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The Cheesecake Factory

Stock Analysis
Kai Liu

1/15/2018
The Cheesecake Factory Stock Analysis
Valuation Date: Jan 2nd. 2018 Recommendation: BUY
Valuation Date Jan 2nd 2018
Stock Exchange: Nasdaq Industry: Restaurant
Methodology WEIGHT PRICE
Current Price: $49.31 Target Price: $62.04
Absolute 50% 70.85
Relative 50% 53.22 Summary: The Cheesecake Factory is an American restaurants company
Target price 62.04 headquartered in Calabasas Hills, California.
Upside return 25.81%
Highlights:
Stock Profile Jan 2nd. 2018 Financial Performance:
Closing Price 49.31
 Proper debt structure and high solvency
Outstanding Shares 44.2 M
BETA 0.48  Outstanding financial performance in the industry

 Stable expanding in the global market


Debt Structure HEALTHY
Debt 145.6 Absolute Valuation:

Assets 1,308.1  A three-stage FCFF model was used to evaluate the company
EBITDA 231.4  We estimated the extraordinary growth period to be 10 years based on
Net Income 140.60
company’s long-term growth plan
D/E 1.6
Coverage 30.2  We calculated a value-per-share of $70.85
Solvency Ratio 1.5 Relative Valuation

Key Financials  Projected price from P/E is $49.62


ROE 145.6  Price derived from EV/S are $60.72 (average) and $49.26 (projected)
PEG 1,308.1
 Price derived from EV/adj.EBIT and EV/adj.EBITDA are
EBIT Margin 231.4
$52.94 and $53.97
NI Margin 140.60
 We have a average projected price of $53.22

60.00mm
CAKE STOCK PRICE
62.00
50.00mm 52.00

40.00mm 42.00

30.00mm 32.00

20.00mm 22.00

10.00mm 12.00

0 2.00
COMPANY OVERVIEW

To get a comprehensive perspective of Cheesecake Factory, we must analyze the

company history, historical stock performance, debt structure, financial performance, and

strategic analysis of the company.

Company History

The Cheesecake Factory is an American restaurants company headquartered in Calabasas

Hills, California. It runs more than 210 casual-dining restaurants all over the country, including

199 The Cheesecake Factory restaurants, 14 Grand Lux Café, and two RockSugar Pan Asian

Kitchen restaurants. Their restaurants offer a diverse menu of items produced from scratch using

fresh, high-quality ingredients.

Fig 1: Company history

Stock Price

The closing price on Cheesecake Factory’s first day of trading in September 1992 was

$3.29. Throughout the years it grew to a closing price of $49.31 on December 30th, 2017: the

time of our analysis. The price increased by 1398% over the past 26 years. In the past six years it

has grown by 6.6% and in the past year it has fallen by 1.7%. Overall, the stock has seen stable

price growth.
Fig 2: Cheesecake Factory stock price September 1992 December 2017

Debt Structure

According to Bloomberg, The Cheesecake Factory has a D/E ratio of 19.3%, and the debt

only takes 8.9% of its total assets. The company has extremely low traditional debt compared to

the average in the restaurant industry (50.12%). Also, some critical ratios related to the

company’s long-term operations shows us the company has a very healthy debt structure, and it

is almost impossible that the company would default its obligations. The company has an

extremely high-interest coverage ratio of 30.4 and a relatively high solvency ratio of 1.5. Under

such a condition, we consider The Cheesecake Factory is financially healthy and will continue

having a proper debt structure in the future.

Financial Ratios

In this part, we focus on the company’s profitability and financial health as the key

financial indicators shown in Figure 3. The company has relatively high profitability and healthy

financial performance. Here we want to highlight the asset turnover of 1.8 and the accounts

receivable turnover of 160.1. These two ratios indicate that the company keeps efficiently using

its assets to generate revenues.


CAKE Industry Average

ROE 25.9% 18.3%

PEG 1.31 1.41


Profitability
EBIT Margin 7.2% 5.2%

Net Income Margin 7.0% 3.3%

P/BV 3.3 5.7

Working Capital 11.44M 10.22M


Financial
Health Asset Turnover 1.8 1.0

Accounts Receivable
160.1 15.3
Turnover
(Bloomberg, end December 2017)

Fig 3: The key indicators of the company’s performance

Strategy Analysis

The Strategic Position & Action Evaluation matrix or short a SPACE matrix is a method

to figure out the optimal strategy position of the company by evaluating the key ratios of the

company and the overall environment of the industry. We assess each part in the method and rate

them. For financial strength (FS) and industry strength (IS), a score of 6 represents the best

condition. For competitive advantages (CA) and environmental stability (ES) a score of -1

represents the best situation. Notice that we need to subtract financial strength score from

competitive advantages score, so does the industrial strength. After that, we add the two final

scores on the number axis to draw a strategy line. This line reveals the optimal strategy position

of the company. Figure 3 shows the standards we used to analyze, and Figure 4 shows the result

of the SPACE Matrix. The optimal strategy position for The Cheesecake Factory is the

aggressive strategy, which means the company will probably get more advantages by expanding

its business.
Internal Position External Position

D/E: 19.3% Same-store sake: +2.9%


Financial Industry
ROE: 25.9% Sales growth: 4.23%
Strength Strength
PEG:1.31 EBIT yield: 2.1 stable
4 4
Working Capital: 11.44 Cash flow yield: 3.8 stable

Market shares: 2.5% Environme


Competitive
Product loyalty:high Life cycle: mature ntal
Advantages
Product life cycle: short Policy stability: high Stability
-2
Diversity: medium-high -1

Fig 4: SPACE Matrix Analysis

Fig 5: Space Matrix Output

INDUSTRY OVERVIEW

The Cheesecake Factory is a firm in the restaurant industry. In this section, we chose

some key financial indicators (see Figure 6) of the industry and applied a Five Forces Analysis in

order to understand the future of the industry and how the company fits within the vision. The

increasing ROE and profit margin of the industry indicates that its profitability is increasing in
the past five years and will probably keep increasing in the future. Also, the long-term solvency

of the whole industry is high, because the D/E ratio and the interest coverage ratio are stable and

fall into a proper range. Both revenue growth rate and net income growth rate of the industry was

also increasing in the past five years. Analysts predict that the industry will continue growing at

a stable rate in the future.

2014 2015 2016 2017 2018F

ROE 15.3% 20.0% 26.1% 33.0% 39.6%


Profitability
Profit Margin 2.1% 1.9% 3.7% 3.2% 3.2%

D/E 42.1% 49.1% 64.9% 44.2% 33.6%


Long Term
Solvency
Interest Coverage 6.8 5.0 8.3 7.4 9.6

Revenue 0.4% 0.1% -0.4% 2.9% 3.1%


Growth Rate
Net income 0.8% 0.8% 8.2% 13.5% 13.9%
(Source: Capital IQ)

Fig 6: Industry financial performance

Figure 7 shows us the Five Forces Model of the restaurant industry. This industry is a

mature industry that contains thousands of companies. Customers can choose from numerous

different brands and frequently switch their choices at a low cost. Also, the profitability of a

restaurant company highly depends on the cost of goods. A small change of the price of

ingredients and equipment can greatly affect profitability. Thus, the bargaining power of both

customers and suppliers are high. Moreover, due to the severe homogenous competition in the

industry, customers can always find substitutes for their favorite dishes. We believe the threat of

substitutes is relatively high. As we know the restaurant industry relies highly on scale merit.

The scale effect makes the threat of new entry lower than other industries. After

comprehensively considering these four forces and the maturity of the industry, we believe that
the rivalry among existing competitors is high.

Fig 7: Five Forces Analysis

Both the financial performance of the industry and the Five Forces Analysis show us that

though the industry is mature, it will keep growing in the future. This result is consistent with our

analysis of Cheesecake Factory’s optimal strategy position, which is the company will gain more

advantages by expanding its business. Thus, we believe The Cheesecake Factory is a well-

managed company with huge upside potential.

RELATIVE VALUATION

Peer Universe

We determined comparable companies for The Cheesecake Factory based on the Restaurant

segment under Bloomberg Intelligence, and we narrowed the list down to include only Casual

Dining Restaurants. We excluded fast food restaurants and firms whose primary incomes do not

come from casual dining. We did not strictly screen out companies by market capitalization,

growth potential, or cash flow size to avoid over-restricting our sample. We ended up with 10

firms: Bj's Restaurants Inc (BJRI), Texas Roadhouse Inc (TXRH), Darden Restaurants Inc (DRI),
Cracker Barrel Old Country (CBRL), Brinker International Inc (EAT), Bloomin' Brands Inc

(BLMN), Denny's Corp (DENN), Fiesta Restaurant Group (FRGI), Chuy's Holdings Inc

(CHUY), and Dine Brands Global Inc (DIN).

Fundamental Metrics

We acquired all fundamentals for comparable firms in the fiscal year 2017 from

Bloomberg. The fundamentals are enterprise value (EV), revenue, EBITDA, adjusted EBITDA,

EBIT, adjusted EBIT, stock price (12/31/2017 closing price), and Earnings Per Share (EPS). EPS

was calculated as Net Income divided by the Basic Weighted Average Shares Outstanding,

which counted potential convertible securities. EV included Minority Interest. For both adjusted

EBIT and adjusted EBITDA, we used Bloomberg-adjusted numbers. EBIT and EBITDA were

adjusting for abnormal items, which includes gains or losses from non-recurring items, realized

investment, restructuring, merger and acquisition, unusual charges, special and reserve charges,

write-downs of assets or goodwill, write-off of debt,spin-off/sell-off expenses, sale of subsidiary,

and acquired research and development costs (Bloomberg).

Key Multiples

By using the fundamentals above, we calculated P/E ratio, EV/adjusted EBITDA,

EV/adjusted EBIT and EV/Sales. The results of this analysis can be found in Figure 8. To avoid

bias, we used peer median as the industry average instead of mathematical mean. Overall,

Cheesecake Factory’s value multiples were below industry average.

The P/E ratio of the ten comparable firms has a standard deviation of 11.90. Both FRGI

and DIN have negative P/E ratios, resulting from negative EPS in 2017 of -1.35 and -18.28

respectively. The industry average of P/E ratio is 17.33x, higher than Cheesecake Factory’s P/E

of 14.4x. By using the industry average, we calculated the firm’s share price to be $58.07. Then
we controlled the difference of growth rate, payout ratio, and firms’ risk, regressing P/E ratio

against the five-year historical compound annual growth rate, dividend payout ratio, and firm

raw beta. We got the regression as : Projected PE = -28.18+0.88*(g)+0.28*(payout

ratio)+49.38*(ß), with R2=0.32 and variable t-stats of 1.21, 1.53, and 0.84, respectively. From

regression, we got a projected P/E as 14.82x and estimated share price as $49.62.

Next, we will evaluate revenue multiples. Cheesecake Factory stock was trading at 1.0x

their EV/S while the peer median is 1.26x. Even when the outlier with the highest revenue

multiples (3.6x) is removed, the peer average of 1.13x is still higher than the Cheesecake

Factory’s. By using the average, we got a share price of $60.72. To control the differences in

operating margin, we regressed the multiples of 10 peer firms against their after-tax operating

margins and got projected EV/S = -0.038+0.21*(after-tax operating margin) with R2=0.89 and a

variable t-stat of 7.90. The expected EV/S is 1.02, close to the trading revenue multiple of

Cheesecake Factory. By multiplying projected EV/S with sales, we estimated the share price of

$49.26.

For operating multiples, we used adjusted operating income for smoothing out the effect

of outliers whose earnings were affected by non-recurring items in 2017. Before adjusting for

extraordinary items, EV/EBITDA has a standard deviation of 30.18 and EV/EBIT had a standard

deviation of 11.26. Adding back extraordinary items, standard deviations were smoothed down

to 1.84 and 3.30 for EBITDA and EBIT multiples. We got a peer median EV/adj. EBIT of

15.23x and EV/adj. EBITDA of 9.82, projecting the company values of $52.94 and $53.57 by

these two multiples.

ABSOLUTE VALUATION
To determine a value for Cheesecake Factory using absolute valuation, we will employ

the Free Cash Flow to Firm (FCFF) model. With a Debt-to-Equity ratio of just .03, they would

initially appear to be appropriate for an equity valuation model rather than one that evaluates the

whole firm such as FCFF. But, Cheesecake Factory currently has a significant future operating

lease obligation. When the present value of this obligation is treated as debt, the debt-to-equity

ratio becomes .46, and we see that the FCFF model is appropriate. Lease information is available

in Figure 10.

Weighted-Average Cost of Capital

Before calculating the value using FCFF, we must first determine the weighted average

cost of capital of the firm (WACC). Beta was calculated in two ways. The first calculation is a

historical beta that comes from a regression of Cheesecake Factory monthly returns over the

previous five years against the S&P 400 index fund monthly returns. This calculation resulted in

a beta of 0.551. The second method of beta calculation came from the bottom-up method. The

comparable firms used were Cheesecake Factory’s direct competitors traded in the S&P 400:

Texas Roadhouse, Cracker Barrel, and Brinker International Restaurant company. Only S&P 400

firms were used for this calculation to eliminate discrepancy in returns that came from index bias

or differences in firm size. Levered betas for each competitor firm were derived by regressing

monthly stock returns against S&P 400 returns over the previous five years. The bottom-up

method calculated a beta of 0.484. As our base estimate, we will use the regression beta of 0.551

going forward.

To get the cost of equity for the firm, we used the Capital Asset Pricing Model. The risk-

free rate used was 3.10%: the U.S. 10-year Treasury rate at the time of calculation. The market
risk premium used is 5%. This is the estimate commonly used by valuation firm Duff and Phelps.

With these inputs, we calculated a cost of equity of 5.86%.

Getting the cost of debt of Cheesecake Factory is difficult because the firm takes on very

little traditional debt. They have no outstanding bonds and borrow using a revolving line of

credit at a rate of around 1.83%, calculated as .5% above the current Federal Funds Rate.

Information regarding this line of credit came from the 2017 10K. Because the rate they receive

does not take the leases into account, we feel that it is not appropriate as a cost of debt. Instead,

we will use the interest rate spread derived from their interest-coverage ratio, which gave us a

cost of debt of 3.64%. The interest-spread information came from Moody’s.

Using these inputs, a weight of debt and weight of equity calculated using the lease-

adjusted debt, and an effective tax rate of 13.5% (estimated by the firm itself in their 10K) we

can calculate a WACC of 5.01%.

The Valuation Model

For our valuation model, we will use a 3-stage FCFF model. The first stage is constant,

extraordinary growth. We will use a base revenue growth assumption of 4.33%, which comes

from Cheesecake Factory’s 10K projections, for this stage. We anticipate that this growth will be

sustained for three years and then decrease linearly during a seven-year stage two to a terminal

growth rate of 2.00%- the GDP growth rate. Our ten-year extraordinary growth assumption

comes from Cheesecake Factory’s long-term growth plan. According to their 10K, they expect

that the United States can currently sustain 300 Cheesecake Factory locations. There are now

214 locations open, and they opened six stores in the last year and 8.5 stores annually on average

over the previous four years. Thus, their current primary method of growth will sustain growth

for ten years.


Our base EBIT margin assumption is 5.8%, derived from current 10K EBIT projections

and not unreasonable relative to their historical (and downward trending) average EBIT margin

of 7.57%. After taxes, which remain assumed at 13.5% annually, an adjustment is made to the

FCFF for the lease expense and depreciation. Lease expense for the first five years comes from

Figure x and is assumed to be equal to the average of the five payments each year after that.

Depreciation of the leased asset is assumed to be straight-line over ten years and is thus equal to

10% of the leased asset annually. Both depreciation and lease expense are assumed to continue

similar to their current amounts after ten years as Cheesecake Factory adds on more locations.

The full FCFF model is provided in Figure 11 in the appendix. After a firm value of

$4,409,603,412 is calculated, the market value of debt (including the value of operating leases) is

removed, and the remaining equity value is divided by the number of shares to arrive at an

amount per share of $70.85.

SENSITIVTY ANALYSIS

For sensitivity analysis, we focused on beta, short stage growth rate, terminal growth rate

and EBIT margin ratio for the company. The betas for the firms used in the comparable analysis

ranged between 0.45 and 0.8. We used this range to produce our WACC range of 4.00% and

6.00%. The WACC outputs are shown in Figure 12.

The interval for stage 1 growth is 2.5% to 8.3%. The lower bound is the lowest that would

be reasonable in a 3-stage model with a stage 3 growth of 2.00% and the upper bound is the

maximum one-year revenue growth over the previous 10 years. The results of this analysis can

be found in Figure 13.


The third term we analyzed is EBIT margin. We checked the last 10 years EBIT margin

and found the high value is 13% and the low value is 5.8%. Therefore, we chose 5.8% to 13% to

be the range for our analysis. The output for this sensitvity analysis is shown in Figure 14.

The final variable we sensitized is terminal growth rate. The lower bound is the current

GDP growth rate rounded down to a value of 2%. Because the firm cannot grow faster than the

whole economy in the long run, the terminal growth rate should be equal to or less than GDP.We

anticipate that long-term, annual GDP growth could be as high as 4%. We did the sensitivity

analysis for the stock price by using the WACC range that is 4% to 6% and terminal growth rate

range 1% to 4%. The results of this sensitivity analysis can be found in Figure 15.

INVESTMENT THESIS

We believe based on our Cheesecake Factory evaluation that the stock is undervalued and

the stock’s growth prospects over the next six months to a year look positive. The stock price as

of December 31, 2017, was $47.01. Our discounted cash flow analysis derived a share price of

$70.85, and our relative valuation analysis originated a range of share prices of $49.26 to $60.72.

The range of share prices was calculated by regression methods using ratios to determine the

appropriate range of values.

Cheesecake Factory has been working on new projects to increase growth. The company

currently has ten restaurants operating internationally and plans to open up 22 more restaurants

outside the U.S in the next five years. Cheesecake Factory is also developing new restaurant

concepts such as North Italia and Flower Child, to diversify their culinary portfolio. The

company plans to enter into the home consumer packaged goods industry to allow customers to

buy Cheesecake products in grocery stores. These growth prospects have the potential to
gradually increase the Cheesecake factory’s stock price in the next year because they present

new opportunities for the company. The new opportunities are not expected to create dramatic

growth or reinvent the brand.

Cheesecake Factory has recently had a consistent edge over its competition. The

company menu features a variety of food choices and is complemented by a modern restaurant

setting that is popular amongst Cheesecake Factory supporters. Internally the company has been

rated one of the best to work for and has paid a consistent dividend to investors over the past five

years. Cheesecake Factory’s success faces challenges when the economy declines and when

competitors lower their prices. The restaurant chain is not considered upscale, but is also not a

cheap option for consumers. If competitors lower their prices or if the economy falters

Cheesecake Factory’s sales growth becomes at risk and is likely to decline. The stock market has

been volatile recently and has caused the stock to slip slightly, but we feel that it will rebound

over the next year.

An investment in Cheesecake Factory has substantial value. The company dividend has been

consistently increasing over the past five years and is projected to stabilize in the long term.

Sales growth has also been consistent as the company is at the top of its grouping in comparison

to its competitors. We recommend buying Cheesecake Factory stock because of its growth

prospects and consistent revenue growth. Our projected price target over the next six to 12

months for the stock is $62.03.

CONCLUSION

After careful evaluation of Cheesecake stock’s fundamentals, we believe that buying the

stock will be beneficial to investors. Investors will reap the benefits of a consistently growing
dividend and can remain confident that revenues will continue to grow each year which will

positively affect the stock price shortly.


APPENDIX

Fig 8: Valuation multiple comparable analysis


Fig 9: Operating multiples comparable analysis

Fig 10: The future minimum lease payments in thousands on the operating leased asset. (From

2017 10K). PV of payments calculated to be $918,770 (thousand).

Fig 11: FCFF model. All numbers besides value per share are in millions

Fig 12: Sensitivity Analysis of Beta chart


Fig 13: Sensitivity Analysis of short stage growth rate chart

Fig 14: Sensitivity Analysis of EBIT chart

Fig 15: Sensitivity Analysis of stock price chart

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