Cheesecake Factory Sliced

Based on "macro trends impacting the restaurant industry," the Calabasas Hills, Calif.-based company said it expected flat to slightly declining same-store sales and 12% revenue growth for the quarter ending July 4. The slumping forecast would make it the first time the company records consecutive same-store sales declines. Comparable sales figures for the quarter ended April 4 declined 1.6%.

Wall Street analysts expected quarterly revenue growth of about 13%, according to earnings tracker Thomson First Call. Quarterly earnings are forecast at 28 cents a share, a 2% drop from the same period a year ago. Analysts expect a 1% drop in earnings for the full fiscal year, predicting an average of $1.08 a share.

Fiscal 2007 estimates call for earnings of $1.31 a share, but Tuesday's news prompted Merriman Curhan & Ford analyst Eric Wold Wednesday to drop his fiscal 2007 estimate by a penny, to $1.32 a share from $1.33. It was the second time he's lowered his estimates on weakening sales trends in the last three months.

The company now operates 107 Cheesecake Factory restaurants and seven Grand Lux Café outlets and has a commercial baking operation that sells about 50 types of cheesecakes to other restaurants and retailers. Both chains are "upscale casual dining" restaurants. The average Cheesecake Factory check is $17, says Destin Tompkins, an analyst with Memphis investment bank Morgan, Keegan & Co.

Because the restaurant chain draws a wealthier diner than many other publicly traded chains, it was somewhat protected from the dip in spending caused by higher gasoline prices, rising interest rates and even higher minimum payments set by credit card companies, but that's no longer the case, he says.

"That's been one argument that CAKE has made in the past, that they do cater to a more affluent customer, who is a little more insulated from economic shocks," Tompkins says. "But there is a percentage of their customers that come from the middle- to lower-income consumer base. If even 10% of their sales base is impacted [by broader economic issues] then you're likely to see it. And even some upper-middle-class consumers are cutting their spending a little bit. They may not be cutting out the Friday night meal, but may be cutting out the Monday lunch."

The Analysis
Like a dedicated gourmand's waistband, Cheesecake Factory was a source of steady, sometimes remarkable growth, climbing almost 60% between the end of 2002 and the stock's all-time peak of $39.28, which it reached in early February.

Concerns over the pace and success of its expansion took a huge bite out of the company after that — the stock dropped 27.9% from Feb. 2 through Tuesday's close.

While management enjoys a good reputation on the Street, Wold has some doubts about CEO David Overton's menu for sustaining growth over time. Cheesecake Factory restaurants are industrial-sized, expensive to build, and most importantly, have saturated most potential primary markets to the point where same-store customer traffic has dropped for four consecutive quarters, he says. The vigorous demand for Chicken Madeira and a slice of White Chocolate Caramel Latte Cheesecake has worn off a bit, it seems.

"You've had a concept that's been very impervious for years, and it's starting to lose a little bit of its luster, a little loss of its bloom," Wold says. "Before, if you couldn't get in to eat dinner at seven or eight o'clock, people would come and eat at four or five o'clock. The weird, fringe dining hours are starting to dry up a bit and that's having an impact on profitability."

But the Grand Lux Café concept, now in place in Las Vegas, Chicago, Los Angeles, Dallas, Houston, Garden City, New York, and Sunrise, Fla., is too similar to the flagship chain, which prompts some skepticism by Wold over company projections of 250 Cheesecake Factory restaurants and 100 Grand Lux outposts.

"If the Cheesecake Factory [chain] has this much growth [potential], I'd rather they focus on this alone," he says. "Dividing up the market with another, similar concept, I think is a poor decision."

However, its track record encourages other analysts.

"The company is in sound financial condition" and has enough operating cash flow to fund any future expansion, wrote Michael Smith, an analyst with New York equity-research firm Oppenheimer & Co., in a note published Wednesday. "CAKE has an impressive record of driving sales; thus, while the company may be experiencing some weakness, we do not think it will last."

The Bottom Line
Future appetite for Cheesecake Factory shares may require investors to reconsider their diet and see whether the company still falls squarely into the growth-stock parameters that have nourished their portfolios.

Newer restaurants are opening either in established markets, possibly siphoning off some customers from existing restaurants, or setting their tables in cities that aren't providing the same returns, Wold says.

"You just have to start ratcheting down the size or the expectations for them," he says of the new outlets.

Tompkins, at Morgan, Keegan, says Cheesecake Factory may simply be turning a corner and becoming a more mature company. He says a set of new promotions and cost management measures, including lower prices, a new menu and reduced portions, is an appropriate approach, and not an overly aggressive course of action.

"David Overton has built one of the best chains in the business from a very small size," he says. "These guys have built one of the best brands in the industry and they know what they're doing. But it's going to be difficult to see them to continue to open up new units at the rate they have been and seeing the same earnings and returns on investment."

That's worth considering before loading up for another helping.