Wall Street applauded P.F. Chang's
In fiscal 2007, revenue and earnings per share are expected to increase by 19% and 17%, respectively. Normally, you'd want to see EPS at least keep pace with revenue growth. Between operational improvements and share buybacks, EPS growth can often substantially out-gain the top line.
No such luck this year for P.F. Chang's. CEO Rick Frederico kicked off the call by pointing to several challenges that will weigh on bottom-line results. Increased pressure from labor and the cost of sales will squeeze restaurant margins this year. Cost of sales, for instance, will expand under commodity pressures from higher poultry and produce prices. Labor expenses will take a hit from a new partner incentive plan at the Bistro sites and minimum-wage pressures at both Bistro and Pei Wei.
Additionally, operating margins will be deflated by ongoing investments in finance, marketing, and technology, all of which will likely weigh on SG&A expenses. The investments in P.F. Chang's operations, however, should be a long-term benefit to the company.
For instance, the chief marketing officer the company hired in 2006 has been evaluating ways to improve marketing support for its Bistro and Pei Wei locations. The result: a new marketing initiative slated for later this year, which is expected to better support new markets and help determine the right level of marketing in more mature markets.
Pei Wei is forecasting $2 million worth of expenses as it tests various marketing and advertising strategies in 2007. According to Pei Wei President Russell Owens, "This is the investment we're making to become smarter about the most effective ways to drive sales for our concepts."
While $2 million is no drop in the bucket, it's good to hear that management expects immediate results from the expense. Owens indicated that every $1 spent on marketing should result in a $1 increase in sales. Investors will begin to notice the effect of these initiatives in the second quarter, and it will continue to accelerate through the remainder of the year.
Taking this year to invest in marketing makes sense. As the company continues to rapidly expand its Pei Wei concept, squeezing out the most sales from both new and existing markets is just good business smarts. Hopefully, improved marketing will lead to better same-store sales performance at P.F. Chang's Bistro segment in 2008.
Speaking of which, one analyst asked what goals P.F. Chang's would set for long-term comps growth, in order to offset continually escalating food and wage costs. Bert Vivian, president of P.F. Chang's, replied, "Historically, we've always said that if we can grow comps, give me a 2% comp year in, year out, I would be [a] happy man, because that would allow us to offset whatever pressures might impact our business."
That sounds good, but don't expect that 2% to happen this year. Bistro is experiencing a "tough" time so far this quarter and forecasting flat comps for the year. This forecast is particularly disappointing because it includes the effect of a fresh new menu, which also contains a 2%-to-3% price increase.
Still a growth story
Despite the sour performance from Bistro, there is a lot of sweetness to savor at P.F. Chang's. Between restaurant expansion opportunities at its Bistro and Pei Wei concepts, the company has two winning restaurant platforms with which to drive solid long-term growth. At roughly $125 million, capital expenditures this year will outpace 2006's spending, reflecting the ramp-up in Pei Wei unit openings. The company plans to open roughly 37 new Pei Wei locations this year.
In addition to these two proven concepts, P.F. Chang's hopes to crack open a new fortune in Taneko Japanese Tavern. The first location opened in the fourth quarter, and it's already surprised management by producing a higher average check from customers than previously forecast. However, the new concept has wrinkles to iron out, including becoming more accessible to a broader audience.
Investors should view 2007 as an important transition year for P.F. Chang's. The investments made to improve its operation, including those on the marketing front, will temporarily weigh on its bottom line this year. But the net effect of these marketing investments, which should act as a nice complement to the growth pursuits of its three concepts, should make P.F. Chang's that much more appetizing for long-term-minded investors.
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