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The Cheesecake Factory:
A Compelling Investment Opportunity

Douglas Gerlach, Editor-in-Chief, Investor Advisory Service, has not featured The Cheesecake Factory (Nasdaq: CAKE) in some time but says the company’s current opportunity is worth a closer look.

“This casual dining restaurant continues to enjoy a loyal following due to its differentiated concept and unique guest experience. Substantially all menu items are prepared from scratch with high quality, fresh ingredients. The restaurant is part of the social consciousness, featured in popular songs and on reality television, while boasting a meaningful presence on social media. Comparable restaurant sales have consistently outpaced those posted by the casual dining industry overall.

The company’s typical restaurant is 8,000-12,000 square feet and possesses a highly distinctive interior décor. It bakes several varieties of cheesecake and other desserts in its own bakeries. The average guest check is moderate at approximately $23, and average unit volumes are about $10.7 million per restaurant. Off-premise dining accounts for a growing percentage of sales, totaling 16% of sales in the most recent quarter. Management has highlighted off-premise dining as a significant growth opportunity in the near term given secular trends. Notably, the company recently extended its exclusive delivery agreement with DoorDash, under which delivery economics improve for Cheesecake.

There are currently 195 Cheesecake Factory restaurants in the U.S. versus an expected opportunity for 300 domestic locations. With long-term targeted 3%-4% unit growth, this leaves several years of expansion ahead in the U.S. Additionally, management has pointed to the opportunity for 8-10 Canadian locations and substantial whitespace for licensed locations internationally. At the end of 2019, the company had over 30 locations internationally under licensing agreements.

Though Cheesecake Factory restaurants are popular and possess ample opportunity for further growth, in July the company came to an agreement to acquire both North Italia, an upscale, casual restaurant in which it already had a minority investment, and Fox Restaurant Concepts (FRC). North Italia should serve as a key new growth vehicle, while FRC should also add to growth while serving as an incubator for future concepts. Additionally, the acquisitions help diversify the concepts to which the company has exposure. Total consideration for the acquisitions was approximately $440 million. Excluding integration expenses, the transactions are expected to be approximately neutral to EPS in 2020 and accretive thereafter.

North Italia currently has 21 restaurants with expected annual unit growth of over 20% and the potential for 200 domestic locations. Current run rate revenue for North Italia is approximately $150 million, which alone contributes a mid-single digit percentage increase in overall revenue for Cheesecake. Comparable restaurant sales growth for North Italia is also better than the flagship Cheesecake Factory restaurants, running in the mid-single digit range. North Italia boasts strong unit economics, generating approximately $7 million in sales per restaurant with restaurant-level margins and cash-on-cash returns superior to The Cheesecake Factory.

FRC is a collection of unique concepts, operating 45 restaurants across seven states and Washington D.C. FRC’s current run rate revenue is approximately $250 million. Management believes there is potential for 20% annual unit growth for the aggregate FRC portfolio. While restaurant level economics for FRC are not as good as North Italia, they are comparable to The Cheesecake Factory.

The addition of North Italia and FRC will help accelerate unit growth from approximately 3% in recent years to closer to 7%. This should help Cheesecake return to mid- to high-single digit topline growth versus more modest results of late. The desire of management to reignite growth and diversify its offerings is easy to understand, but it is worth highlighting the risk associated with these newly acquired concepts. The casual dining business is highly competitive and if the acquisitions do not achieve their planned potential it would put a significant dent in the growth story for The Cheesecake Factory. It would also raise questions from investors as to why management chose to invest behind emerging concepts when the alternative was to increase investment to grow the presence of one of the best-loved concepts in casual dining, The Cheesecake Factory.

Earnings this year have been negatively impacted by acquisition costs, which have held back EPS growth. Five years of 10% compound earnings growth could lead to EPS of $3.83. Multiplying that by a high P/E of 20 (a discount from the observed average 5-year high P/E of 25.1) results in a high price of 77. Applying a discounted low P/E of 15 to trailing earnings of 2.35 results in a low price of 35. The upside/downside ratio is 5.2 to 1.”

Editor’s Note: The Investor Advisory Service (IAS) is one of the nation’s top-performing stock investment newsletters. IAS has outperformed the market over the last 10- and 20-year periods, making it one of the top-ranked newsletters for consistent long-term stock market performance. The Hulbert Financial Digest named Investor Advisory Service to its Investment Newsletter Honor Roll for the ten years (2010-2019).

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