The `Retire Young` portfolio is coming close to maturation as I will have the rest of the portfolio introduced in the coming days. After announcing Monster Beverages (MNST), Statoil (STO), American Express (AXP), Wells Fargo (WFC), The Walt Disney Company (DIS), Hewlett Packard (HPQ) and Smith & Wesson (SWHC), it's time to diversify the portfolio a little bit more while adding some taste to it. I am talking about adding a restaurant that has grown a lot and still has a lot of growth left, The Cheesecake Factory (CAKE).
Introducing the Cheesecake Factory
The company started in 1978 as one restaurant in Beverly Hills, California and opened the second restaurant in 1984. By 1988, a third restaurant and by 1990, a fourth restaurant was opened. Fast forward to 2012, the company operates 177 restaurants and there is still plenty of room for growth in and outside of the USA.
2012 was a successful year for the company. It reported the highest earnings ($1.88 per share vs. $1.64 in 2011), highest operating margins (i.e., 8.2% vs 7.7% in 2011) and highest revenues ($1.81 billion vs. $1.75 billion in 2011) since the recession of 2008. Also, the Cheesecake Factory opened 8 new restaurants in the USA (and closed down 3 of the least profitable restaurants) during the year. Keep in mind that each restaurant generates $10.22 million in annual revenues and $838,000 in operating profit which is impressive.
Of the $195 million it generated in free cash flow, the company is returning $114 million to the investors in the shape of dividends and share buybacks. This year marks the first year the company will be paying dividends. In the last 3 years, the number of the company's outstanding shares fell from 60.28 million to 53.40 million.
Last year, the company opened its first restaurants outside of the US with a partnership in the Middle East. For now, the partnership involves three restaurants (i.e., two in Dubai and one in Kuwait) but the number will increase over time. The company reported that there were long lines and strong demand at these three restaurants. In fact, in the latest earnings call, it was said that the company's Middle Eastern restaurants receive a much larger volume on average than the American restaurants even though no specific numbers regarding these restaurants were mentioned. Furthermore, The Cheesecake Factory is in the process of forming another partnership in Latin America in order to enter this market. The restaurants are likely to be in the "premier" or "luxury" category. In 2014, the first Latin American restaurant will be opened in Mexico City, followed by restaurants in Chile, Peru, Brazil, Argentina and Colombia in the rest of the decade. Notice that the company doesn't open a bunch of restaurants at once; rather it initially "tests the water" with pilot restaurants to make sure that its investment will pay off in the long term.
In the US, the company's brand value and consumer demand continues to be very strong. The Cheesecake Factory plans on increasing the number of restaurants in the US to 300 over time, which means almost doubling the number of restaurants. The restaurants have a very rich menu of 250 items, which makes it very desirable among all age groups. Nation's Restaurant News named The Cheesecake Factory the "most preferred casual brand in the US" for the second year in a row in its "Consumer Picks" report. Furthermore, some of the company's desserts made it in Zagat's "America's best desserts" list. In one study, American teens preferred the Cheesecake Factory as their favorite casual restaurant to eat at. The restaurant chain is increasingly popular with the younger population.
Same-Store Growth Continues
In the last 3 years, the company's same store sales growth remained between 1.8% and 2.0%. This number concerns some analysts but I am not too worried because the company can keep opening new stores to ignite further growth. Besides, even though it happens at a rather small rate, the company has been growing its same-store sales for 13 quarters in a row. Compared to 2 years ago, comparable sales were up by 3.8 in the last quarter. This is a tough accomplishment in an economy full of uncertainties. Last year and early this year has been tough on the restaurant industry as the margins were attacked from two directions: 1) consumers looking for discounts and lower priced items, 2) increased food and staffing costs. Despite this, The Cheesecake factory reported increase in its margins even though there is still more room for improvement.
A Word on Fundamentals
In the last 1 year, the share price of The Cheesecake Factory has appreciated by 26% which beats the market slightly. This year, I expect the company to beat the market. Currently, the company trades for a P/E ratio of 21 on earnings of $1.88 per share. This year, the company is expected to earn $2.16 followed by $2.46 in 2014 and $2.87 in 2015. Effectively, we are looking at a forward P/E ratio of 18 for the end of this year, 16 for the end of 2014 and 14 for the end of 2015. For a company that just gained exposure to international markets, with a double-digit growth rate, healthy margins and lack of debt, the company's P/E ratio is not high at all.
In conclusion, we are adding 200 shares of CAKE at $40.74 to our portfolio. We are also selling 2 contracts of covered calls with a strike price of $42.00 expiring in July. This will effectively give us $90 per contract, which will reduce our breakeven price to $39.84. I am confident in this company's performance in the medium and long term.