Shares of Cheesecake Factory (CAKE 48.53, -7.50, -13.39%) are getting slammed
lower after the company reported Q2 earnings last night that came up well short
of expectations. In absolute terms, it was the company's worst EPS miss in over
five years. Adding fuel to the fire is that the company issued downside EPS
guidance for both Q3 and FY18 during the conference call last night. Though the
company saw some favorable performance in revenue and cost of sales, higher
medical insurance costs and legal costs present two primary headwinds that the
company is having difficulty mitigating right now.
First, taking a look at the company’s Q2 results, EPS came in at $0.65, missing consensus by $0.16. Interestingly, cost of sales was actually down 10 basis points from last year, driven by favorable seafood and produce prices. As many investors are aware, higher commodity costs have been an issue this quarter for many food-related companies.
On the top line, revenue was up 4% year/year to $593.2 mln, which actually slightly exceeded analysts' $592.4 mln forecast. Comparable store sales were up 1.4%, essentially in-line with its expectation.
So, with cost of sales dipping a bit and with revenue basically in-line with expectations, some may by wondering how CAKE missed earnings estimates so badly. As we noted above, the company was hit with much higher medical and legal costs than it had anticipated. Specifically, it experienced a negative $0.07 impact from each of these factors. The company also saw labor expenses attributable to wage increases and overtime payments rise compared to the year-ago quarter.
With regards to medical insurance, CAKE is self-insured, so costs incurred are based on actual claims made. Consequently, there can be some significant volatility from quarter to quarter with this expense -- as 2Q18 demonstrates. But, the company still believes that over the long-term, this model is the best approach for them from a cost standpoint.
As for legal, management wouldn't elaborate much on why this expense jumped during the quarter, other than to say that it is facing a "litigious environment" and that it is involved with two distinct cases. Management did say, however, that more details will be available in the 10-Q when it is released.
Based on CAKE's guidance for the remainder of the year, it is clear the company expects these costs to remain an issue. For Q3, it guided for EPS of $0.56-$0.60 vs. the $0.64 consensus, and for FY18, it is projecting EPS of $2.40-$2.48 vs. the $2.69 expectation. Although, if you take into account the $0.16/share miss this quarter and ratchet down the $2.69 consensus to $2.53 to account for that, this guidance doesn't look nearly as bad. And, indeed, the company is still expecting comparable store sales to range 1.5-2.0%, indicating that it isn't anticipating any change to its operating performance.
All in all, the EPS miss and downside guidance certainly don't look good on the surface. But the two main issues facing CAKE at the moment -- higher medical insurance and legal costs -- aren't indicative of a change in customer demand or operating performance in general. Therefore, some may argue that today's 13% dive in the stock might be overdone.
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