The Cheesecake Factory Provides Significant Total Return Potential
Summary
- The Cheesecake Factory is a restaurant operator with a strong growth outlook.
- The company produces high cash flows despite investing for growth.
- These cash flows allow for compelling shareholder returns.
Article thesis
The Cheesecake Factory (NASDAQ:CAKE) is a compelling total return investment, as it combines a nice dividend, an inexpensive valuation and a positive growth outlook.
The restaurant industry has had a harsh year, but The Cheesecake Factory performed better than its peers. With International expansion continuing, the company will become less dependent on the U.S. market over the years, which could lead to less cyclical results in the future.
Headwinds for the restaurant industry
The Cheesecake Factory operates restaurants in the U.S., and there are several licensed restaurants in the Middle East and Latin America. Due to the majority of the restaurant base being located in the U.S., The Cheesecake Factory is highly dependent on the U.S. restaurant market, though:
source: The Cheesecake Factory presentation
The restaurant industry in the U.S. isn't in the best spot right now. During 2017 comps sales declined by more than two percent, but The Cheesecake Factory performed significantly better:
source: The Cheesecake Factory presentation
The company managed to achieve another year of positive comps sales, although the increase has been the worst over the last couple of years. Rising comps are important for restaurants, as those allow for margin increases: Fixed costs per existing location are not rising, but gross profits increase (all else equal). This combination allows for rising operating margins, which helps drive earnings growth for The Cheesecake Factory.
The Cheesecake Factory has a positive growth outlook
The Cheesecake Factory's restaurant base is still rather small (about 200 locations in the U.S.), which means that there is a lot of potential for more restaurant openings. The company targets a meaningful increase in its restaurant count both domestically as well as internationally.
source: The Cheesecake Factory presentation
Four to six new restaurants in the U.S. will increase the restaurant base by two to three percent. On top of that management expects another four to five new restaurant openings internationally (by licensing partners). These licensed restaurants are very beneficial for investors: The company doesn't have to spend any cash at all, yet each restaurant contributes, on average, one cent a year to the company's EPS.
If the international restaurant count (i.e. licensed restaurants) rises to the same level as the number of restaurants in the U.S., this alone would add about $1.80 to The Cheesecake Factory's earnings per share. These high margin license revenues, for which the company doesn't have to spend any capex, will be a major growth driver for the company in the future, but the outlook in the U.S. is not bad at all, either.
The Cheesecake Factory is generating a return on capital of roughly 15%, investments into new restaurants in the U.S. thus drive shareholder value as well. When it is building new restaurants the company targets prime locations such as grade A malls, lifestyle centers, etc. This means that the company will very likely not be negatively impacted by lower mall traffic, as that is primarily a problem for lower-grade malls. Traffic at the country's best malls remains very strong, which keeps the number of customers that can dine at The Cheesecake Factory high.
The Cheesecake Factory returns a lot of cash to shareholders
The company is still in the growth phase, but due to strong cash flows and low capex (due to the license model for international expansion) The Cheesecake Factory produces high free cash flows.
The Cheesecake Factory has started paying a dividend a couple of years ago and has steadily increased the payout since. Right now shares are yielding 2.3%, which is well above the broad market's dividend yield of 1.8%. The company has returned even more money to its owners via share repurchases though: Over the last decade the share count has declined by 32% -- this alone has driven earnings per share up by 47%.
The company's guidance for 2018 calls for free cash flows of $150 million, which is not unrealistic when we look at the cash generation over the last couple of years:
source: The Cheesecake Factory 10-K filing
Over the last three years the company has generated free cash flows of $100 million, $160 million and $100 million. The free cash flows are somewhat lumpy, depending on the timing of investments into new restaurants. It is clear that $150 million in free cash flows for 2018 are achievable, as the company has produced even higher free cash flows in the past (with a smaller restaurant base). Tax legislation changes will have a positive impact on earnings and on cash flows in 2018 as well, as the company has been paying a rather high effective tax rate in the past due to operating a U.S. focused business.
As the company's market capitalization is just $2.2 billion, $150 million in free cash flows will allow for substantial shareholder returns, as this equals a free cash flow yield of 6.8%. With the dividend yielding a little bit more than two percent, The Cheesecake Factory could easily repurchase another four percent of its shares during the current year.
With a 20% annual dividend growth rate (over the last two years) and a dividend payout ratio of just 43% the company looks like a compelling dividend growth investment. Most of its peers either offer significantly lower dividend yields or have much lower dividend growth rates, which makes the company one of the best dividend growth investments in the restaurant industry.
As long as the company keeps growing its EPS (which is highly likely due to the good growth outlook mentioned above), its dividend can be raised at a double digits rate easily.
Analysts are currently forecasting a 13.5% EPS growth rate over the coming five years. If the company hits this target and raises its dividend payout ratio to 50%, it could raise the dividend by a whopping 93% through 2022. This would make the dividend rise to $2.24 a year, which would mean a yield on cost of 4.6% for those who purchase shares at $49.
The high earnings growth rate does not only allow for high dividend growth rates, though, it also provides a positive total return outlook. The Cheesecake Factory trades at 18 times this year's earnings right now, which isn't a very high valuation at all.
Even if the valuation declined over the coming five years, investors could still see compelling share price gains: If the company hits the forecasted 13.5% EPS growth target, it will earn $4.50 in 2022. When we put a 16 times earnings multiple on this EPS target, we get to a target share price of $72. Shareholders would thus see annual share price gains of 8.0%, which, combined with the dividend, results in a 10% annual total return. If the multiple doesn't decline over the coming years (or if it expands), total returns could be even better.
Bottom Line
The Cheesecake Factory is a rather small restaurant company with a good track record. The company managed to keep its comps positive through the last year, despite the industry facing meaningful comps sales declines.
The growth outlook in the U.S. as well as internationally is positive, and at the same time the company is able to return a lot of cash to its owners thanks to high free cash flows.
Shares are not overly expensive, and due to a positive growth outlook it seems likely that shareholders will see compelling total returns going forward.
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This article was written by
Jonathan Weber holds an engineering degree and has been active in the stock market and as a freelance analyst for many years. He has been sharing his research on Seeking Alpha since 2014. Jonathan’s primary focus is on value and income stocks but he covers growth occasionally.
He is a contributing author for the investing group Cash Flow Club where along with Darren McCammon, they focus on company cash flows and their access to capital. Core features include: access to the leader’s personal income portfolio targeting 6%+ yield, community chat, the “Best Opportunities” List, coverage of energy midstream, commercial mREITs, BDCs, and shipping sectors,, and transparency on performance. Learn More.
Analyst’s Disclosure: I/we 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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