Geoff Gannon September 26, 2017

Cheesecake Factory vs. The Restaurant Group

A blog reader emailed me these questions:

“With respect to CAKE and its same-restaurant sales decline, do you have any thoughts on the following:

1.       The strength / source of its economic moat?

2.       Will the cost spread between eating at home and eating away from home narrow, and if so, what will cause it to do so?

3.       Are you worried about declining foot traffic at malls, and brick and mortar stores in general, as it pertains to CAKE?

I’m also wondering if you still feel The Restaurant Group is a potentially attractive idea?”

First, an aside: For those who don’t know, what he’s talking about in #2 is the fact that food prices in U.S. supermarkets have been falling for about 2 years even while food prices in U.S. restaurants have been rising. That’s historically rare. In fact, the recent rate of change in the relative price of food in supermarkets versus food in restaurants may be historically unprecedented.  Other things equal, such a relative price change obviously causes restaurant traffic to fall and supermarket traffic to rise.

Back to the questions…

1) I don’t think Cheesecake Factory (CAKE) has a moat. Everyone goes to multiple restaurants. The most successful restaurant chains do a good job of compounding wealth for shareholders and earning high returns on capital. But, no restaurant is insulated from competition with others. So: no moat.

2) Yes. At some point, prices of food in supermarkets will rise faster than prices of food in restaurants. Several publicly traded supermarkets had EPS declines of 10% to 20% this year. That won’t continue indefinitely. At some point, they will have to open fewer new stores, close some existing stores, and raise prices. Food at home prices have fallen because retailers have accepted pricing that earns them less money. What’s happened is not that food costs are down. It’s that supermarket profits are down. The cycle will get worse as long as rivalry in food retail gets more intense and then it will get better only once rivalry in food retail gets less intense. Right now, food retailers are more intense rivals than restaurants. I haven’t seen anything that changes costs in food. I’ve just seen supermarkets and other retailers lowering prices without lowering costs – and thereby lowering profits for themselves and their competitors.

3) Yes. Declining traffic to malls is the biggest risk for Cheesecake Factory. Management thinks it can grow from about 200 locations in the U.S. to about 300 locations. That means finding another 100 good locations for a Cheesecake Factory where there isn’t already a Cheesecake Factory. If there is a societal shift away from visiting malls, I’m not sure it’ll ever be possible to add 100 more Cheesecake locations in the U.S. It’s true that Cheesecake is in better malls and what I’ve seen anecdotally is the very best malls I’ve been to in New Jersey and Texas show no signs of any traffic decline while the very worst malls I’ve been to in New Jersey and Texas show signs that they are on the verge of being totally abandoned.

I don’t like The Restaurant Group as much as Cheesecake Factory. The Restaurant Group is a fairly typical operator of fairly typical casual dining restaurants in the U.K. Basically, The Restaurant Group does in the U.K. today what plenty of U.S. casual dining operators started doing a couple decades ago. The problem is that the U.K. is behind the U.S. in terms of the development of casual dining restaurant chains. Chains have been expanding faster over there. This means that the pace of expansion of casual dining concepts and the starting of new casual dining concepts in the U.K. is intense compared to the U.S. I don’t like investing in an “unsettled” industry. In the next 5 years, I believe more competing restaurants are going to open near a Restaurant Group location (Franky & Benny’s, Chiquito, etc.) than are going to open near a Cheesecake Factory location.

Cheesecake is a more differentiated concept (it can go in places that make sense for Cheesecake, Maggiano’s, or a higher end restaurant but don’t make sense for your average Chili’s, Olive Garden, Texas Roadhouse, etc.) Cheesecake has a well-known brand (the mindshare is abnormally high for a casual dining restaurant chain). And then Cheesecake is just in places (the U.S., “A” malls, etc.) that aren’t going to add as many restaurants within a drivable radius as what you’re going to see with The Restaurant Group in the U.K.

I’m not saying The Cheesecake Factory stock is better priced probabilistically versus The Restaurant Group stock. Cheesecake may not be a better investment. I’m just saying Cheesecake Factory has a more certain future. And I’m the kind of investor who prefers to put my money into the business with the more certain future.

Just as one indicator of what I mean: The Restaurant Group closed something like 30 locations in just one year recently. By comparison, Cheesecake Factory has rarely ever closed a location with the exceptions of: A) moving to a different nearby location or B) Not renewing a lease after there’s been a change to the mall in some way. In fact, I think they still opened one net new store in 2008-2009.

I am speaking only about The Cheesecake Factory concept. I have no opinion on Grand Lux and Rock Sugar. In my appraisal of the stock, I assume those concepts are worthless and only the company’s namesake concept has value.

For those who don’t know The Restaurant Group, it’s a collection of U.K. casual dining restaurant chains. I wrote a 10,000+ word report on the stock maybe a year or so ago (it’s up on the member site). The company has had problems recently. For a description of what those problems are and what management is doing to fix them, I recommend reading the latest Interim Results press release.