The Cheesecake Factory's Return On Equity Falters: DuPont Ratio Analysis

| About: The Cheesecake (CAKE)


The Cheesecake Factory's return on equity was increasing steadily until this quarter's announcement.

Revenue gains were 1.34 percent compared to last quarter.

Earnings per share announced on Wednesday missed estimates by $0.06.

On Wednesday, The Cheesecake Factory (NASDAQ:CAKE) announced its earnings report that surprised many investors. Earnings of $0.43 per share missed analysts' estimates of $0.49 per share. In the past quarter, The Cheesecake Factory increased its revenue by 1.34 percent from its previous quarter. Using the DuPont equation, we can assess this bottom-line ratio in greater detail and look for trends.

The DuPont Equation

The DuPont equation displays the relationships between profitability, asset management, and debt management ratios. The equation shows that return on equity is the product of profit margin, total asset turnover, and the equity multiplier:

ROE = (Net Income/Sales) * (Sales/Average Total Assets) * (Average Total Assets/Average Total Common Equity)

The Cheesecake Factory's Financial Data

USD In Thousand 2012-12 2013-03 2013-06 2013-09 2013-12 2014-03
Revenue $ 464,695 $ 463,018 $ 470,118 $ 469,699 $ 475,075 $ 481,431
Net Income $ 22,139 $ 25,292 $ 28,583 $ 27,481 $ 33,000 $ 22,518
Total Assets $ 1,092,167 $ 1,071,108 $ 1,124,887 $ 1,101,138 $ 1,124,114 $ 1,073,756
Stock Holders' Equity $ 579,726 $ 581,842 $ 634,296 $ 583,171 $ 577,353 $ 502,518

Source: Morningstar and SEC.

This data is all that is needed to calculate the ratios for the DuPont equation.

2013-03 2013-06 2013-09 2013-12 2014-03
Profit Margin 5.46% 6.08% 5.85% 6.95% 4.68%
Total Asset Turnover 0.4281 0.4282 0.4220 0.4270 0.4484
Equity Multiplier 1.8624 1.8057 1.8284 1.9175 2.0353
ROE 4.3548% 4.7006% 4.5145% 5.6871% 4.2683%

Source: Morningstar and SEC.

As seen above, The Cheesecake Factory is indeed making a profit and has a return on equity much lower than that of the restaurant industry. This appears to be the result of The Cheesecake Factory's 4.68 percent profit margin, which is much lower than the industry average of 10 percent from the most recent quarter, and is even lower than the services sector average of 7.9 percent.

The total asset turnover ratio, the ratio dealing with asset usage, appears impressive at just below 1.69 for the year compared to the industry's .95. The Cheesecake Factory seems to be efficiently utilizing its assets to generate revenue.

The equity multiplier or leverage ratio, the ratio concerned with debt management, appears healthy. The Cheesecake Factory could probably take on more debt and still be considered conservative. Conversely, Buffalo Wild Wings (NASDAQ:BWLD), another casual dining restaurant chain, has a lower multiplier near 1.5.

Trend Analysis

The analysis of the three ratios over time can usually offer some insight on the position of the firm and why the return on equity is changing.

Source: Calculated using data from Morningstar and SEC.

Until the most recent quarter, profit margin along with revenue has increased with each quarter. The Cheesecake Factory was not only generating a greater amount in revenue, but also retaining a larger portion as profits. As seen in the graph, profit margins recently fell to Q4 2012 levels. The labor cost increased substantially during the first quarter of this year, taking away an additional 1.5 percent of revenue from quarterly profits. Bad weather this season was a major cause of the higher labor costs.

Source: Calculated using data from Morningstar and SEC.

The Cheesecake Factory's total asset turnover has been outperforming the industry's average and has started an upward trend over the last two quarters. It has become more efficient at managing current assets and inventories while expanding non-current assets.

Source: Calculated using data from Morningstar and SEC.

The equity multiplier has been increasing due to sizable increases in treasury stock. This causes total stockholder equity to decrease. The increase of leverage will not be a good way of raising return on equity as it grows because it increases risk as well.


The Cheesecake Factory has increased revenue steadily but will need to curb its operating costs such as labor, which got away from it this quarter. In previous quarters, The Cheesecake Factory turned a higher profit as it shifted, and continues to shift to a "broader sales portfolio with less concentration and higher profit margin." The total asset turnover trend is a positive, setting The Cheesecake Factory apart from others in the industry. Furthermore, the equity multiplier is not near an alarming level. One point to note is that the California minimum wage will be increasing to $9 per hour effective this July. This may cut into profits even more, especially as California is The Cheesecake Factory's largest market. $2-$3 million of additional labor costs have already been factored into guidance. However, labor costs seemingly got away from management at the start of this year, which could be a cause for concern.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.