Investment Conclusion
The Cheesecake Factory (NASDAQ:CAKE) reported mixed financial results for F4Q2021. Although revenues were significantly higher compared to a year ago as well as two years ago, overall margins contracted due to Omicron, as sales declined over the later part of December, and employees had to be provided with financial assistance to deal with the outbreak. Nevertheless, the increased spending over the quarter was undoubtedly a one-time expense, and management indicated that the firm was committed to defending FY2019 margins through price increases and operating efficiency. In regard to higher menu prices, CAKE’s customer demand appears to be price elastic as historically sales have not declined following the initiative. The group opened four new restaurants during F4Q2021, compared to three during F4Q2020. Sales trends across the current quarter have been solid predicting considerable growth over FY2022.
Over the short-term, we expect the momentum in sales being witnessed over the first quarter to continue, as dine-in sales expand driven by folks increasingly opting for the full service restaurant experience, even as off-premise sales, particularly those of The Cheesecake Factory’s cheesecakes are sustained. In regard to margins, we have no reason to believe that they will not revert to FY2019 levels as management has indicated. Our conviction is driven by CAKE’s decision to raise menu prices by ~2% over the third quarter, following a 3.25% increase during the current quarter, resulting in a cumulative advance of ~4.75% for the year. Further, given our thesis that substantial revenue growth is likely over upcoming quarters, the marginal cost of sales/dollar is likely to decline as fixed costs are allocated over a larger revenue base, reflecting in additional leverage. Moreover, the company has locked in prices for ~65% of its primary commodities, which indicates that any inflationary pressures that might surface during the year are unlikely to damage margins.
Overall, given higher sales and margin expansion, boosts to earnings and free cash flows are possible over the near-term, in our opinion. CAKE anticipates launching between 17 to 19 new restaurants during FY2022, comprised of approximately five The Cheesecake Factory locations, between five to seven North Italia stores, and roughly seven other FRC Concepts restaurants, including approximately three to four Flower Child locations .
Longer-term, the company has committed to ~7% annual net new unit development, comprised of ~1% to ~3% year-over-year increase in 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 same-store 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 F4Q2021 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 growth rate 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 an associated note for our long-term opinion on the stock).
Key Takeaways From The Fourth Quarter
F4Q2021 Results Summary. For the quarter, revenues came in at ~$777 million (+40% compared with F4Q2020), above consensus estimates of $775 million, and earnings per share came in at $0.04 (vs. a loss per share of $0.85 during the prior year’s same quarter), missing analyst projections of $0.58. In addition, comparable sales at The Cheesecake Factory and North Italia restaurants increased by 33.8% and 37% compared to F4Q2020. Net income for the period was ~$2.1 million compared to a net loss of ~$32.3 million during the previous year’s same quarter.
In FY2021, compared to FY2020, CAKE generated: ~$2.93 billion in revenues reflecting an increase of 47.6%, comparable sales growth at The Cheesecake Factory and North Italia of 44% and 48%, ~$72.4 million in net income vs. a net loss of ~$253 million during FY2020, earnings per share of $1.01 vs. a loss per share of $6.32, ~$213 million in operating cash flows and ~$146 in free cash flows.
Earnings Lower On One-Time Items. Clearly, given CAKE’s weak bottom-line over the fourth quarter, the strong revenue growth the firm witnessed during the period failed to translate into commensurate profits. Based on financial data outlined by management, the difference between the top-line and bottom-line was due to one-time events, including the contraction in two years sales growth from the ~10.6% it was trending at pre-Omicron to ~7.7% for the quarter, representing 1.5% of the 2.5% shortfall in margin from two years ago. In addition, expenses related to Omicron sick-time employee bonuses, and higher natural gas prices, came in at $3.8 million, resulted in a 50 bps decrease in margins. The above described elements reflected in between $0.16 to $0.21 of lost earnings for the fourth quarter. Adjusting for the one-time items, CAKE’s earnings/share for the quarter would have been in a range of $0.20 and $0.25, had Omicron not surfaced, and natural gas prices remained stable.
Off-Premise Sales Being Sustained. Off-premise transactions associated with The Cheesecake Factory brand accounted for 27% of its total revenues during the fourth quarter. In addition, on an annualized basis, the element continued to trend at twice FY2019 levels. Considering that The Cheesecake Factory continues to generate strong off-premise sales despite the return of dine-in customers in significant numbers, is highly favorable, and a testament for the channel’s potential to develop into a secular growth driver for the brand. Overall, the accelerated growth of the off-premise channel associated with its primary brands, has provided CAKE an opportunity to generate significant incremental sales, indeed far beyond those evidenced prior to the pandemic.
North Italia and FRC Concepts Showed Momentum. During F4Q2021, CAKE’s new brands, predominantly North Italia and Flower Child, generated solid financial results. North Italia’s comparable sales expanded by 37% on a year-over-year basis and were 14% higher than two years ago. Off-premise sales accounted for 15% of the brand’s total sales. The robust performance continued into F1Q2022, with comparable sales registering a growth of ~38% over F1Q2021. The restaurants associated with FRC Concepts, including those operating under the Flower Child brand, similarly outperformed, with sales/operating week advancing to ~$104,000. Undoubtedly, the acquisition of North Italia and the FRC Concepts is working out well for CAKE. As these groups represent the next leg of growth for the company, their continued solid financial performance is extremely encouraging for the business.
Several Opportunities For Additional Revenue Growth. CAKE has upgraded the e-commerce website associated with its The Cheesecake Factory brand. The new website features a contemporary outlook and is more customer friendly in regard to order placement and check payment. The firm believes, the upgrade is likely to encourage customers to place larger orders which could translate to higher check values.
In addition, considering that the viral outbreaks which typically resulted in substantial declines in sales associated with CAKE’s restaurants (as they have historically relied heavily on dine-in transactions), are largely behind the U.S., the company clearly stands to benefit from the development.
Moreover, as urban centers and tourist areas have yet to return to normal, the gradual shift enfolding towards regular office hours and increased leisure travel, represents an additional opportunity for revenue growth for the CAKE.
Further, with a view to bolster lunch time traffic, which appeared softer than the industry average in some territories, even before the pandemic, the firm is actively directing efforts to build awareness around their lunch business. As large malls, where a significant fraction of CAKE’s restaurants are located experience increasing traffic, we expect sales associated with its lunch offerings to improve.
Overall, given the additional opportunities for higher customer demand, the sales momentum, CAKE’s restaurants are evidencing, will further accelerate, in our judgment.
Guidance Appears Conservative. For FY2022, CAKE anticipates revenues in a range of $3.3 billion to $3.4 billion (representing a year-over-year growth of between ~+12.7% and ~+16.1%), average unit volumes of >$12 million, commodity inflation of low double digits, labor inflation of 5%, price increase of ~4.75%, operating margins consistent with FY2019 levels, all leading to substantial growth in earnings/share.
For F1Q2022, the company expects to generate between $770 million and $790 million in revenues. In addition, CAKE is currently rolling out a ~3.25% increase in menu prices. Based on these elements it expects its restaurant operating margins for the quarter to be around that experienced over F1Q2019. However, corporate level operating profits will revert to FY2019 levels only after the ~2% planned hike in menu prices is implemented, over the third quarter.
Given the considerable opportunities for revenue growth and margin expansion, we believe CAKE is well-positioned to over deliver on its guidance.
Balance Sheet Remains Strong. At the end of F4Q2021, the company had a cash and cash equivalents balance of ~$190 million and long term debt of ~$475 million on its balance sheet. CAKE can borrow an additional ~$240 million to fund operations under a revolving credit facility it has available. Given its funding position, we believe that the firm will handily maintain liquidity over the final days of the pandemic. Management indicated that CAKE is contemplating reinstating the quarterly dividend and declaring a share repurchase program.
Bottom Line
CAKE is in an envious position. It has three strong brands, The Cheesecake Factory which represents a cash cow, North Italia which is clearly the firm’s key growth driver, and FRC Concepts, including Flower Child, which represents emerging brands, with significant growth ahead of them. Revenues associated with all three ventures are expanding nicely and the organization on the whole is profitable, although margins and earnings could be better.
CAKE is committed to rapidly advancing the number of North Italia and FRC Concepts restaurants, and improving same-store sales growth at The Cheesecake Factory. In addition, considering that management is putting efforts behind maintaining earnings, the shortfall in margins, represents a leverage opportunity.
Since we take a long-term view on stocks, we are satisfied with CAKE’s progress. Undoubtedly, the company’s best days are ahead of it.
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