Stephens Upgrades The Cheesecake Factory, Denny's To Overweight

• In a report issued Thursday, Stephens analysts Will Slabaugh and Billy Sherrill shared an update of their view on the restaurant industry.
• They upgraded Cheesecake Factory Inc CAKE and Denny's Corporation DENN from Equal-Weight to Overweight, setting price targets of $58 and $12.

Analysts at Stephens believe the U.S. consumer is not only healthy, but also improving, especially at the lower end of the spectrum. They “reject the notion that localized declines in energy and industry productivity are negatively impacting consumer spending and believe the restaurant space is becoming increasingly attractive--especially as YOY compares ease after Jan. and restaurant sales outlooks win the relative battle for consumer investors' capital.”

The firm continues to favor the quick service restaurants space, which is exposed to the inflecting lower-end consumer group, but is also becoming increasingly constructive on the broader restaurant industry.

In this context, the analysts decided to upgrade shares of the Cheesecake Factory and Denny’s “on valuation upside as restaurant sentiment likely improves.”

The experts noted that select full service diners now offer a better risk/reward profile than in the past, and listed the Cheesecake Factory, Red Robin Gourmet Burgers, Inc. RRGB and Buffalo Wild Wings BWLD as “primary beneficiaries.”

Cheesecake Factory

Slabaugh and Sherrill believe that the Cheesecake Factory will continue to outperform, not only the restaurant sector, but also the broader consumer space. This will occur on the back of its profile of sustained SSS growth, MSD unit growth, surging international franchised growth and aggressive share buybacks. While analysts acknowledge that the hard quarter-to-date lap could mute guidance for the first quarter, they believe current valuations already reflect this.

The analysts also said they think that “CA cost inflation is both well understood and increasingly offset by declining commodities at this point.” They noted that consensus estimates and guidance imply growth rates that are pretty conservative.

Denny's

Denny's reported record same-store sales growth last year, as its ameliorating brand positioning “led its peers in capturing a larger share of the recently growing family dining segment.”

After the 30 percent tumble the stock experienced since its 2015 highs, the risk/reward seems quite favorable now, especially given the business’ stability and highly cash generation capabilities. Lastly, they highlighted that “impressive steady FCF generation of the business in recent years that, after the stock's pullback, now produces a ~6% yield.”

Disclosure: Javier Hasse holds no positions in any of the securities mentioned above.