Sector: Manufacturer
Industry: Industry
Key Statistics

Shares of Cheesecake Factory (CAKE), which runs more than 100 casual dining restaurants, with a menu of items ranging from sandwiches and salads to steaks and seafood, as well as about 40 different varieties of cheesecake, are off nearly 30% since the beginning of the year.  The sharp decline in the stock reflects recent concerns about weaker growth rates due to larger trends hurting the restaurant industry, such as steep gasoline prices and higher interest rates, along with risks associated with the ongoing investigation into the company's stock options practices and negative traffic trends. 

As reported in late July, Cheesecake Factory's preliminary second quarter revenue grew 12% to $322.2 million, driven by continued expansion.  However, same store sales fell 0.8% - the second consecutive drop for the Calabasas-based restaurant operator - led by a 1.2% decline at the company's flagship brand.  That was partly offset by a 5.5% increase at the company's new brand, Grand Lux Cafe.

Like many other restaurant chains, Cheesecake Factory said it is feeling pinched, as consumers, hurt by higher gasoline prices and interest rates, continue to trade down to fast-casual chains such as Panera Bread (PNRA) and Chipotle Mexican Grill (CMG), and to fast food restaurants like McDonald's (MCD).  Increased pressure on the consumer also means more customers are giving up appetizers and desserts and choosing lower-priced entrees and drinks, eroding revenue. 

Last month, Cheesecake Factory, already under pressure from a challenging retail environment, said it expected to restate past results, based on initial findings of an internal probe into past stock options practices, which caused it to miss its second quarter filing deadline with the Securities and Exchange Commission.  Cheesecake Factory, which joins a growing list of companies that are being investigated by federal regulators or conducting internal reviews, said the adjustments are due to incorrect measurement dates for stock options grants that were issued before June 30, 2002.  The SEC is currently conducting an informal inquiry into the company's stock options granting practices. 

While consumers have undoubtedly tightened their spending behavior, we believe Cheesecake Factory's longer-term growth prospects remain in tact, and would be inclined to recommend long-term investors stay the course with the stock as the economic climate improves and the company's aggressive expansion efforts begin to bear fruit.  The company, best known for its array of cheesecakes, including White Chocolate Raspberry Truffle and Chocolate Peanut Butter Cookie-Dough, is one of the most unique and highest quality restaurant chains in the industry. 

However, with the company's backdating issues weighing heavily on the near-term outlook, we would not recommend purchasing shares until a conclusion is reached.  Our concern stems from the possibility of the restatement of earnings, as well as any potential repercussions related to the management or operations.  At the current price level, the stock is trading at roughly 24.6x this year's projected earnings, compared to 33.1x for P.F. Chang's China Bistro (PFCB) and 26.0x for California Pizza Kitchen (CPKI).  Although valuations look compelling, the current price is discounting the recent sales slowdown and reflects the risks associated with the ongoing investigation into the company's stock options granting practices.   

--Richard Jahnke, Briefing.com