Tag Archives: CAKE




The summaries we show, while not complete in detail and involve a number of approximations, provide a good starting point for our own investment banking activities and will hopefully do the same for our readers.

























We published an analysis on October 22nd, showing almost all the publicly held restaurant companies, comparing their current valuations to those before the pandemic. That chart is provided below, with prices updated to midday on 11/17. Based on the 2/15/20 (pre-pandemic) estimate of 2020 earnings, and today’s estimate of 2021 earnings, it appears that Cheesecake Factory (CAKE) is substantially overvalued, which suggests that CAKE is somehow in a much better fundamental position coming out of the pandemic than going in. The stock is within 10% of its high, but the current consensus estimate for 2021 of $1.58 per share is very much below 2019 results and expectations back in February.

Let’s take a fundamental look at CAKE. Back on February 15th, CAKE was selling at about $41/share, with earnings expected in calendar 2020 in the area of $2.85/share. Trailing EPS, for calendar 2019, had been $2.61/share. This premier operator of large box restaurants (206 CAKE restaurants at 12/31/19, with 39 in CA, 19 in FL, 16 in TX) averaging over $10M per unit (almost 1,000/sq.ft.  has had several years of relatively flat operating results. Comp sales, as shown just below, have been slightly positive, with traffic, adjusting for price, slightly negative:

The table below, from Bloomberg LP, shows the historical EPS trend, as well as the current 2021 consensus EPS estimate, obviously still restrained from working through the pandemic burden.

It should be noted that while Cheesecake Factory Restaurants are the heart of this business, CAKE operates an additional 88 restaurants under the names North Italia, Grand Lux Cafe, Rock Sugar, Social Monk Asian Kitchen and Flower Child.   CAKE also operates two bakery facilities that supply their own restaurants as well as third party customers.  As you can see from the summary financials below, Income From Operations declined over the five years ending 12/19, from $165M to $106M. However, the steady cash flow from operations, combined with an increase of $200M of long term debt (to $290M) allowed the Company to shrink the fully diluted shares outstanding from 50.6M to 44.5M. This process, along with a lower tax rate, allowed earnings per share to do better than Income From Operations or Pretax Earnings.

In addition to the summary results just above, it is relevant that, between 2017 and 2019, Cost of sales was reduced by 40 bp to 22.6% of sales, Labor increased 190bp to 36.3%, Other Operating Costs increased by 110bp. Income From Operations decreased 260 bp to 4.2%, obviously reflecting the deterioration in store level margins.

Having pointed out the above lackluster sales trends and deteriorating profit margins, it cannot be ignored that CAKE restaurants serve the broadest menu in the industry, provide an outstanding value of food and service, and consistently receive very high marks in terms of customer satisfaction. Sales of just below $1000 per square foot are unmatched by any large scale casual dining chain. The Brand’s reputation, in the eyes of customers, is far from diminished.


In terms of cash flow in 2020 and the current balance sheet : the Company took the necessary steps during the heart of the pandemic to assure adequate liquidity. Between 12/31/2019 and 9/29/20, cash increased from $58M to $243M (an increase of $185M, supplied by $200 of convertible preferred stock and an $86M increase in long term debt to $376M).  Cash Generated By Operating Activities  in the thirty nine weeks was a negative  $33M. Management indicated on the conference call that $96M was repaid on the credit line in October out of the 9/29 cash balance, bringing the long term debt balance back to $290M.

Same store sales at Cheesecake Restaurants were down 23.3% in Q3, a lot better than the 56.9% decline of Q2. There was a Loss from Operations of $34.9M, much better than the $83.7M of Q2.  Store level EBITDA margin of 7.8% was also much better than the negative 7.0% of Q2. Most importantly, comps improved sequentially throughout the quarter, from down 32% in July to negative 10% in September, and  running through October 27th at a negative 7%. There are lots of operating details we could provide, but the most important takeaway seems to be that the off-premise effort has apparently been retained even as dining rooms have reopened. Management expressed their confidence that this enlarged off-premise effort can be largely sustained, and the 35% flow through of cash from the incremental Q2 to Q3 sales can be sustained as sales build further. Management guided on the conference call to positive operating profit in Q4, with positive EPS after a 10% tax rate. Looking toward 2021, management indicated that commodity inflation would be about 2%, and wage rate inflation might not be quite as difficult as in recent years. Overall, management seemed to hold out hope that store level margins could be back to pre-pandemic levels (approximately double the 7.8% of Q3),  even at something just short of matching year ago sales (a 95% comp). This seems to be based on their confidence that off-premise sales can be maintained, better margins can be produced by call-in and online ordering (more than offsetting lower margins for deliveries) and labor inflation will be 1-1.5%, rather than the recent 5.5-6.0% annual increase. While we can’t forget that 18% of the Cheesecake restaurants are in lockdown challenged CA, that’s been the case already in the reported numbers and presumably included in management guidance.


Putting it all together, we believe Cheesecake’s fundamentals are within reach (a year or so) of achieving pre-pandemic sales and margins. A large part of our consideration is the newly built satisfaction level of off-premise customers. We also consider that CAKE is in a class by themselves in terms of providing a very broad menu of well prepared food at compelling prices. We don’t doubt that their packaging and service, off premise,  is among the best within casual dining, and the possibility exists that off-premise can be largely sustained even as dine-in rebuilds. It therefore wouldn’t be shocking if two years from now, the AUVs are 10-20% higher than just before the pandemic, and operating margins could return to levels well above 2018 and 2019. Considering that the recovery is well established, CAKE’s operating skills are second to none, and an important new venue is now available to be served from existing facilities, CAKE shares are reasonably priced relative to their peer group.

Roger Lipton




There are 294 total company operated restaurants in US and Canada, @ 12/31/19,  including 206 Cheesecake Factories CAKE, 23 under the North Italia brand, 50 within Fox Restaurant concepts, 13 under Grand Luxe Café, 1 under RockSugar Southeast, and 1 under the Social Monk Asian Kitchen brand. The Fox Concepts and North Italia comprise 28.3% of 12/19 assets and 3.7% of consolidated revenues (or only about $90M, as North Italia and the remainder of Fox were completed on 10/2/19). There are also 26 CAKE restaurants operating internationally under licenses, as well as the bakery subsidiary.  Comps for Cheesecake Factory restaurants, for the two months ending 5/31, were down 63%, including 87 full or partial closures. Stores that are opened without dining rooms are doing about $4M annualized.

It is worth noting that off-premise activity represented 22% of Q1 sales, more than at most of their full service casual dining competitors, a solid base on which to build. In April CAKE amended their credit line with covenant relief, reduced operating costs, suspended the dividend and stock repurchases, and raised $200M from a convertible preferred equity raise. The cash balance was $260M as of 4/30.

As of  6/2, CAKE has reopened about 25% of all 294 (that would be about 73 locations), of which 34 are Cheesecake Factories  (out of 206), restaurants under COVID-19 capacity restrictions. They hope to have 65% of dining rooms opened, with limited capacity, by mid-June. They began reopening dining rooms the second week of May. The (17% of) Cheesecake Factories that have so far opened their dining rooms  have recaptured about 75% of last year sales average. Stores that are opened without dining rooms are doing about $4M annualized.

We suspect that the 17% (34 of 206) Cheesecake Factories that have opened are those most easily accessed by today’s stay at home customers. Time will tell how successfully average sales will build as the system openings proceed. Recovery of profit margins will be inhibited by delivery expenses and increased packaging costs, like everybody else, and also by fewer high-margin drink sales.

Also, while Cheesecake Factory is clearly the dominant brand within the portfolio, other than pointing out that North Italia has a lot of growth potential and Fox is an incubator of new brands, there has been no update on how they are doing. They do, after all, represent 28% of corporate assets and hundreds of millions of dollars of annualized sales (as of Y/E ’19).


CBRL reported its financial results for the third quarter ending May 1, 2020 and provided an update relative to COVID-19.  For the third quarter of fiscal 2020, through April, all 664 Cracker Barrel stores remained open, comp restaurant sales declined 41.7% and comparable store retail sales declined 45.5%. However, all stores were operating in an off-premise-only model with no dine-in service from late March through late April, with incremental dine-in openings initiating thereafter. It is noteworthy that off-premise sales only represented 9% of the mix prior to COVID-19.  A relatively old customer base, with breakfast representing 25% of sales, are relevant factors in the rebuilding process.

Since the end of Q2, the table above shows the weekly progress over the last four weeks for all comparable stores. The Company points out In the week ending May 29, 2020, when compared to the comparable period in 2019, comparable store restaurant sales for stores with limited dine-in service For the full week (434 out of roughly 664, about 2/3 of the system) decreased approximately 32% compared to approximately 76% for stores that were limited to an off-premise-only business model.  The Company points out that, as of 5/29, 505 stores had limited dine-in service, and the Company expects that substantially all stores will have limited dine-in service by the end of June. It can be expected that the system restaurant comps will move closer to the negative 32%, and hopefully improve from there over time.  Retail comps have been steadily improving and will presumably move higher as restaurant activity brings more customers inside.

CBRL had a strong balance sheet ahead of the pandemic, has not raised equity capital but drew down its full revolving credit line in Mid-March and net debt to trailing twelve month EBITDA rose to 2x as of 4/30/20, vs. 1x three months earlier.

Once again, however, a negative 32% or 22% or even a negative 12% doesn’t bring profitability back to previous levels.  Labor is higher, protein is costing more (at least temporarily) and sanitizing efforts provide an additional expense line.


Prior to their June 1 release, the Company had provided a Q1 (3/31) updates, with subsequent events as well. They indicated that off-premise revenues had tripled from 14-15% of sales to 45-50% of (old) sales, roughly 20 percent of that from delivery.  Online ordering was 45% of off-premise activity, compared to 18% before the pandemic. The weekly burn rate was $200,000 by end of May, compared to $500k/wk in April. They had cancelled non-essential capex, temporarily suspended rent payments, continued to work with landlords. As of 5/17, they had $27M of cash on hand and they announced on 6/1 their intention to sell $50M of common stock.  Amid the pandemic, they furloughed 80 pc of hourly employees, 40% of store management, 40% of corporate and administrative staff. Non-furloughed workers had salaries reduced by 25-50 pc, senior mgt. took pay cuts of 50-75% and Board of Director compensation was suspended. They continued paying health premiums for eligible furloughed employees.

As reported on June 1st, for the second quarter (two months) through May 24, 2020 comparable restaurant sales decreased approximately 49.8% from the same period last year. The following table shows selected weekly comparable restaurant sales and average sales, for the 92, out of 101 system-wide locations that are open.

The Company commented that: “during the eight-week period ended May 24, 2020, we remained current with all of our vendors but deferred a majority of our lease obligations and as allowed under the Coronavirus Aid, Relief, and Economic Security Act deferred the payment of our employer social security taxes. Had we fully paid these expenses during such period, we estimate that we would have had approximately $27 million of cash and cash equivalents as of May 24, 2020 (down from actual current $32M).

“In response to the business disruption caused by the COVID-19 pandemic, during the eight-week period ended May 24, 2020, we transitioned our restaurants to a more limited menu and a primarily off-premise operating model with reduced labor, operating expenses, marketing and corporate overhead expenses, along with the cancellation or postponement of all non-essential planned capital expenditures. At the end of the eight-week period ended May 24, 2020, we were operating 18 restaurants in to-go only format, 74 with limited dine-in seating and nine were temporarily closed.  Based on our operations over this eight-week period, we estimate we achieve positive EBITDA (1) with average weekly sales above approximately $43,000 after taking into account all restaurant operating costs, including rent, and G&A expenses.   As we expand our operations by increasing our dine-in capacity and reducing the off-premise operating model for our restaurants, we expect to incur additional restaurant operating expenses and G&A expenses. With the increased expenses resulting from such expanded operations, we estimate we achieve positive EBITDA (1) with average weekly sales above approximately $54,000.”

Management actions, to get through these challenging times, have been commendable. We accept the fact that the cash burn has been reduced, and that the cash flow breakeven point has been lowered, for the time being. However: the new fully loaded (with corporate G&A) EBITDA breakeven point as described may be optimistic. $54,000/week annualizes to $2.8M per store, or about $290M system-wide. In calendar 2019, CHUY reported $426M of revenues, with income from operations of $3.4M. Adding back $20.7M of D&A, $14.2M of Impairment and closing costs, $0.6M of legal settlement, and $2.9M of pre-opening costs, provides Adjusted EBITDA of $41.8M. That means that ($426-290M) $136M of sales above “break even” last year generated only $41.8M of Adjusted EBITDA, or a 30.7% “flow-through”. That’s not much “leverage” from the higher sales. We believe cash generation from the incremental sales should be 40-50%. (Cost of sales, 26%, is variable, Labor, 35.4% is perhaps half variable, Operating Expenses, 15%, is perhaps half variable, Occupancy, 7.5% is mostly fixed, G&A, 5.6% can’t by leveraged by more than a point, so 26 + 17 + 8 + 1 = 52% variable, ballpark).  That leaves 48% theoretical flow through. Especially since there is no expense line that is expected to help, our conclusion is that the average weekly sales need to be $60-65k/wk. to generate positive corporate EBITDA. It’s interesting that $60-65k/week is 74%-80% of the previous sales that we suggested in our recent Darden (DRI) analysis as the approximate EBITDA breakeven range for full service casual dining restaurant chains.  Let’s watch 🙂


CAKE, CBRL, and CHUY are all well run restaurant chains, strongly positioned competitively, supported by strong balance sheets, with admirable operating histories. The reports described above show definite sequential progress over the last two months. There is, however, a lot of “wood to chop” before profit margins recover and an attractive return on capital can be earned. We stand by our prior reasoning that year to year sales comparisons have to recover to a negative 20-25% to provide a breakeven corporate EBITDA. While companies in all industries like to report “Adjusted EBITDA”, for old school analysts and investors that consider GAAP earnings relevant: GAAP breakeven (depreciation is not “free cash flow”, and interest expense will be higher than before) will require 10-15 points more of revenues. That means that GAAP breakeven will require sales to be down only 5-15% YTY, 10% as the midpoint. Above this GAAP pretax breakeven point, the last 10 points of revenues will generate perhaps 4 points of pretax profits, 3% after tax.

It is a new world, on many levels.

Roger Lipton



The questions are numerous. The problems are obvious. The solutions are not so easily manufactured. We don’t know what sales will be, what labor will be required to service customers that have new requirements. Cost of goods is not the biggest problem, but distortions in the supply chain could create price volatility as well as product shortages. We will have lots of new “other” expenses, necessary to deal with health concerns of employees and customers. There has to be negotiation with landlords, convincing them that you are here to stay, but need their help. You must economize at the executive level, but the needs are broader and deeper than ever before. You have to maintain a strong balance sheet somehow, but financing is more difficult, and more expensive than ever with the fundamental uncertainty. With all of this, management is working for reduced pay and Board compensation has been reduced or eliminated.

It’s no wonder, then, that something like a dozen publicly held companies, have had changes at the Board level, sometimes suggested (or imposed) by activist investor groups. Roark has invested $200M in Cheesecake Factory (CAKE) and KKR now owns over 8% of  Dave & Buster’s (PLAY). Vintage Capital owns over 10% of Red Robin (RRGB) and is represented on the Board. Among smaller companies, Kanen Capital Management has taken major positions and is represented on the Boards of both BBQ Holdings (BBQ) and The One Group Hospitality (STKS). Shake Shack (SHAK), Bloomin’ Brands (BLMN), Cheesecake Factory, Dave & Buster’s and others have raised money publicly at what most would consider to be distress prices.  It’s clear, therefore, that management and the Board must be capable of evaluating strategic financial alternatives. We wonder, for example, how and why Bloomin’ Brands was able to raise capital at much better terms than Cheesecake  Factory.

Investment bankers are beating the bushes to “write tickets”, but their possibilities must be evaluated from a realistic standpoint. We heard of a highly regarded investment banking firm suggesting (this past weekend) to a privately held chain that they could still get a multiple of historical EBITDA close to what was considered reasonable before the pandemic. This chain, by the way, is a big box casual dining company. Their sales are currently down 50% YTY, and the chain is, predictably, cash flow negative. That particular Board won’t likely go down that fruitless road, because they have at least one  very smart Board member (my friend), but other companies might not know better and could be forced to do a very unattractive deal at the last minute with a gun at their head.

Now comes the commercial: I’M AVAILABLE ! Two of my most recent Board involvements have ended recently, one of them very successfully, the other a privately held company that required refinancing and the new lender didn’t know that he needed me:)

I was on the Board until just recently of publicly held Diversified Restaurant Holdings (SAUC), which we took private on 2/25/20 (how’s that for timing?) at a price over 100% higher than the stock had been trading. SAUC was operating 65 franchised Buffalo Wild Wings locations, clearly a troubled restaurant system even before the pandemic. They had about $100M of debt, which they were servicing as required, but the net cash flow after debt service was non-existent. I was on the Special Committee and, with the great help of Darren Gange of Duff & Phelps, we found the “needle in a haystack” private equity buyer.  Parenthetically, while we were negotiating with the ultimate buyer on virtually a daily basis, an activist investor (and shareholder) was screaming his desire to “help us out”, at what turned out to be about half the price we sold for. It was tedious but we closed the deal for an Enterprise Value of about 7.5x the “run rate” of Adjusted Cash Flow. Intense and lengthy as the negotiations were, it was stimulating and satisfying, especially since it was very successful.

The other recent Board position was a 17 unit big box privately held casual dining company that required new financing.  The chain was, and is, very successful in their home state, but geographically remote locations, opened before my arrival, proved to be their undoing. I’ve always been predisposed to keep operations  “close to home”, suggesting expansion outward from the base so there is always brand awareness and maximum ability to adjust when necessary. I learned from Norman Brinker forty years ago that “running a restaurant chain is like managing a military campaign”. You want your troops “massed”, for strength and speed and flexibility.  It was the old formula that Shoney’s used so successfully decades ago, finally running out of steam when the third or fourth generation of managers that followed founder Ray Danner allowed the operating standards to slip too far.

I’m well aware that compensation for Board members has been suspended in many cases, reduced at the least. I can, fortunately, afford to work for the “going rate” along with other Board members. My major requirement is that the chain has the corporate culture that provides the foundation for long term success. I would naturally like to work with colleagues that enjoy the hospitality industry as much as I and are committed to the task at hand.

Other than reminding all of you that I have a good education,  operated my own chain of fast casual restaurants  many years ago, and have had four decades of  investment banking experience relating to the restaurant/retail industry, more details are provided at the “About Roger” section of this website (from the Home Page)..

So much for the pitch. Publicly held or “Up & Coming” privately held companies can respond, and we’ll talk.  I can be reached at lfsi@aol.com or call 646  270 3127. Please leave a message if I don’t pick up, there is so much spam these days.

Along with you, I will be closely watching developments within the restaurant/retail industries over the critical coming months. There will be lots of closings, but some operators  will emerge stronger than ever. We will remain in touch with all of you, doing our best to contribute to your thought process.

Roger Lipton








In the last few days, five prominent restaurant companies, with company operated locations, have reported fourth quarter results. These data points give us a reasonably accurate view into current trends, and allows us a best guess as to what 2020 might look like. While franchising companies such as Wingstop and Domino’s have also reported, with excellent results it so happens, precise store level margins are not reported and we are not commenting here on those results. We have also not included Chipotle, which has become very much of a “special situation”, still recovering from the problems of several years ago, at the same time establishing themselves as a leader with off-premise sales, and it’s the four wall economics that primarily concerns us here.

The table just below shows the five companies listed above, with their Q4 results at the store level. We will fill in the other blanks later, with full updated writeups on these companies, but a quick look at four wall economics can tell us a lot quickly.

We’ve been saying for some time that a couple of points of comp sales is not enough to overcome higher store level expenses, wage inflation most notably but also higher occupancy and other store expenses. That conclusion is pretty clearly demonstrated by these results.

Only Texas Roadhouse (TXRH) improved same store sales materially (+4.4%), and that was accompanied by the best traffic trend among the five companies (+1.5%).  That allowed TXRH to leverage the sales trend into a 117 bps increase in their store level margin. The other four companies , even with slightly better comp sales, suffered material deterioration of store level EBITDA margin.  Labor Expense was higher by varying degrees, most notably at BJ’s, with Texas Roadhouse, again, being the only company to hold the line in this regard.  Cost of Goods was not much changed across the board, except at RUTH with their heavy dependence on beef costs.

We have indicated also, at the bottom of the table, the indication as far as Q1’20 sales to date, or guidance for 2020. Once again, Texas Roadhouse leads the pack with a 6.4% comp sales increase in Q1 to date. BJ’s gave us a 1.7% number for Q1 to date. The others provided guidance for 2020 as a whole, very much in line with the modest recent increases. It is worth noting that the weather this winter so far has been fairly good on a comparative basis, and each of us can make our own judgements as to what effect this is having on Q1  results to date and management’s guidance for 2020.

In summary, there is no tangible reason to expect a material change in operating trends at company operated restaurant chains. Outliers can exist at special situations, but the overriding factors that have challenged the industry are still in place.

Roger Lipton



Late last week, Cheesecake announced second quarter earnings, not shocking in that comps were up a touch (1%), traffic was down a little (2.8%), cost of sales and labor were well controlled, down 20 bp and up only 20 bp respectively. G&A was 90 bp lower, allowing for a good EPS comparison. Basically, the historical quarter was more of the same.

Other than noting management’s expectation of continued 1-1.5% comp growth, 2% higher commodity prices and 6% higher wages during the rest of ’19, we would rather focus on the major acquisition that was announced.


CAKE has provided the investment community with a presentation regarding the planned acquisition of Fox Restaurant Concepts, for which they will pay $308M plus $88M previously invested pus $45M of cash over the next four years. This total of $440M is 1.1x the projected run rate ($400M) at the close of the transaction in late Q3. The acquisition provides for 100% of two growth vehicles developed by Fox Restaurant Concepts (North Italia and Flower Child) that CAKE had previously invested in, as well as full ownership of Fox’s other concepts.

The 20 current North Italia units are doing $7M per unit, and the 22 units will be doing about $150M at the close of the transaction. North Italia, 5,000-6,500 square feet in size, with an average check of $25-30, had comp sales of 5% in ’18, up mid-single-digit in ’19. They cost $3-3.5M of capex plus 12% of AUV (or 840k) in pre-opening expense. As described in the presentation: store level targeted EBITDA in year three is 18-20%, which would generate a 35%+ cash on cash return (excluding pre-opening expense). There can be, potentially, 200 North Italia locations in the US. Annual unit growth is projected at 20%. On the conference call, management indicated that in ’20 North Italia should have a store level EBITDA of about 17%, Fox as a whole at 15.5%. The growth of 20% in units at North Italia should provide an incremental 2 points at CAKE.

Fox Restaurant Concepts, including Flower Child and aside from North Italia, generate about $1,000/square foot, have a targeted EBITDA store level return of 16-18% in year three, have capex per square foot of $500/square foot, and have a targeted cash on cash return of 25-30%. Annual unit growth is projected at 20%. It is expected that the 20% unit growth at FRC will also add about 2 points to Cheesecake’s plan of 3% unit growth. The total acquisition is expected to be earnings neutral in 2020, accretive after that.


Best we can tell from the slide presentation and management’s comments, the concepts other than North Italia will be generating revenues about $250M by closing. The run rate of $400M by the end of Q3’19 will grow to $450M of sales in 2020. Between heavy pre-opening expenses and the inefficiency of new locations, it is not surprising that an earnings contribution will not occur until 2021.

CAKE’s presentation indicates the targeted sales/unit, the restaurant level EBITDA, the cash on cash returns and the sales/investment ratio for the Fox Restaurant Concepts (including Flower Child) vs. those at North Italia. Though the sales per square foot ($1,000 vs. $1,250), the targeted restaurant level margins (16-18% vs. 18-20%), the cash on cash returns (25-30% vs 35%+) are all materially lower at Fox (including Flower Child) vs North Italia, the profitability parameters at Fox are still impressive.


The appeal of the FRC acquisition lies with the high sales per square foot of North Italia and (probably) Flower Child, and the expectation that operating margins can be improved to provide attractive cash on cash returns. While normally we view targeted returns as suspect, Cheesecake Factory has a long and distinguished history of operating high volume restaurants with a very broad menu while controlling costs well and generating high returns on invested capital. The sales per square foot at North Italia are about the highest in the multi-unit casual dining industry, rivaling those at their new parent. If anyone can convert those sales to an appropriately high return on invested capital, it would be CAKE management. Unit growth at CAKE can grow from 3% annually to 6% or more, and operating margins, overall, could improve over time. We conclude that this acquisition will likely generate an attractive cash on cash return at both the restaurant and corporate level, and allow for better growth at CAKE in sales, cash flow from operations and earnings per share than we have seen in recent years.

Roger Lipton



We consider Cheesecake Factory (CAKE) and Habit Restaurants (HABT) to be two of the better managed publicly held restaurant companies, CAKE within casual dining full service, and HABT among the QSR/Fast Casual segment. Both companies reported their first quarter results wednesday evening. The numbers, and especially the conference call commentary provide a timely report on Q1, and, most importantly, a view into the short to intermediate term future for the dining industry and the general economy. We consider the restaurant industry to be a valuable leading indicator for the general economy, because the public “walks the talk”, or doesn’t, depending on their willingness to back up the “sentiment surveys” with actual spending. We now have a current view into how the “best of breed” can use “best practices” to build their businesses further, and what it implies for other less skilled restaurant companies and the economy as a whole.

Cheesecake Factory (CAKE)

The news headlines described comp sales up 0.3%, barely less than the estimated (by analysts) 0.6%. “Adjusted” earnings were $0.72 vs. $0.73 estimated. Fully diluted GAAP earnings were $0.71 vs. $0.68 on 49.2M shares O/S vs 50.0M shares a year earlier. The company guided Q2 to $.85-.88, versus a street estimate of $.86, very much in line. For all of ’17, the Company guided to $2.93-$3.02, just a little lower than the previous guidance of $2.95-$3.07. Not too bad, on the surface. If there is a story, it is “how the sausage got made”. The details, from the income statement, include: Cost of Sales lower by 70 bp, labor higher by 90 bp, occupancy and other higher by 70 bp, G&A the same at 6.4% of sales, D&A up by 20 bp, pre-opening expenses lower by 10 bp, Income from Operations DOWN by 90 bp and DOWN year to year by 8.6%. What saved the day was a tax rate of 17% versus 27% a year earlier and 2% fewer shares outstanding due to stock buybacks (“cash being returned to shareholders”), allowing EPS per share to be up by $.03.

The above details are interesting, but we are equally interested in the company commentary on the conference call about “the state of the restaurant world”. In a nutshell: it is still very challenging out there, apparently right up to the present. Comps were slightly positive in Q1, but menu pricing and product mix were up a total of 2.6% so traffic was down 2.3%. The weather and the timing of Easter hurt by about 50 bp, which will presumably come back in Q2. February was the weakest month, apparently typical of the industry, but there was no indication that traffic and sales have rebounded strongly in April. The guidance for ’17 includes an assumption of comp sales between 0.5%-1.5% and, importantly, commodity inflation of 1-2% and wage rate inflation of 5%. The tax rate is expected to be about 23% for ’17, down from 27.3% in ’16, and the shares outstanding is expected to shrink by 4-5% from $100 million of share repurchases. It’s fair to say that the EPS progress (about 6%) this current year is more a result of “financial engineering” than improved operating earnings. There is nothing wrong with that but what it is worth in terms of the stock’s valuation is another subject. (Just sayin’, we have no horse in this particular race at this time.)

Other noteworthy commentary included: “we did not think we were affected by the timing of tax refunds….overall, for the quarter we continued to take share, and we maintained our healthy sales gap to the industry….GDP grew 0.7% in Q1..leads us to believe that 2017…is going to look a lot like 2016…our business is stable. We’re just not seeing any macro lift right now……..we’re not seeing a difference in the malls, per se…in those A locations and most instances…….we would expect to see a year over year decline in operating margin…about the operating margins..we’ll see a little pressure on it. The bottom line margin we shouldn’t (see as much deterioration, after taxes, etc.)……..commodity inflation in Q1 was flat to slightly up..we continue to expect it to be 1-2%..into the next 3 quarters.” There was additional conversation about delivery initiatives, CAKE as a destination rather than an impulse in the malls, trends in Texas and California, etc.et., but we have excerpted above the comments most interesting to us.

Habit Restaurants, Inc. (HABT)

The news headlines included: Comp sales up .9% vs. Street estimates of 0.4%, EPS of $0.09 versus $.08 estimated, Company sees comp sales for ’17 at 2.0%. The headlines of the Company release included Adjusted EBITDA of $9.5M compared to $8.7M in ’16. This predominantly company operated chain is on track with their planned ’17 openings (31-33C + 5-7F), which, as described on their conference call, seem to be meeting or exceeding targeted levels of sales and profitability.

Our affectionately termed Q1 “sausage” in this case included: Franchise revenues up from $144k to $329K in the quarter, growing dramatically but still modest overall. More importantly, Cost of goods was down 90bp, labor was up 110 bp, “occupancy and other expense” was up 100bp, G&A was flat at 9.9%, D&A was up 30 bp, pre-opening expenses were up 10bp. Pretax Income from Operations was 5.3% vs. 6.8% of sales, DOWN about 7% in absolute dollars. You can see that the 150 bp decline was primarily due to higher labor costs and higher “occupancy and other”, partially offset by lower cost of goods (which won’t help going forward). After a higher tax rate of 32% vs. 23% in ’16, Net Income was down about 19% in dollars. Below the net income line, “net income attributable to non-controlling interests” was $1.1 million less this year than last, so the “Net Income attributable to Habit Restaurants, Inc., was $1.843M vs. $1.381M, up 33%. The fully diluted shares outstanding were 20.2M, up from 14.0M in ’16, still affected by pre-IPO calculations, and the fully diluted EPS was $.09 vs. $.10 – compared to the “pro forma” $.09 vs. $.08 shown in analyst presentations.

Once again, we are even more interested in the color commentary from the call to see what’s happening on the ground, and what it looks like going forward. With good reason, management is proud of their result, having posted another positive comp quarter (53 in a row) in a continuing difficult QSR environment. It is pertinent, of course, that menu price was up about 2.2%, partially offset by a negative mix impact, so the average ticket was up about 1.5% and traffic was down about 0.6%. Even adjusted for weather and Easter, as discussed below, traffic was close to flat at best. This trend is better than many competitors are showing, but not exactly Panera in its heyday (and again, most recently) or Wingstop of a couple of years ago. The promotional environment continues, but no worse than it has been. HABT prides itself on not discounting, providing an exceptional level of “hospitality, great every day value of the core menu, plus a continuous flow of interesting Limited Time Offers. They are steadily moving out of their California base, with successful beachheads being established in distant markets such as Florida and New Jersey. Management indicates that the new markets are meeting and beating initial expectations. Their commentary made passing mention of unprecedented amounts of rain in both Northern and Southern California, but the timing of Easter helped a little, so “normalized” traffic might have been about flat, for all intents and purposes.

The most noteworthy comments by management during the call included: “comp sales are expected to increase approximately 2% for ’17.. restaurant contribution margin (EBITDA) expected to be approximately 20% for the full year…commodities will be up 1-2% for the year, primarily driven by short term Q2 pressure on produce combined with escalating ground beef and chicken prices. Our prior expectation was flat for 2017….we continue to expect our average wage rate to increase 6%-8% in 2017” (thank you, California)….”we have been working on labor productivity initiatives that we believe will help to offset some of the commodity inflation……increased amount of strong promotional discounting….by the bar grill category in the full service category……commodity pressure….will have some affect on the ability of traditional burger QSR players maybe not to be able to do as much deep discounting…….with our results over the last 53 quarters…..we don’t have to go there (discounting wars)…..we know the macro environment is going to ebb and flow, but we feel really good about Q1 and…..the outlook for the remainder of the year……our sales trajectory is pretty much in line with the last couple of quarters….in Q2 running up against, running up against our strongest quarter last year….our target on average is $1.4 million for the new traditional stores and for the last three years of openings, we’ve been above that average, exclusive of the drive throughs….which are at higher volumes….stores that aren’t in the compo base but are open more than 12 months are performing at a number that’s significantly higher than the comp totals we reported. ….we are opening in the East, against well entrenched Smashburger and Five Guys, at volumes that are well above their system average…occupancy expenses will be up for the year but not as much as in Q1…..produce is going to be up over 27% in Q2……we feel like we can attain our 20% store level (EBITDA) margin for the year…..with a little bit lower margin in Q2 than we maybe initially thought and a little better in Q3 and Q4.

Bottom line:

These are well run companies,  continuing to cope with a very competitive industry situation and material macro headwinds. Even for these relatively “Best of Breed” companies, traffic gains are hard to come by, Labor Expense continues to rise, Cost of Goods Deflation is behind us, Occupancy Expenses continue upward. Over time, menu prices will rise, as restaurant companies do their best to prevent profit margins and ROIs from collapsing. Unfortunately,  price increases cannot be aggressive in a competitive world and a sluggish economy.  My concluding takeaway, as an analyst and money manager, I wouldn’t shy away from an attractive long term situation because of commodity prices alone, because protein and produce prices can (and do) change in a matter of months. However, traffic trends, competition, labor, and rent concerns are far longer term in nature, and will continue to make life difficult even for the best of operators.