Tag Archives: Cost of Goods



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.



There are four major components of profits for restaurants (and retailers):

Revenues (made up by same store sales, price and menu mix, and traffic)

Cost of Goods (food and paper)

Labor Cost (Store level managers and crew expense, including benefits)

Occupancy expense, consisting of minimum rents adjusted for volume overages, and common area management charges (CAM) when appropriate, normally also including utilities, real estate insurance and real estate taxes. Occupancy expense is important, usually at 6-8% of sales (if you’re lucky), but nowhere near the 30 points, give or take a few points, that make up both Cost of Goods and Labor.  For this piece, suffice to say that occupancy expenses are trending higher, clearly not helping store level margins.

This discussion, however,  is primarily meant to summarize restaurant executives’ expectation for revenues, cost of goods, and labor expense in 2017, which represent larger variables than occupancy expense. In that effort, we have excerpted the numbers presented below from the most recent corporate reports (including conference calls) from each of the companies shown below.

For context, over the  last couple of years, while labor costs have marched consistently upward, commodity costs have reliably been a “partial offset”. At the same time, store level traffic has been challenged, which obviously puts store level margins at risk if one or both of these major line items increase as a percentage of sales. Very few restaurant companies have shown increases in traffic during 2016. Typically, it goes like this: Same store sales were up 2-3%, price and menu mix increases were 2-4%, so traffic was up (maybe 1%) or down (probably 1-3%). The labor percentage was up anywhere from 50-150 basis points, partially offset by commodity deflation of 25-100 basis points. The table above shows the commentary from nineteen publicly traded restaurant companies. You can see that the “good times” in the form of lower commodity costs seem to be behind us. Almost all the companies are looking for cost of goods to be flat or UP, rather than down.

You can also see that the labor percentage is often expected to be up by  3,4 or 5 percentage points, which would translate to 90-150 basis points of margin if the labor percentage is 30%. Suffice to say we are moving to the top of the previous range rather than the bottom.

Lastly, the table shows that comp sales expectations are (perhaps conservatively, perhaps not) estimated at 1-2% (higher at PNRA and TAST), and that implies continued traffic challenges since menu prices will generally be a couple of points higher.

Putting it all together, traffic and sales will be challenged, labor % will be up, probably by more than in ’16, commodity % will be “flattish”, less of an “offset” than in ’16. Occupancy expense, FWIW, won’t help either. For good measure, it will be difficult to raise prices at the store level, when grocery prices seem well controlled, which has no doubt helped to contribute to the sluggish store traffic we have been recently experiencing.

If you have any questions relative to the above information, don’t hesitate to contact us.

Roger Lipton