Now that we’ve discussed The Cheesecake Factory’s (CAKE) business model, revenue, sources of revenue, and financial ratios, it’s time to discuss its valuation multiples in an effort to understand where it’s trading compared to its peers.
There are two methods by which we generally compare restaurant companies: trading comparables and discounted cash flows.
Under trading comparables, companies’ price-to-earnings (or PE) and enterprise value-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) ratios are generally used for valuation purposes.
We’ll use forward PE for CAKE’s valuation. PE is the most popular valuation multiple. It’s suitable for businesses with high earnings visibility, such as restaurants. However, while PE can be used to compare companies with stable earnings, it has some disadvantages. For example, PE doesn’t consider a company’s excess cash and cash equivalents.
Comparing CAKE’s PE ratio with its peers’
Over the years, customers have preferred fast food restaurants over casual restaurants. Ever-increasing labor costs have also contributed to slowing growth in the casual restaurant business.
In the last five years, CAKE has traded in the PE range of 12.8x–24.1x. Better-than-expected 1Q15 and 2Q15 results pushed CAKE’s valuation multiple higher. As of May 29, 2016, CAKE was trading close to its midpoint at 18.3x. CAKE’s peers Darden Restaurants (DRI), Bloomin’ Brands (BLMN), Texas Roadhouse (TXRH), and Brinker International (EAT) were trading at PEs of 17.3x, 13.2x, 25x, and 12.6x, respectively.
By focusing on its signature dishes and improving its customer experience, CAKE managed to trade above its peers’ median PE ratio. Darden Restaurants, Bloomin’ Brands, and Brinker International performed worse than expected, which led to falls in their PE ratios.
Although CAKE has reported better-than-expected results in its last two quarters, its share price has fallen. Investors may be worried about CAKE’s falling same-store sales growth and the rise in labor wages, which could negatively affect the company’s margins. This has led to a fall in CAKE’s valuation multiple.
To mitigate company-specific risks, you can invest in the Consumer Discretionary Select Sector SPDR ETF (XLY), invests 13.8% in restaurant and travel companies.