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Cheesecake Factory Rides on Unit Expansion, Cost Woes Linger

Zacks Equity Research

The Cheesecake Factory CAKE banks on various sales building efforts, menu innovation, digitalization and expansion strategy. However, high costs associated with fluctuating consumer discretionary spending and intense competition from other restaurant chains are potential headwinds.

Shares of Cheesecake Factory have lost 17.2% over the past year against the industry’s 10.9% rally. However, earnings estimates for the current year have been revised 0.4% upward over the past 30 days. Let’s delve deeper into the factors that substantiate its Zacks Rank #3 (Hold).

Unit Expansion Drives Growth

Cheesecake Factory is making efforts to expand in domestic and international markets. As of Oct 1, 2019, it operated 289 restaurants throughout the United States and Canada under brands including The Cheesecake Factory and North Italia, and a collection within the Fox Restaurant Concepts subsidiary. Internationally, the company operates 24 The Cheesecake Factory restaurants under licensing agreements.

Of late, it is foraying into lucrative markets like the Middle East, North Africa, Central and Eastern Europe, Russia, Turkey, Mexico, Kuwait and Lebanon and Chile. In 2019, the company plans to open five company-owned restaurants — including the Gainesville, FL location that opened during the fiscal third quarter. Moreover, during the reported quarter, it opened its second restaurant in Abu Dhabi and debuted in Macau.

During the fourth quarter, it expects to open three additional locations and one North Italia restaurant. Management believes that the company has the potential to open more than 20 new restaurants — including as many as six Cheesecake Factory locations, six North Italia restaurants and eight restaurants within the FRC subsidiary — by 2020.

Strategic Efforts to Boost Sales

Apart from brand revitalization efforts, Cheesecake Factory is focused on menu innovation, operational improvement and creating a better customer service platform. On the menu innovation front, its Super Foods program has increased consumer awareness of brands. The company launched its brown bread in grocery stores in the Southeast with nationwide distribution capabilities. Going forward, the company intends to carry on with menu innovation by adding new Super Food items and the famous indulgences of The Cheesecake Factory.

Moreover, Cheesecake Factory’s technology-enabled initiatives bode well, with positive feedback on its mobile payment app, CakePay. The company entered into an exclusive national delivery partnership with DoorDash and expects to reap benefits from these collaborative marketing opportunities. Moreover, it is also witnessing incremental sales from its delivery service, which continues to roll out on a nationwide basis. DoorDash, in conjunction with BuzzFeed, introduced a channel named Tasty on BuzzFeed’s YouTube. Moving ahead, the company is set to grow the off-premise, online-ordering business via carry-out, delivery and catering. Resultantly, in third-quarter 2019, the off-premise business accounted for 16% of total sales.

Major Concerns

Higher costs remain a concern for the company. Pre-opening cost of outlets — given its unit expansion plans, expenses related to sales initiatives and higher labor expenses — is likely to hurt profits. In 2018, labor expense ratio was 35.8%, up 140 basis points (bps) from a year ago, primarily driven by higher hourly labor, including more wages, overtime and training costs. Also, in third-quarter fiscal 2019, the labor expense ratio was 36.4%, up 100 bps from the year-ago period. Other operating costs accounted for 25.5% of revenues, up 100 bps from the year-ago quarter. Moreover, the company projects food and wage inflation to be 2% and 5.5%, respectively, in 2020.

Key Picks

Some better-ranked stocks in the same space include Chipotle Mexican Grill, Inc. CMG Cracker Barrel Old Country Store, Inc. CBRL and Dunkin' Brands Group, Inc. DNKN, each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Chipotle, Cracker Barrel and Dunkin’ have an impressive long-term earnings growth rate of 19.6%, 10% and 9.8%, respectively.

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