The Incorporated Cheesecake Factory (NASDAQ: CAKElisten)) is a casual dining restaurant chain that operates primarily in the United States. It operates restaurants under its namesake and other brands like North Italia, Flower Child, etc. By acquiring Fox Restaurant Concepts in 2019, CAKE added new concepts with more growth potential.
My previous article on The Cheesecake Factory dates from June 2020. I was then focusing on the issues of the coronavirus.
It looked like the stock price would recover quickly from there. The stock price exploded as the Reddit crowd targeted very short stocks. I sold my shares during this period because the valuation was becoming unreasonable. CAKE has come back down and is currently trading around the same price as in June 2020. A new significant risk has arrived: a possible recession.
Prospects for sustained growth
Over the past two years, corona has had a major impact on Cake’s revenue growth. First, the closures caused a sharp decline. In 2021, the company’s sales have recovered quickly, with offsite revenue remaining stable and onsite revenue rebounding.
The rapid recovery so far is promising and should continue. First quarter results and second quarter expectations confirm the rapid growth, with first quarter growth of 27% and a forecast of 9% in the second quarter. Analysts expect 15% growth to $3.37 billion in revenue.
7% annual long-term growth plan
Cake’s revenue grew by a CAGR of 4.63% from 2012 to 2019. The concept behind this growth is simple. It continues to open new restaurants which are quickly operating at the same level as existing restaurants.
Adding new units is an easy way to ensure long-term growth. The acquisition of North Italia and FRC was crucial for Cake’s growth rate to continue. The 7% growth rate seems a little too optimistic. Cake plans to open 15 to 16 restaurants in 2022, an increase of 4.8% to 5.2% of its total units. He was aiming for a few more units before. Supply chain issues delayed a few restaurants in 2023.
I like the 7% growth ambition, but I expect the units to grow a bit slower. Price inflation could push revenue growth above 7% over the next few years.
Free movement of capital
Free cash flow is crucial because a company can use it for its shareholders. Successful businesses must generate strong net income and similar free cash flow. Free cash flow is essential for redemptions and dividends.
Margins are still below pre-pandemic levels and management is targeting margins from the second half of 2019 to the second half of 2022.
The Cheesecake Factory converted around 5.3% of its revenue into free cash flow before corona. Its equity compensation is modest compared to the FCF.
Returns to shareholders
Cake has just reinstated its buyback program and a quarterly dividend of $0.27 per share. The dividend is lower than 2020, and I expect management to want some safety and room for growth.
Share buybacks and a growing dividend are signs of shareholder-friendly management.
FRC’s timing just before corona was unfortunate and degraded Cake’s balance sheet. It has already taken on debt to finance the acquisition and had to make up several loss-making quarters. It also raised cash through convertible debt to cover the covid-19 period. It increased shares outstanding by 8 million to 52.9 million.
The increase in debt is manageable. The long-term net debt is comparable to the debt after the acquisition of FRC. Its EBITDA is also recovering which reduces the leverage effect. It produced $190 million in EBITDA over the past twelve months.
I think valuations are important when buying stocks. Ratings help to see how the sentiment is currently affecting a stock. As Graham said, in the short term the stock market is a voting machine, but in the long term the market is a weighing machine.
CAKE traded at an average PE of 20.2 and an average EV/FCF of 17.8 from 2012 to 2019. CAKE’s growth profile has improved thanks to FRC and off-premises sales. On the other hand, it had to go into debt to acquire FRC. Suppose these factors balance out and CAKE deserves a similar valuation as in the past.
last six months
Cake looks cheap at the current stock price. The TTM P/E is still high due to some difficult quarters with (partial) shutdowns in 2021. Going forward, earnings should improve in comparison. It only trades at a PE FWD of 9.8, which is half of the pre-corona PE.
EV/FCF is also well below average at 13.1. This takes into account the increase in debt. Free cash flow still has some growth potential, and that multiple would drop further.
My price target
There are always several ways to look at a company’s potential “right” price. I think Cake’s past review is very relevant. I expect slightly stronger growth over the next few years. The current economic uncertainty is an opportunity to buy cheap stocks if you’re willing to wait long enough.
My price target is based on 2021 numbers, as 2022 is too uncertain to model. I expect an increase in FCF in 2023, which would likely increase price targets significantly. If the expected higher growth materializes, I might be overly pessimistic with my multiple targets. The “sell above” target implies a 50% rise in the current stock price.
Several risks beyond CAKE’s control could affect the stock. A resurgence of the corona could cause further blockages with a direct impact on CAKE’s income. A general economic downturn or recession would also negatively impact The Cheesecake Factory. However, it handled the 2008 financial crisis quite well.
Cake’s net income took a hit during the Great Recession. The company remarkably maintained a positive result and turned to positive free cash flow by suspending capital expenditures. This showed the company’s resilience during difficult times.
Increased leverage could slow dividend growth and share buybacks relative to the past. CAKE may also require higher capital outlays to fund its share growth. A slower capital repayment would require a larger discount on CAKE’s ratios.
The Cheesecake Factory is appealing on many levels. The stock price was punished too harshly as the company’s fundamentals improved. Long-term investors are getting a bargain with significant upside potential.
Growth over the next decade is expected to be relatively flat, as Cake’s revenue growth is expected to more or less follow its unit increase. I expect the market to revalue the stock as more quarters roll in, proving the stability of the business model, just as it has in the past.
The projected growth, reinstated dividend and redemptions at this stock price show that it is possible: you can have the CAKE and eat it.