The Cheesecake Factory (Nasdaq: CAKE). Just the name sounds delicious. This upscale, casual restaurant chain has been extremely popular almost since it first opened its doors. If you have not had a chance to sample from the diverse menu, I suggest you do. Generous servings and delicious desserts -- let's see if the company is just as tempting as an investment.
The company operates 104 restaurants nationwide under The Cheesecake Factory name, usually just one per metropolitan area. It operates in 29 states and D.C. It has been slowly growing over the years, using cash flow instead of debt. More than 60 restaurants have opened in the last four years; most openings occur in the second half of each year. Management has said that it's targeting about 200 total locations in the U.S., and it expects to open about 21 locations this year. It also operates seven Grand Lux Cafe restaurants, as well as providing fresh-baked desserts for the restaurants and various suppliers through two bakeries. More than 94% of revenue comes from its restaurants.
That revenue comes in at quite a pace -- about $11 million per restaurant per year, for those open more than a year. There is an average of 12,500 productive square feet per restaurant. Within all that acreage, the restaurants provide a choice from among 200 menu items for lunch and dinner and more than 40 varieties of cheesecake. They are developing a strictly Asian menu and plan to implement it in some locations sometime in 2007. While I have been to several locations, some more than once (ahem), I haven't begun to take full advantage of the selection.
With its careful, slow expansion strategy, Cheesecake Factory is able to find prime locations, keep demand up (every time I go, the place is crowded), and stay out of debt. Essentially, all of its free cash flow is used to open new locations (capital spending slightly outpaces operating cash). Once a restaurant reaches maturity (two to five years), it expects to have a 2-to-1 ratio of sales per year to net cash invested, and returns of 30% to 40% per year.
Competitors include Outback Steakhouse (NYSE: OSI); BrinkerInternational (NYSE: EAT), which operates Chili's and On The Border Mexican Grill; and Darden Restaurants (NYSE: DRI), which operates Red Lobster and Olive Garden. You should also include P.F. Chang's (Nasdaq: PFCB) in that group.
Per the company's most recently available earnings report (from Capital IQ), Cheesecake Factory posted operating cash flow of $165.2 million for fiscal 2005 and capital spending of $170 million. This number is a bit deceiving, because the company funds all of its restaurant openings with cash. Fortunately for our purposes, the company breaks out its expansion/maintenance capital spending allocation, which appears to be somewhere in the vicinity of 80/20 -- making free cash flow net of expansion-related costs about $131 million. I've opted to value the company based on open locations, because, being conservative, we cannot reasonably expect that future locations will achieve similar success going forward. Based on some fairly conservative assumptions of price increases, traffic growth at existing locations, and reasonable comps, I get a $26 price tag. It seems a bit pricey, but I wouldn't let this scare you straight away, because this may well underestimate the growth to be achieved by future openings and the potential its Grand Lux concept holds.
While there are fads in restaurant popularity, this restaurant seems to be just as popular now as it was five years ago. The company has been slowly, steadily growing over many years. In addition, the stock price has been on a steady, relatively smooth rise since about 1997. While the above valuation indicates the current price is too high, be aware that it is quite conservative, assuming no future openings, something that probably is priced into the current level. If management can continue as it has, remain out of debt, and keep the menu fresh, this could be a worthwhile investment, even if it's overvalued by my conservative estimate. It certainly merits more research, including tasting some of that cheesecake.
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For a taste of what others are saying, see the Fool's discussion boards for Cheesecake Factory, Darden Restaurants, Brinker International, and P.F. Chang's.
Fool contributor Jim Mueller likes to visit his local Cheesecake Factory every couple of months. He loves the grilled shrimp and bacon club sandwich. He does not own shares in any company mentioned, all according to the Fool's disclosure policy.
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