Cheesecake Factory Stock: Strong Q2 Earnings Results (NASDAQ:CAKE)

Investment Conclusion

The Cheesecake Factory (NASDAQ:CAKE) reported mixed F2Q2022 financial results. Despite the surge in Covid-19 cases, pent-up customer demand for experiential dining, sustained off-premise sales, and significant improvement in staffing levels, resulted in substantial growth in revenues and same-store sales associated with all three of the company’s brands, on a year-over-year basis, and compared to F2Q2019. In addition, annualized average unit volumes associated with The Cheesecake Factory restaurants, in particular, expanded to ~$12.3 million, relative to the $11.7 million linked to the first quarter. However, although CAKE raised menu prices during the period, margins across the board contracted compared to the previous year’s same quarter, driven by inflationary pressures related to energy prices, commodity costs (dairy and produce), and hourly wages. The firm opened two restaurants during the second quarter, one each associated with North Italia and The FRC Concepts.

Over upcoming quarters, despite an expected downturn in discretionary spending, we anticipate that the sales momentum experienced by CAKE’s brands during recent quarters will be sustained, as on average, the company’s customers earn >$100K, and are affluent and highly educated. In addition, restaurants across all of the firm’s concepts are located in highly prized real estate in economically upscale districts. Further, sales are likely to be favorably impacted by menu innovation expected to be rolled out early in the third quarter, comprised of the Summer Menu and a new Cheesecake variety, a Classic Basque Cheesecake, which is crustless, with a burnt top and a creamy custard-like center, and served with berries and fresh cream.

With regard to margins, we anticipate sequential expansion, and expect the figure to advance to pre-pandemic levels, based on revenue leverage due to lower fixed costs/dollar of sales, a potential menu price hike, continual improvement in front-line staffing levels, decrease in commodity costs, and stabilizing hourly wages, at the restaurant level, and better economies of scale associated with advertising, the digital platform, and administrative expenses at the corporate level. In addition, given that the company is continually buying-back shares every quarter, we expect some decline in the number of outstanding shares for the year. Considering the above described factors, earnings and free cash flows are likely to increase on a year-over-year basis, for FY2022, in our judgment.

CAKE plans on launching 15 new restaurants across its concepts, over the year. Management expects revenues for F3Q2022 of between $785 million and $805 million reflecting a year-over-year increase of 5.3% from the midpoint of the estimate, and in a range of $3.32 billion to $3.37 billion for FY2022, indicating an annualized growth of 14% from the midpoint of the projection.

Longer-term, the company has committed to ~7% annual net new unit development, comprised of ~1% to ~3% year-over-year increase in the The Cheesecake Factory footprint, ~20% annual growth in the number of North Italia restaurants, and between ~15% to ~20% expansion in the FRC Concepts restaurant base every year, including that of Flower Child. Incremental revenues from the launch of new stores will be supported by comparable sales growth through: menu innovation, the continued uptrend in off-premise sales, and loyalty programs (associated with all of CAKE’s brands), which we expect to be rolled-out, in the near-future. As a flow-through of revenue expansion, and economies of scale related to: corporate spending, the digital platform, and advertising, leverage at the restaurant and corporate levels will kick-in, reflecting in higher margins, which in turn will ensure surges in profits and free cash-flows, over an elongated time horizon.

Considering that F2Q2022 results have only improved our confidence that CAKE is likely to meet and exceed our conservative 10-year normalized revenue growth rate of ~6% and 10-year straight-lined operating cash flows margin of ~10.7%, we remain bullish on the stock. Therefore, we’re maintaining our 1-year Price Target of $71/share for CAKE. Reiterate Buy Rating. (Please go through our initiation report “The Cheesecake Factory: Undervalued With Little Downside Risk Over The Medium Term” and associated notes for our long-term opinion on the stock).

Key Takeaways From The Second Quarter

F2Q2022 Results Summary. For the quarter, revenues came in at ~$833 million (+8.3% compared with F2Q2021), below consensus estimates of $838 million, and earnings per share were $0.50 (vs. $0.31 during the prior year’s same quarter), missing analyst projections of $0.78. In addition, comparable sales at The Cheesecake Factory and North Italia restaurants increased by 4.7% and 12% relative to F2Q2021. Net income for the period was ~$25.7 million reflecting a decline of 24% compared to the previous year’s same quarter. CAKE generated ~$54 million in operating cash flows over the period.

Economic Recession Impact Likely To Be Muted. As per management, CAKE prospered during the fiscal downturn of 2007-2008, exiting the period with improved sales and margins. Overall, the effect was mixed between territories, with regions demonstrating declines of between ~1% to ~20%. The result is not surprising as the firm’s clientele has always skewed affluent and well educated. In addition, CAKE’s restaurants are typically located in affluent neighborhoods.

Nevertheless, the company plans on leaning on value deals, the rewards program, and promotions, to mitigate any repercussions of a possible recession over upcoming months. The strategy will be to launch an additional menu with lower priced items, reintroduce promotions on Cheesecakes and delivery orders that appeared to appeal to customers during the pandemic, and launch the loyalty program, which will position CAKE with opportunities to appeal to customers through rewards for frequent ordering and through predictive selling that tailors promotions based on guests prior purchasing history. In addition, that the menu prices range from $5 to $30 and that portion sizes are typically large enough to support sharing among guests, are other elements that could likely encourage customers to dine at CAKE even if discretionary spending declines.

Further, statistical data demonstrates that consumers typically save for experiential dining occasions during economic downturns, forgoing visits to Quick Service Restaurants, in anticipation of dining at table-service restaurants. Moreover, given that unit economics favor CAKE compared to its closest competitors, the white table cloth independent full-service mom-and-pop restaurants, the company appears to be insulated for the most part from a major impact in case a financial crisis were to unfold. Overall, simply based on the significant value proposition CAKE’s concepts provide guests in form of great food at reasonable prices and excellent customer service, its restaurants are likely to sustain a majority of their foot traffic during a potential economic decline, in our opinion.

Additional Concepts Firing On All Cylinders. During the second quarter, North Italia’s comparable sales expanded by 12% versus F2Q2021 and by 22% compared to F2Q2019, with annualized average unit volumes associated with mature locations accelerating to ~$9 million. In addition, driven somewhat by periodic price hikes to offset inflationary trends, the brand’s restaurant margins were 13% overall and 16.4% at its mature restaurants. Similarly, FRC Concepts, experienced substantial advance in its top-line and bottom-line performance during the second quarter. The group, including Flower Child, generated average weekly sales of $116,000. In total, North Italia and the FRC Concepts’ restaurants accounted for ~$147 million in sales over F2Q2022.

FRC Concepts launched its first Fly Bye restaurant, featuring Detroit style enhanced stretch pizzas and crispy chicken, in Phoenix, Arizona, a couple of weeks ago. With sales for the first two weeks exceeding expectations, CAKE plans on opening an additional Fly Bye location towards the back-half of the year. The concept started as a pop-up ghost kitchen at one of FRC Concepts culinary drop-off locations during the earlier stages of the pandemic, and began to enjoy significant customer demand right out-of-the-gate.

In addition, CAKE appeared bullish on future prospects associated with Flower Child. Management indicated that the firm is working on plans to accelerate footprint growth, including strategies to launch into new markets, fill key leadership positions, and leverage the supply chain to optimize restaurant level margins. Overall, given the growth in revenues and profits over recent quarters associated with The FRC Concepts, fueled for the most part by Flower Child restaurants, we are satisfied with the brand’s progress and believe the group is well positioned for continued success.

Accelerated New Unit Development Remains On Track. With significant resources available to CAKE, including $195 million in cash and equivalents, as well as additional capital from a revolving credit facility, management indicated that a possible economic downturn is unlikely to impact the rapid footprint growth plans guided to earlier. Although, the pace of development might moderate due to commodity cost inflation, labor shortage, and supply-chain restrictions, CAKE believes the ~7% annual footprint growth target is achievable for FY2023. In that regard, it is noteworthy that the firm currently has more active construction sites that ever in its history, indicating a significant number of new restaurant openings over the next couple of years.

For FY2022, CAKE has set a new unit development target of 15 restaurants, comprised of five The Cheesecake Factory locations (including one out-licensed international restaurant), four North Italia locations, and seven The FRC Concepts locations, including three Flower Child locations. CAKE’s brands are one-of-a-kind and rapidly monetizing the customer demand associated with their restaurants appears prudent. Therefore, we are glad that management intends to take advantage of any upcoming economic downturn by securing highest quality real estate at discounted prices, with a view to maximize shareholder returns.

Balance Sheet Remains Strong. At the end of F2Q2022, the company had a cash and cash equivalents balance of ~$195 million and long term debt of ~$475 million on its balance sheet. CAKE can borrow an additional ~$238 million to fund operations under a revolving credit facility, it has available. Given its funding position, we believe that the firm is well equipped to operate efficiently and execute on its considerable footprint growth targets. During the second quarter, CAKE repurchased 360K shares for a sum of ~$10.9 million. In addition the company declared a dividend of $0.27/share for the period.

Bottom Line

CAKE is on the cusp of a breakout. Based on business trends associated with its brands, we expect runaway growth in the firm’s revenues and earnings, over the next three to five years. In addition, even if a recession were to materialize during the next several quarters, we believe that although demand might somewhat moderate due to macroeconomic conditions, based on the strong customer appeal CAKE’s brands enjoy, its restaurants are likely to outperform the competition.

Overall, there is a disconnect between the current market value of the company’s shares and its intrinsic value determined by the future value of its three restaurant chains. Therefore, we suggest investors view pullbacks in CAKE’s stock due to market volatility, as an opportunity to dollar cost average down on shares, to generate almost guaranteed significant returns on capital.