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The Cheesecake Factory: Buy At A Discount

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About: The Cheesecake Factory Incorporated (CAKE), Includes: BLMN, DRI
by: Enterprising Investors
Enterprising Investors
Value, growth at reasonable price
Summary

The Cheesecake Factory is valued below average in comparison to peers and historical valuations.

The company pays dividends since 2012 and increased the dividend yearly.

Rising wages and recession fears are a big concern for the market. The Cheesecake Factory has been resilient to recessions in the past.

The Cheesecake Factory is a buy.

Cheesecake Factory Cake

Source: 2018 annual report

Value Left On The Table

The Cheesecake Factory (CAKE) is valued below average in comparison to peers and historical valuations. There are some risks like increasing labor costs that could keep the value low at the moment. If it could accelerate growth again, I would expect a higher share price.

The Cheesecake Factory used to be a very fast grower. It grew revenues from $438 M in 2000 to $2.101 M in 2015. This is a pretty impressive growth path, mainly accomplished by opening new restaurants. The total restaurants also grew from 41 to 200 in the same period. Since 2015, the growth of new restaurants hasn't been as fast though. The total number of restaurants expanded to 217 in 2018. This number includes its Grand Lux Cafe locations as well. This reflects in the revenue as well, only growing to $2.332 M. Further down, I'll paint a picture of the future restaurant openings.

Recently, the company announced the acquisition of Fox Restaurant Concepts (FRC) and North Italia. FRC covers a scale of restaurant concepts: Flower Child, Culinary Dropout, Blanco, The Henry, Zinburger, The Arrogant Butcher, Dough Bird, The Greene House, Olive & Ivy, Wildflower.

The Cheesecake Factory

The Cheesecake Factory is a famous upscale casual dining restaurant chain. It offers a large menu with freshly made dishes.

The Cheesecake Factory Incorporated is a leader in experiential dining. We are culinary forward and relentlessly focused on hospitality. Delicious, memorable experiences created by passionate people - this defines who we are and where we are going.

Source: The Cheesecake Company website

Opening New Restaurants At A Faster Pace

Looking forward, growth should pick up again with the acquisition of North Italia and FRC. These other concepts open up new possibilities for new restaurants. This differentiates its income and makes future growth easier.

North Italia and FRC are in the early stages of their expansion, just as The Cheesecake Factory used to be in 2000. CAKE's current number of restaurants is 294 in total. These operate under the following brands: 206 Cheesecake Factory, 14 Grand Lux Cafe, 2 Rock Sugar, and one Social Monk. They had these before the acquisition. CAKE also operates 22 North Italia restaurants and 49 of the Fox Restaurant Concept family. Based on these numbers, it plans to add approximately 6 Cheesecake Factory restaurants, 4 North Italia, and 10 other restaurants per year. This comes down to an increase of ~7% in restaurants per year, they also expect the same growth of revenue from these additional units.

CAKE, currently, operates 206 Cheesecake Factory locations in the U.S. and sees room for approximately 300 locations. North Italia only has 22 locations today and has a potential of 200 locations. This ensures continuous growth by opening new restaurants. CAKE doesn't specify the potential of the restaurants under the FRC concept.

Cheesecake Factory Growth

Source: CAKE Investor Presentation October

As mentioned, CAKE is valued low at the moment. I use the EV (Enterprise Value=market cap+net debt)/EBITDA ratio because EV includes debt and EBITDA excludes one-offs like write-offs. It has been valued at these levels before, but mainly traded at a higher level. As the growth picks up again, I expect CAKE will return to a higher ratio.

ChartData by YCharts

CAKE is at an interesting point; it can pick up growth and is valued below average.

Increasing Dividend Since 2013

CAKE started paying a dividend in 2012 as it became a more mature company. It has been increasing its dividend yearly at a pretty high rate. The quarterly dividend increased from $0.12 to $0.36. This is an impressive 17% yearly increase.

This did coincide with an expanding payout ratio as well. The payout ratio is about 63% at the moment. In the past, this ratio was only about 30%. It doesn't have as much room anymore to use a higher payout ratio to increase the dividend. Together, with the recent acquisition, this will probably slow down future dividend increases.

ChartData by YCharts

Buyback Programs Since 2007

Since 2007, CAKE spent quite a lot on share repurchase programs. In the first 3 quarters of 2019, it spent $50.6M on stock purchases as opposed to $60.9M in the first three quarters of 2018. This is a nice way to increase EPS and to return capital to shareholders.

Source: Quarterly Report November 2019

The share repurchases slow down due to the recent acquisition. The future growth of CAKE is more dependent on actually growing revenue and cash flows. CAKE does mention it wants to continue buybacks:

Cheesecake Factory Shareholder Return

Source: CAKE Investor Presentation October

International Expansion

Cheesecake Factory Shanghai

Source: CAKE Investor Presentation October

We project each international licensed location to contribute approximately $0.01 in annual earnings per share ("EPS"), on average, once the location has been in operation for a full year.

Source: CAKE 2018 annual report

This is one of the most interesting growth aspects of CAKE. It does its international expansion with reliable partners who get a license from CAKE. On average, each international restaurant adds $0.01 EPS without any capital investment. So far, international expansion has been going on in the Middle East, Mexico, and Asia as you can see on the map below.

CAKE mentions opportunities in other regions and with new partners could emerge in their presentations. There is nothing concrete reported at the moment.

Cheesecake Factory International Expansion

Source: CAKE Investor Presentation October

The recent developments in the Middle East could put a bit more pressure on the stock price since CAKE has a significant presence there. I don't expect a big impact, though.

Recession Fears Are Overstated

CAKE is a public company since 1994 and experienced two recessions since then: 2001 and 2008-2009. During both terms, the restaurant chain's results kept pretty steady. These are the results of 2001 and 2009:

Cheesecake Factory 2002 Results

Source: CAKE 2002 annual report

CAKE barely noticed the (short) recession of 2001. The share price kept pretty steady back then as well, only dropping about 20% of its highs and recovering quickly. This is logical because the stock market mainly digested the dot-com bubble back then. CAKE wasn't as inflated as some other stocks and its resilient results kept the stock at a decent level. 2009 played out differently.

2010 CAKE Results

Source: CAKE 2010 annual report

As can be seen, comparable restaurant sales dropped in 2008-2009. Due to the opening of new restaurants, the bottom line kept pretty steady. The revenue and cash flow stayed at a decent rate as well. I believe both 2001 and 2008-2009 show that CAKE can keep up decent results during a recession.

The company doesn't have a significantly higher debt today, so it isn't riskier now. The long-term debt reported at $335M in the latest quarterly earnings. This debt comes from the acquisitions. Before, they had close to no long-term debt. They comply with covenants accompanied with this debt:

We are subject to certain financial covenants under the New Facility requiring us to maintain (I) a maximum "Net Adjusted Leverage Ratio" of 4.75 and (II) a minimum ratio of EBITDAR to interest and rent expense of 1.9 ("EBITDAR Ratio")

Our Net Adjusted Leverage and EBITDAR Ratios were 3.3 and 2.5, respectively, at October 1, 2019, and we were in compliance with all covenants in effect at that date.

Source: 2019 third quarter 10-Q

The stock reacted pretty hard in 2009 and went from a high valuation to historically low valuation. It's impossible to predict how the share price would react during another recession. I think it's a good sign that results kept steady, which would restore share price as well at some point.

ChartData by YCharts

Comparison To Peers

I'm going to compare CAKE to Darden Restaurants, Inc. (DRI). Darden is active in the same segment as CAKE and also carries little debt. It's a larger company with these brands: Olive Garden, LongHorn Steakhouse, The Capital Grille, Eddie V's, Cheddar's Scratch Kitchen, Yard House, Seasons 52, and Bahama Breeze. Darden's management and analysts expect a slightly higher growth than CAKE. This supports a higher valuation at this point as well. I do, however, believe CAKE's value is lagging too much. Depending on which metric you use there is a difference of about 20% to 30% difference in valuation.

So, let's take a look at some key stats and compare them historically.

ChartData by YCharts

I use the EV/EBITDA ratio again. It's an easy ratio to compare similar companies in valuation. This shows, historically, Darden and CAKE had a more or less similar valuation. Over the past few years, CAKE has been lagging in comparison. It's not at an all-time low but looks pretty good in the current market. When the EV/EBITDA returns to 10, this implies a share price increase of ~25%. This still leaves a gap of ~15% in value against Darden.

Bloomin' Brands (BLMN) is another restaurant stock active in the same segment but does carry more debt. This makes it a tougher comparison. Bloomin' also seems priced low. The EV/EBITDA of 7.03 is lower than CAKE's EV/EBITDA of 8. It does have a much lower dividend yield because of a higher debt. Its debt also adds risk.

ChartData by YCharts

Risks

The risks with CAKE are pretty well-known on Seeking Alpha. It has a significant amount of labor costs that are increasing. I don't see this as the biggest risk for CAKE. Competitors also have to cope with these increasing costs and should adapt prices as well. In the past labor costs fluctuated as well, CAKE didn't have problems adapting then.

Consumer behavior changes, which could have an impact on traffic at their mall locations. There is a lot of talk about the retail apocalypse that is going on. This retail apocalypse impacts many malls. CAKE is mostly located in A-malls, which suffer less. CAKE is often a destination for customers. The restaurants often have a separate entrance. This makes them less dependent on overall mall traffic. In the long term, CAKE could change locations if necessary. The company isn't obliged to stay in malls forever and people would still go out to eat and have a nice evening.

There is also a shift to more home delivery. People like to stay in and eat instead of going out and spend more time at a restaurant. CAKE offers home delivery in cooperation with DoorDash. In this segment, a lot of people will also continue to prefer to be served at a restaurant.

Conclusion

CAKE is valued cheaper than its peers or its history. It increased the dividend pretty fast since 2013, and I expect this will slow down due to the higher payout ratio and the acquisitions. The share buyback program will continue with a smaller amount. I believe there is upside potential for CAKE.

The acquisitions will contribute to the growth of the top and bottom line. They unlock the potential to open new restaurants at a faster rate. The return to a higher growth path implies a return to higher multiples as well. As I have shown a recession doesn't necessarily have a large impact on results. CAKE is buyable at this price.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CAKE over 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.