Why The Cheesecake Factory Inc Shows Tasty Potential

It isn't easy to get a table at most locations of The Cheesecake Factory (NASDAQ: CAKE), a strong sign that the restaurant chain operator's business is thriving. The company tries to ensnare wealthier consumers, and judging by the wait times at its locations, this is the right approach to take.

Granted, the stock has traded down over 7% since releasing its third quarter results, likely due to a weaker-than-expected top line. Investors shouldn't be concerned about this, however. In this video segment, Motley Fool analysts Vincent Shen and Sean O'Reilly discuss The Cheesecake Factory's latest earnings report and what investors should expect going forward.

Listen to the full podcast by clicking here. A full transcript follows the video.

Vincent Shen: There's two companies I want to talk about in particular for the restaurant industry. Those being The Cheesecake Factory...

Sean O'Reilly: You really like your high calorie meals, don't you?

Shen: I look at this company as having recovered very well compared to some of the other companies in the sector since the financial crisis. It's developed this leading brand and dining experience that has resonated very well with upper-middle class consumers.

O'Reilly: My family and I went to the location in Clarendon over the weekend. Forty-five minute wait, place was hopping; it was nuts.

Shen: Yeah. Most of the times I've tried to go there, there's usually a wait. If you go there on a Friday night, for example, you can expect a nice, long wait.

O'Reilly: Game over. How did they do this quarter?

Shen: Revenue came in at about $526.7 million, which is up 5.5% year over year. Their same-store sales growth was also up 2.2%. Definitely positive. Adjusted earnings per share were about $0.59. That's actually up from what the gap EPS would have been.

O'Reilly: [...] to the bottom line, it looks like.

Shen: Exactly. It took a write down of about $6 million on their RockSugar Pan Asian concept.

O'Reilly: I've never heard of that. Have you ever been?

Shen: No. They only have one of those.

O'Reilly: They're clearly throwing in the towel on that one.

Shen: Adjusted at $0.59 per share, that's still a 23% bump year over year. That's very strong on the bottom line. That represents -- at least on the same-store sales front -- 23 consecutive quarters of same-store sales growth. Like I said, that recovery has actually taken place very strongly since the financial crisis.

O'Reilly: The results sound pretty good, yet we don't care about short-term stock prices; but just for the heck of it, we'll talk about it. The stock was down 5% after the release. What gives?

Shen: This morning we came in, it was down 5%. Ultimately, I think on the bottom line people were pretty happy, but on the top line, it fell short of estimates. We're not concerning ourselves with that too much. Overall, you've got to keep in mind that the stock's declared a $0.20 per-share dividend. Yield was 1.5%, and that's not bad at all.

O'Reilly: The profit number was awesome. Did you catch why it was a bigger check size, or more people? Did they even break that out?

Shen: I did not see that in the report. In terms of breaking down their costs a little bit, across the restaurant industry, labor costs have been going up. This is going to impact the other company that we talk about, as well. They were able to hold that steady. Their cost of sales, they actually brought it down 100 basis points from the quarter a year ago. Overall, I think their operating margin was still about steady. They were still able to deliver that earnings growth. It was strong.

O'Reilly: Looking forward, what about the longer-term outlook for the company's expansion? They do have restaurants in every major city now. What's the deal there now?

Shen: There's been guidance -- just giving you the numbers -- they had a midpoint of about $2.62 in earnings per share for fiscal 2016. That puts the company trading at about 20x their forward earnings. That's not too bad.

O'Reilly: Pricey, but not crazy.

Shen: Exactly. It's in line with what the stock has traded at pretty recently. I'm glad you brought up overall expansion. It's very interesting the way their business operates because, overall, they're very selective in terms of where they open a new location.

O'Reilly: You need a certain population density, traffic...

Shen: It's not even that. It's really about what kind of customers they want, and where they want them. For example, they'll often target what is considered the "top tier, class A" malls. These malls will have anchor stores that are stronger than a J.C. Penney's, or a Macy's that has struggled in the recovery. They'll target a Nordstrom, or Bloomingdales. We're talking about overall wealthier customers who have done much better in the recovery since the financial crisis, who are OK opening their pocket books to go out to eat.

O'Reilly: They have disposable income. End of story.

Shen: Cheesecake Factory gives them the consistency of a chain-restaurant experience, but also that more upscale dining feel. They're targeting that market very selectively. Overall, management thinks they can sustain about 300 restaurants.

O'Reilly: In America.

Shen: Yeah. Right now, they have about 194 total. That includes some of their Grand Lux Cafe, which is around 12 restaurants, but most of them are Cheesecake Factories. They're also expanding a bit through licensing agreements abroad, so they have new locations coming in Mexico, in the Middle East, Lebanon, and Kuwait.

O'Reilly: I don't know this for a fact, but I bet money there's one in the UAE.

Shen: They're also going to open their first one in China soon. I'm sure that will be big for them as well.

O'Reilly: Oh, yeah. I'm sure it will be huge.

Shen: That's early stage, I think they have 11 locations abroad. I'm sure that's going to be a big part of their expansion opportunities.