Cheesecake Factory's Sales Initiatives Impress, Costs High

The Cheesecake Factory Inc. (NASDAQ:CAKE) has been undertaking prudent strategies to improve its performance. The company’s strong sales-building initiatives like extensive employment of digital and social media campaigns to showcase its high-quality ingredients and preparation techniques, as well as focus on menu innovation are significantly contributing to its topline.

However, high costs are denting profitability of the company. In the first quarter of 2018, the company’s earnings fell short of analysts’ expectation while revenues surpassed the same. Earnings declined 22.2% year over year. Higher-than-expected insurance costs along with some legal settlement expenses have particularly dented the company’s earnings in the quarter.

Also, the company’s shares have declined 10.7% in the past year, comparing unfavorably with the industry’s gain of 4.2% in the same time period. Moreover, downward earnings estimate revisions raise questions over the stock’s upside potential. Estimates for 2018 have gone down 1.5% over the past month.

Sales-Building Initiatives Bode Well

Cheesecake Factory is committed to boost its sales for surviving in the competitive environment. The company has been investing heavily to improve guest experience. This is turn started stabilizing the company’s sales trend starting from the fourth quarter of 2017. In the first quarter of 2018, total revenues grew 4.8% year over year on the back of increased comparable sales.

In order to boost comps, the company is focusing on improving its speed of service and training its servers so that they render a higher level of service. In addition to labor productivity, the company is majorly focusing on menu innovation and food efficiency.

Cheesecake Factory is preparing 50 menus under its Super Foods program, fresh from scratch in the restaurants, to increase consumer awareness of the brand. To this end, Cheesecake factory is leveraging its brand power through the launch of products in the CPG channel.

The company launched its brown bread in grocery stores in the Southeast with nationwide distribution capabilities. Going forward, the company intends to carry on with menu innovation by adding new Super Food items as well as the famous indulgences of The Cheesecake Factory.

Meanwhile, Cheesecake Factory’s technology-enabled initiatives have been doing well, with positive feedback for its mobile payment app, CakePay. The company is also witnessing incremental sales from its delivery service that continues to roll out nationwide. Presently, about 95% of the Cheesecake Factory restaurants offer third-party delivery.

The company continues to improve its to-go business including online ordering capability, which could be in pilot by the end of the year. This is anticipated to be a major contributor to the growth of the company’s strong off-premise sales channels. In 2017, the company’s takeout business increased to 12% of the sales.

Efforts to Return Shareholders’ Value Seem Encouraging

Cheesecake Factory continuously returns wealth to its shareholders via dividends and share repurchases. The company returned $175 million in cash via share buybacks and dividends in 2017. In the first quarter of 2018, management declared a quarterly cash dividend of 29 cents per share on the company’s common stock.

The dividend is payable on May 22, 2018 to its shareholders of record at the close of business on May 10, 2018. Also, during the quarter, Cheesecake Factory repurchased approximately 0.7 million shares of its common stock at a cost of $34.9 million.

Rising Costs to Keep Profits Under Pressure

Of late, Cheesecake Factory’s profits have been under pressure owing to a rising wage rate scenario. Moreover, the pre-opening cost of outlets, given the company’s unit expansion plans and expenses related to sales initiatives are adding to its costs, and likely to hurt profits, going forward.

In the first quarter of 2018, cost of sales ratio increased 10 basis points (bps) year over year to 23%. Meanwhile, the labor expense ratio was 35.7%, up 1300 bps from the year-ago quarter. This was primarily driven by higher hourly labor, including more wages, overtime and training costs.

General and administrative expenses accounted for 6.6% of the revenues in first-quarter 2018, up 20 bps from the prior-year quarter due to higher marketing costs, repairs and maintenance, and additional workers' comp insurance costs. Notably, pre-opening expenses were 0.2% of the total revenues, down 10 bps from the year-ago quarter.

Heading into 2018, the company expects food inflation of more than 3%, particularly across poultry, dairy, bread and seafood. Wage inflation is anticipated to be about 5% in 2018.

Zacks Rank & Stocks to Consider

Cheesecake Factory carries a Zacks Rank #3 (Hold).

Some better-ranked stocks in the U.S. restaurant space include Wingstop (NASDAQ:WING) , Denny’s (NASDAQ:DENN) and Dine Brands (NYSE:DIN) . While Wingstop sports a Zacks Rank #1 (Strong Buy), Denny’s and Dine Brands carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Wingstop, Denny’s and Dine Brands’ earnings for 2018 are expected to increase 9.5%, 12.1% and 22.9%, respectively.

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