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business newsPF Chang's Fails to Deliver
By
Kristin Graham, CFA Apr 29, 2010 11:20 am
The stock returned about 38% in the last six months, but, like many in the casual dining arena, it's quickly becoming a has-been.
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The vast number of chains popping up and rapidly expanding has made competition fiercer than just about any other industry. Some chains seem to collapse as quickly as they grew. A few, such as McDonald's (MCD) and Yum Brands (YUM), have managed to generate strong return on equity even as very mature entities. But many end up lingering in flat growth, declining margin territory for years after people tire of the fad they created.
Enter PF Chang’s (PFCB). I can remember years ago, friends raving about the infamous lettuce wraps and unique “Chinese” ambiance of this place (I use quotation marks as having been in China for awhile now, I can attest that PF Chang’s menu offers little resemblance to authentic Chinese food). PF Chang’s was essentially the Chipotle (CMG) of yesteryear.
Like many in the sea of casual dining establishments though, PF Chang’s is emerging into a has-been brand. It’s not that the company has financial troubles or will disappear anytime soon, it’s just that there’s not really anywhere for it to go in terms of growth.
For some reason, the stock has been on a tear as of late, returning about 38% in the last six months and 190% since the end of 2008, when it bottomed around $15 per share. If I had to guess, I’d say the momentum stems from a general anticipation of overall recovery in the restaurant sector because it has historically been one of the first places consumers start to spend following a recession.
My doubts about the validity of recent returns were validated yesterday with first-quarter earnings. The company posted a slip in revenue and a plummeting bottom line that fell 34.9%. Comps at Pei Wei rose 2.2%, but declined 2.7% at Bistro locations, thanks to heavy discounting.
Things really aren’t all that bad for PF Chang’s, specifically given the environment it’s competing in. Sales have exhibited positive growth in the last few years, even without raising prices in the last two years. And its balance sheet appears quite sound. Even with 37% debt to equity, it generates plenty of operating income to cover debt obligations.
The company also recently established a relationship with Unilever (UL). But it seems as if the competition between casual dining restaurants and the grocery store's frozen-food aisle is becoming as competitive as between the restaurants themselves. It’s by no means a first move and it almost seems as if casual dining chains have to compete in grocery stores to maintain strong brand identity among consumers. The new segment will undoubtedly help expand margins and bolster sales, but I don’t think it’s a growth avenue to rely on long term.
To me, PF Chang’s just doesn’t stand out as a stellar investment. Its operating margin is razor thin against industry competition; management doesn’t expect operating margins to surpass 2009 levels the rest of this year.
While the relative PE doesn’t stand out as greatly overvalued in comparison to some of its peers, several other factors suggest the stock is overvalued. Management recently unloaded shares -- 30% net insider shares sold in the last six weeks. And they recently declared a dividend rather than a share buyback to employ idle cash.
The dividend also represents the fact that management sees more value in returning cash to investors rather than expanding the business. PF Chang’s will open 50% less stores this year. And while I applaud management’s prudent growth strategy, since many restaurants tend to way over expand -- i.e. Starbucks (SBUX) -- these facts indicate that PF Chang’s is no longer the hot shot grower it once was and suggest it's becoming a more mature establishment. And alas, the company’s PE should be smaller than some of its faster growing peers.
For the restaurant sector in general, I think it’s better to bet on up-and-comers, ride the growth up, and get out. Many maturing restaurants struggle to deliver shareholder value and I feel that’s where PF Chang’s stands today.
No positions in stocks mentioned.
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