U.S. Markets closed

Restaurant Stock's Breakout Has the Potential for Double-Digit Profits

Melvin Pasternak

With continued slow growth in the United States, many restaurants are fighting for customers.

The Cheesecake Factory (CAKE) -- a reasonably priced restaurant chain known for its generous portions and mouth-watering cheesecakes -- has won over diners' loyalty. The California-based company just reported better-than-expected fiscal first-quarter 2013 results with both revenues and earnings coming in well above analysts' expectations.

Due to international expansion, strong performance in new overseas units, and reduced food costs, the company is flourishing.

The Cheesecake Factory currently operates 174 restaurants, mostly in the United States. Management announced better-than-expected volume growth at three new overseas restaurants in the Middle East. In total, the company plans to open 8 to 10 new restaurants in 2013.

Lower product costs should also help boost profits. Management currently expects food cost inflation to be roughly 2.5% in 2013, down from previous estimates of 3%. Lower ingredient costs, coupled with cost-containment efforts, should help margins over the coming year.

A final positive is customer loyalty. In its most recent financial report, the company said surveys showed strong food quality and overall guest satisfaction scores.

From a technical perspective, CAKE stock appears strong.

CAKE Stock Chart

Rising off an October 2011 low near $23, shares have formed a major uptrend, climbing more than 70% to an all-time high of $41.02 on April 25.

In September 2012, CAKE peaked just under $36, but then retreated to support near $32, a level that was tested three separate times between October 2012 and January 2013. The third test in mid-February also saw CAKE probe the intersection of the major uptrend line and hold that key support.

Immediately after, the stock soared. An accelerated uptrend line formed, and by mid-March, shares reached the $38.50 range, and were briefly capped at this level.

However, this April 22 trading week, on upbeat first-quarter results, the stock broke through $38.50 resistance. In the process, shares bullishly broke out of a small ascending triangle marked by the intersection of the accelerated uptrend line and $38.50 resistance. This freshly broken resistance level should now mark support.

Trading near its all-time high, just under $40, CAKE has no overhead resistance and could move higher. According to the measuring principle for a triangle -- calculated by adding the height of the triangle to the breakout level -- the stock should reach a minimum target of $44.39 ($38.50-$32.61 = $5.89; $5.89+$38.50 = $44.39). At current levels, this target represents more than 11% potential returns. And with no resistance in sight, CAKE could go even higher.

The bullish technical outlook is supported by strong fundamentals. On Wednesday, April 24, Cheesecake Factory reported better-than-expected fiscal first-quarter results. With an increased number of customers, revenue increased 6.3% to $463 million from $435.8 million in the comparable year-ago period. Analysts expected revenue to be around $455.6 million.

For the upcoming second quarter, analysts project revenue will increase 5.2% to $478.2 million, from $454.8 million in the year-earlier quarter. Over the full 2013 year, analysts expect an increase in visits by restaurant goers to push revenue up 5.5% to $1.9 billion, from $1.8 billion last year.

In part, because of an expanded menu selection, comparable sales rose 1.4% from the year-earlier period. Quarterly comps have increased for about 15 consecutive quarters since 2009. Management anticipates full-year comparable store sales growth will rise 1.5% to 2.5% from 2012.

The earnings outlook is also upbeat. For the most recently reported first quarter, increased demand, coupled with higher profit margins, pushed earnings up 27% from the year-ago period to $0.47 per share, compared to $0.37 in the year-earlier quarter. Analysts expected earnings of $0.42 per share.

For the upcoming second quarter, management anticipates earnings will be in the range of $0.55 to $0.57 per share, an 8%-12% increase from $0.51 per share in the year-earlier quarter. Based on its plans to open several new restaurants in 2013, management's full-year earnings guidance is $2.12 to $2.18 per share, an increase of 13%-16% compared to $1.88 from last year.

In the first quarter of 2013, the company spent $42 million to buy back 1.2 million shares. Over the remainder of the year, management said it plans to use the majority of its free cash flow for additional share repurchases and dividends. Currently, the stock offers a reasonable forward yield of about 1.3% ($0.48 per share).

Risks to consider: Management is, in part, banking on lower food costs to ensure rising profits. An unexpected rise in commodity prices could affect margins. However, there may be some room to offset these increased costs with small, selective price increases.

Recommended Trade Setup:

-- Buy CAKE at the market price
-- Set stop-loss at $37.79, slightly below support marked by the rising accelerated trendline
-- Set initial price target at $44.39 for a potential 11% gain by the end of the third quarter of 2013

Related Articles

How I Collected an 8.7% Yield in Just Under 3 Months

Chart Says This Restaurant Stock Could Pop Within 2 Weeks

Quadruple Shareholders' Returns if This Stock Hits My Conservative Price Target