultry, dairy, produce costs. We expect this inflation to be front-end loaded with approximately 4% estimated in the first quarter, and then expect it to moderate each quarter for the balance of the year,” (Matthew Clark, CFO).
HEDGEYE – Management is confident that commodity costs will move in their favor as the year progresses because they are locked into favorable costs, when compared to last year (currently have ~70% of basket locked in).