Fool on Call: Cheesecake Factory Banks On Expansion

Cheesecake Factory (Nasdaq: CAKE  ) is among the best restaurant concepts for squeezing the most dollars out of each site. Though, like anything, you can only go to the same well so many times before it's tapped out. The latest results suggest the restaurateur will now need to focus its attention elsewhere to drive growth and add value for shareholders.

In the third quarter, sales from restaurants opened for more than a year declined 1.6% compared to the same period a year ago. My Foolish colleague Ryan Fuhrmann hit it right on when he stated that it is "hard for comps to increase indefinitely." One might say it is impossible.

I also agree completely with Ryan's final analysis when suggesting that from here on, it will be "expansion opportunities" that drive shareholder value. We will pick up his assessment in this edition of Fool on Call. Utilizing Cheesecake Factory's latest quarterly earnings conference call, we will examine the following areas as they relate to the company's growth strategy:

  • Cheesecake Factory expansion
  • Grand Lux Cafe expansion

Filling out the markets
One of the qualities I find very appealing in the Cheesecake Factory concept is that it original enough to differentiate itself from other casual restaurants. O'Charley's (Nasdaq: CHUX  ) , Chili's by Brinker (NYSE: EAT  ) , Applebee's (Nasdaq: APPB  ) , Ruby Tuesday (NYSE: RI  ) , and Bennigan's all just kind of seem the same, but whether it is the restaurant decor or its monstrous menu, Cheesecake has set itself apart from the rest of the pack. Its distinctive quality will prove to be a major advantage when the company enters new markets that already have a strong presence from the aforementioned concepts.

Before addressing new markets, it is worth mentioning that Cheesecake still has plenty of opportunity for growth in existing markets. CFO Michael Dixon made it very clear in the call that filling out existing markets will be an important part of its expansion efforts, stating, "The strategy of capturing additional profitable market share in areas that we know very well and where our brand recognition is high has worked well for us and we will continue to maximize this opportunity in the future."

Look for the company to fill in existing markets with a slightly smaller version of the mammoth-sized Cheesecake Factory that most of us have become accustomed to; these newer sites average about 5% less "productive seats." The advantage of the smaller design is that the company can fit a restaurant to the size of "preferred sites" in high-traffic markets.

As for new markets, management is very pleased with the performance in such locations as Albany, Oklahoma City, and Omaha. These cities are smaller markets than where many of the concept's first 100 sites are located, but the results have been no less impressive, with sales averaging in excess of $250,000 per week in the first four weeks of operation.

If there were any doubts as to where Cheesecake was going to find growth going forward, Dixon removed them, stating, "We remind our investors that the majority of our expected revenue growth for the next few years will continue to come from the opening of new restaurants." In the fourth quarter it will open 13 new locations -- a record high for the company -- adding to the 126 sites already in the portfolio. In 2007, it will open an additional 21 locations, giving it an estimated 18% increase in square footage growth. Again, the bulk of these openings will come in the fourth quarter.

The openings carry costs, however. Management estimated that pre-opening expenses in FY 2007 will be 10% to 15% higher than in FY 2006, with the bulk of the increase attributed to the expansion of newer concepts; for the full year, FY 2006 pre-opening expenses are expected to be $24 million to $25 million. But, as Ryan Fuhrmann pointed out, Cheesecake Factory has a proven ability to generate strong cash flow from operations. So, while the higher pre-opening costs are noteworthy, they are not worth fretting over.

Management has stated all along that they believe the market can sustain 200 Cheesecake Factory operations. With 126 sites in existence today, there is still plenty room for growth. And given the recent success it has found in some of the smaller markets, my hunch is that we will eventually see that 200 target revised substantially upward.

Going uppity
Beyond the Cheesecake concept, the restaurateur seems to have identified another niche in the market with its new upscale casual dining location called Grand Lux Cafe. The concept blends the decor of European-style cafes with a more Americanized menu selection.

To date there are only eight Grand Lux Cafes in operation, all of them in prime markets, including New York City, Las Vegas, Chicago, and Los Angeles. Its newest site in Boca Raton, Florida averaged nearly $220,000 a week in sales during the first nine weeks in operation. Management is pleased with this figure considering the restaurant was opened without any brand awareness, and no promotions or advertising.

In FY2007 look for it to add five to six more Grand Lux Cafes, which would bring the total to about 14. Management believes the market can sustain approximately 150 Grand Lux sites, making it a significant growth opportunity for the parent company.

Table for two?
Are the growth opportunities at Cheesecake Factory and Grand Lux Cafe a compelling enough reason to dine with this business? Management will lay it out more clearly in the fourth-quarter conference call, but they indicated in the question-and-answer portion of this quarter's call that it is reasonable to expect approximately 18% square footage growth annually for the foreseeable future. When we consider that over the last two years, average sales per restaurant open for the full year were an industry-leading $11 million per year, I think there are plenty of reasons why Cheesecake Factory should be considered by prospective investors interested in this part of the market.

Bite into related Foolishness:

Fool contributor Jeremy MacNealy has a player rating of 85.61 and is ranked 2,337th out of 16,235 participants at Motley Fool CAPS, the Fool's new stock-rating service that's open to everyone. He has no financial interest in any company mentioned. The Motley Fool has a disclosure policy.


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