The Cheesecake Factory (CAKE): A Bullish Case Of Restaurant Growth And 3% Dividend Yield

Thesis Summary

Today’s research article covers The Cheesecake Factory (NASDAQ:CAKE), in the consumer discretionary / restaurant sector, to which I gave a buy rating. My portfolio strategy with this stock is (stable dividend income generation and growth, capital gains).

A few points supporting my rating include YoY revenue growth and expected continued growth of new restaurants, a return to profitability after a net loss a year ago, a return to dividend growth after the pandemic years along with a +3.3% yield, and a justifiable P/E valuation.

An offsetting factor would be overvaluation on the price-to-book valuation which I think is overvalued.

A potential downside risk to my bullish sentiment is the risk of a recession in 2024 causing an impact to discretionary spending on restaurants.

My portfolio strategy would be to buy this one to add exposure in my portfolio to a growing brand in the restaurant sector, with a goal of steady and growing dividend income.

Stock & Industry Snapshot

Some quick facts about this stock, from its SA profile, are: It was founded in 1972, has headquarters in California, trades on the Nasdaq, and its key businesses in the US and Canada include restaurant brands Cheesecake Factory, North Italia, and Fox Restaurant Concepts.

My own personal experience with this brand is that of a customer, rather than an investor, as Cheesecake Factory has long been a common sight at malls across America, although the first one I tried was during my long-ago student days in Washington DC.

Today, though, I want to consider this company as an investment opportunity thanks to the Seeking Alpha platform.

Any financial data in this article refers to this company’s income statement, balance sheet, dividend, and valuation data, as well as its most recent earnings results. My forward-looking outlook will relate to its next earnings date which is expected a month away on Feb. 22, as well as longer-term business sustainability.

My straightforward way to explain their business model the I way I understand it is that in order to cover the high overhead of running so many brick-and-mortar restaurants, which is a capital-intensive model, as is developing new restaurants, it requires a lot of traffic and tables filling up every day so that cash register keeps ringing, but in recent times they can also rely on the various food delivery apps as well.

Though I would not put it in the same category of essential as a supermarket selling bread and milk, I would say its demand comes from customers with the discretionary income to eat out frequently.

Here is what market data shows about equities in the consumer discretionary sector, which improved nearly +29% in 1 year and nearly +5% in 3 years, however so far in the new year the sector has been on a decline. This might have an effect on this company’s stock price too.

Equities Analyzer Dashboard

Our Equities Analyzer Dashboard presents a holistic rating approach by looking at 5 metrics including top and bottom line earnings growth, dividend growth, and valuation. Our overall rating is based on the holistic score we gave this stock. Each of the 5 categories (such as revenue growth) is worth 20% of the total score.

Revenue YoY Growth

The income statement data shows us that revenue grew +5.8% on a YoY basis.

On a longer-term trend, it is also now significantly higher than the pandemic-era quarter of March 2021, so indicating a nice recovery in that regard.

The CEO in their Q3 comments pointed to continued customer demand as a driver:

Our performance amidst the softening sales environment is a testament to the resilient consumer demand for the distinct, high-quality dining experiences we provide our guests.

Another positive factor I should mention is the growth of new restaurants. This company ended up opening 2 new ones, in what I would call a “population growth region” in the southeast US, states like Florida and the Carolinas:

During the third quarter of fiscal 2023, the Company opened two Cheesecake Factory restaurants, one in Birkdale, NC and the other in Estero, FL.

Supporting my point is the following chart from Statista showing population growth trends in the US:

So, besides proven YoY revenue growth in Q3, I expect sustainable revenue growth going forward especially if the company can continue to capitalize on those growth regions of the US and expand their brand presence.

This of course always is subject to the time it takes to get building permits, develop restaurants, and finally open up, so it is certainly not quick. So far, the company stated they plan to open “as many as four to six new restaurants in the first quarter of fiscal 2024.”

Earnings YoY Growth

The most recent Q3 earnings figures showed a whopping +845% YoY growth. This must be understood in the context that the quarter ending Sept 2022 saw a net loss of -$2.4MM. After Jan 2023, the company has shown three straight quarters of profitability again.

Despite taking a $1.5MM charge from acquiring Fox Restaurant Concepts, the company in their Q3 comments provided a positive sentiment when it comes to financial performance:

As the macroeconomic environment has gradually stabilized and input costs have continued to improve this year, the stability of our operational and financial performance reinforces our belief we are well positioned to drive meaningful growth, shareholder value and market share gains going forward.

We see from income statement data that total operating expenses have been on the decline since Jan 2022, and interest expenses on debt have been relatively flat since then.

Although the YoY earnings growth is impressive, more importantly, my outlook looking ahead is positive based on stabilizing costs combined with expected continued revenue growth as new restaurants continue to be built.

Dividends 10-Year Growth

We can see that the annual dividend went from $0.61 in 2014 to $1.08 in 2023, for a +77% growth in a decade.

That nice double-digit growth, combined with a trailing dividend yield of +3.3% now, and a return to steady quarterly payouts after the 2020/2021 pandemic-era slump (no dividends were paid in 2021), tells me this company has steered through that storm successfully and has come out stronger, ready to return profits back to shareholders again.

I believe there is a greater probability of more dividend increases this year if the return to profitability continues. Right now it seems the earnings-per-share (EPS) estimate for Q4 is around $0.74, which if met would be a nice YoY improvement.

My own sentiment is that there is a good chance of meeting or beating this estimate, on the basis of lower costs combined with revenue growth. In fact, considering that many of Cheesecake Factory’s restaurants are in major US malls, one cannot ignore this week’s headline in Reuters: “strong US retail sales underscore economy’s momentum heading into 2024.”

Valuation: Price to Book Value (P/B Ratio)

Next, before talking about valuation let’s take a quick look at this stock’s chart which compares the most recent share price vs the 200-day simple moving average:

The chart above shows the share price of $32.82 practically hovering at its 200-day SMA, after a surge and then a dip. It is also quite a bit above its October lows.

At the same time, from the balance sheet, we know that equity fell from $323.5MM in Sept 2022 to $321.6MM in Oct 2023, for a less than 1% YoY decline, or practically flat growth in book value.

This brings me to the forward P/B ratio, which is 4.74, almost double that of the sector average which is 2.40.

I think the driver of this elevated valuation, when relating back to the share price and equity, is that book value had practically flat growth while the share price has grown significantly vs its autumn lows.

My outlook then is that it is overvalued at this multiple of 4.74x book value, and I think it would be more justified if we saw single to double-digit percentage growth in equity.

Valuation: Price to Earnings (P/E Ratio)

Using the same YCharts already looked at, and the earlier talk on earnings, what we know is that the share price has grown since autumn but is now flat vs its moving average, while earnings have grown such on a YoY basis that the company is back to profitability again.

We can see the forward P/E ratio is 12.87, quite a bit below the sector average of 16.54.

Because it is a case of earnings growth along with share price growth, I call this valuation justified, and as for future outlook since I already mentioned that I expect sustainable profitability going forward I think it could help the valuation if Q4 earnings show YoY growth by single to double-digit percentages.

Key Risks

Since my rating is a bullish one, here I will go over a potential downside risk. For the type of business it is, it is more of a macroeconomic risk and that has potential for a recession in 2024 cutting into customer demand for non-essential restaurant spending and impacting revenue.

We heard a lot of talk in financial media in 2023 about the potential recession risk as credit costs soar in the current rate environment.

However, it is a new year, and here is what this week’s CNBC article had to say after the World Economic Forum in Davos, Switzerland:

Overwhelmingly, economic experts and executives privately said they don’t expect a U.S. recession in 2024. The Fed’s potential interest rate cuts in the coming months, combined with rising consumer confidence, have led to optimism about the health of the economy – barring another major geopolitical crisis.

Although you may see in some media that countries like Germany are facing a recession, keep in mind that Cheesecake Factory does not have a presence there as far as I know.

Other sources, like a Jan. 20th article in Business Insider, indicated that despite positive consumer confidence there is a slump in borrowing as interest rates remain high, and this lower borrowing could have macro effects:

The credit contraction means that companies are borrowing less, with higher interest rates making it more expensive to take out loans. When it’s harder to raise debt, businesses are less likely to press ahead with spending projects, which can further drag on economic growth.

Despite that, another angle on this issue focuses more on consumer spending growth itself as a positive metric, according to a Jan. 17th piece by Investopedia:

Consumers kept on spending in December, providing more signs that the economy is continuing to grow.

So, my takeaway on this potential downside risk of macroeconomic headwinds in the event of a recession is that for now Cheesecake Factory should continue to be in good shape as it has decided to keep growing new restaurants and it will get tailwind from consumer spending, and a return of the great American mall shopping experience which also can create foot traffic to many restaurants in those malls.

There is also the growth in the use of food delivery apps too, or pickup/takeout orders, and the geographic diversification of this company which is not exposed to one location or even just one state but many states, which I believe spreads risk more effectively.