Cheesecake Factory in Trouble or Not?

Last week, Yahoo Finance reported that The Cheesecake Factory Inc.'s profits fell 46% for 4th quarter 2008. Today, they closed at $8.09; one of worst performing stock performance behind Brinker International (EAT) and P.F. Chang's China Bistro (PFCB) but ahead of Morton's Steakhouse (MRT) and McCormick and Schmick (MSSR). Compared with S&P 400 MidCap index, the NASDAQ Composite (US) index and the Nation's Restaurant News Stock Index with a 2002 base year, Cheesecake Factory's stock performance is a D. And yet, they are registering record sales. Revenues are up +14.43% a year since 2003 inspite of a bad economic environment. So what's up!

In 2008, their revenues increased due to two price hikes of 3.0% in December 2007 and of 1.5% in December 2008. They also opened 16 new Cheesecake Factory locations and 5 new Grand Lux Cafe in 2007 plus, 6 Cheesecake units, and 1 Rock Sugar Pan Asian Kitchen in 2008. New store openings add sales that could not have been there the prior year.

But this expansion came at a cost. Labor expenses jumped from $240 million in 2003 to $492 million in 2007, a 15.44% annual average increase. This is due essentially to new restaurant openings and successive increases in minimum wages which impacted 2/3rd of the 200-250 staff unit. General administrative expenses increased by 17.33% during the same period. So, sales did increase but in a manner that is not sustainable in the long run.

At the same time, the Adjusted Net Working Capital plummeted from $123.9 million in 2006 to $-28.5 million in 2008, while the long term debts and landlord liabilities sky rocketed from $26.9 million to $226.5 million. This means that while the money to run their operation lowered by $150 million, their long term debt inflated by about $200 million. They are due in 4-5 years.

So now what? Well, while the company has reported positive growth for 2008, it has engaged itself in a performance decline that might become irreversible by 2012 and catastrophic by 2016. In my opinion, they ought to halt new spending and new constructions now and, abandon the new concept Rock Sugar Pan Asian Kitchen, in order to focus on labor and administrative cost control.

Another issue is that the menu features close to 200 items. This presents the advantage that their food cost is relatively independent from food price increases but imposes on them to have a huge, difficult to manage inventory. A large inventory means extensive labor to monitor, order and control waste but also in terms of staff training. With 60 entrees on the menu, the largest of any restaurant I have ever been to, it takes a new employee three weeks to learn. Most full service restaurants feature 17-35 main dishes such as Applebee's, Ruby Tuesday's and Denny's.

Dinner entree pricing fluctuates from $12 to $32, with a guest check average of $17.50 for 2007 and an estimated $17.75 for 2008. To give you points of reference, on the low end they would be attracting Denny's and Bakers Square customers and, the high end they are targeting Weber Grill and Gibson's. It is pretty much the entire full service restaurant business as defined by the NAICS 722110, the United States Government business classification standard. But you can't appeal to everyone, it's too combursome and not cost effective.

The average price of a dinner at Cheesecake costs $18 and the guest check average is $17.75. This could mean four things. (1) that your menu pricing is too expensive for the customers you are actually attracting or, (2) your typical guest only orders one dinner and nothing else or, (3) the people who you actually cater to only purchase your low end items or (4) that your high end meals are not appealing. For this price, one could get a better value at Olive Garden, Ruby Tuesday's and Applebee's. Either way this is defnitely a long term problem for TCF.

By eliminating the 10 least profitable appetizers and the 20 least popular entrees, the company could be saving $3.8 million in direct labor cost, $0.5 million in direct management labor and $4.0 million in indirect labor cost nationwide. That's about $8.3 million a year. Plus another 5% increase in hourly productivity would generate another $26 million in savings. This would be enough to compensate for the decrease in Adjusted Net Working Capital.

Furthermore, the 19-page / 27-section menu includes Mexican, Thai, Vietnamese, Italian, Chinese, Classic American, Jamaican, Louisiana, Japanese, Southwestern, Hawaiian and Barbeque inspired dishes. You can enjoy anything from a simple fare like a burrito, a burger or a meatloaf to more refined ones such as the Herb crusted Salmon Salad, the succulent filet mignon or the exotic Asian Charbroiled Ahi drizzled with a soy-ginger glaze. But the menu is not defined, it's everything and nothing in particular while being difficult to navigate. If you have a specific taste in mind for tonight, you would need at least twenty minutes to digest this first, while your date would be just as puzzled or annoyed. This menu could use some workout and serious fat trimming.

I went to the Schaumburg location three times in three months with a disappointing result. I neither enjoyed the wait nor the service. Then visiting several blogs and websites such as Yelp, I found that the large majority of guest feedback is that they wouldn't go back to the Schaumburg location anytime soon. A typical wait time on weekends has been 1 1/2 to 2/1/2 hours plus 1/2 hours to read the menu and another 1/2 hours for the dinner to come. It is more than most people are willing to endure when going out with friends or dates.

In Illinois, the company operates five Cheesecake Factory units, including one in Schaumburg and, one Grand Lux Cafe. The local restaurant is at: 301 Woodfield Mall, Schaumburg 60173, (847) 619-1090 . Their hours of operation is: Monday - Thursday 11:00 Am - 11:00 Pm, Friday - Saturday 11:00 - 12:30 Am and, Sunday 10:00 Am - 10:00 Pm.


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Sources:

1. http://biz.yahoo.com/ap/090213/cheesecake_factory_ahead_of_the_bell.html?.v=1
2. http://media.corporate-ir.net/media_files/irol/10/109258/ekit_08/AR_07.pdf
3. http://finance.yahoo.com/q/bc?s=CAKE&t=2y&l=on&z=m&q=l&c=PFCB,DRI,MSSR,EAT