Cheesecake Makes All The Difference

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It's tough to pick out winners in the highly competitive casual dining restaurant business. Cheesecake Factory (NASDAQ: CAKE), however, has managed to clearly differentiate itself and reward shareholders handsomely. As one of the few restaurants with a unique concept to differentiate itself from others, will Cheesecake Factory continue to reward investors over the next five to ten years?

Ingredients for success

Always located on prime real estate, the Cheesecake Factory franchise (which makes up the majority of Cheesecake Factory's revenue) features over 200 menu items. It's designed with French limestone floors, an exhibition kitchen, and decorative columns. While the majority of sales come from dinner items like pasta, pizza, and steak, its 40 flavors of cheesecake represent a solid 15% of sales. The restaurant's renowned cheesecake offers a source of differentiation for the company.

Differentiation, of course, is paying off. Among the top 100 restaurant chains, Cheesecake Factory has, by far, the highest average sales per restaurant, almost doubling the sales of runner-up P.F. Chang's. Similarly, Apple's brand showcasing retail stores have more than doubled the runner-up in sales per square foot among retail chains in the U.S. Just as Apple's retail store sales highlight the pent-up demand for Apple's products, Cheesecake Factory's massive lead in sales per restaurant speaks volumes about their ability to stand out among other diners.

At an average check per customer of $18, investors and analysts have expressed concern for the companies prospects in an economic environment with deteriorating consumer confidence. But the company continues to deliver. In the companies most recent earnings release (Q3) revenue was up 5.4%. More importantly, comparable restaurant sales at its Cheesecake Factory franchise were up 2.9%, despite rough economic headwinds. Finally, gross margin even expanded by 80 basis points.

Delighted shareholders

While Cheesecake Factory ramps up expansion and records increases in margins and comparable store sales, many other diners are struggling. Darden Restaurants (NYSE: DRI), for example, faced a 2.7% decline in same-store sales across its three core franchises: Olive Garden, Red Lobster, and LongHorn Steakhouse. Furthermore, while Cheesecake Factory ramps up expansion, others are slowing expansion. Darden recently announced that it is slowing unit openings in fiscal 2014, reducing its CapEx by 10%. 

Though Cheesecake Factory's stock price has lagged peers like Darden Restaurants, Brinker International (NYSE: EAT), and DineEquity (NYSE: DIN), it still stomped the market's returns over the last five years.

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CAKE data by YCharts

What can investors expect going forward?

Will Cheesecake Factory continue to underperform its publicly traded peers over the next five years? Probably not.

One simple way to identify potential winners for the next five or ten years is to identify restaurants with (a) a form of differentiation and (b) plenty of room for growth. With only approximately 150 Cheesecake Factory locations and current penetration in just about half of the top 100 U.S. markets, the differentiated casual diner is poised for success over the next five to ten years.

Raking in 5.8% of sales in free cash flow and trading at a 6.2% free cash flow yield, Cheesecake Factory trades at a valuation in line with both Darden and Brinker International. But Cheesecake Factory management is very optimistic going forward, projecting mid-teens earnings growth as the company ramps up expansion. 

The bottom line

Cheesecake Factory has not only managed to differentiate itself from its peers with a unique dependence on cheesecake in its branding, but it also has ample opportunity for expansion into more major U.S. markets. These two factors make Cheesecake Factory a great long-term bet. With a P/E of 17 and a FCF yield of 6%, the stock isn't cheap. But solid economics and a positive outlook for the next five to ten years make the stock a solid bet for long-term investors.

DanielSparks has no positions in the stocks mentioned above. The Motley Fool owns shares of Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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