P.F. Chang's Sweet and Sour Outlook


By Eric Wahlgren In little more than three years since its debut as a public company, P.F. Chang's China Bistro (PFCB) has whipped up a promising recipe for success. The Scottsdale (Ariz.) company is building a nationwide chain of upscale Chinese restaurants whose only real competition is the tens of thousands of independent mom-and-pop operators where Americans typically go for their Chinese food.

Proof of fast-growing P.F. Chang's popularity? The chain, which went public in December, 1998, increased revenues 35% in 2001. In early January, it told Wall Street it expects to exceed fourth-quarter profit estimates of $0.30 to $0.32 a share when it reports earnings on Feb. 13. And in 2002, revenues are expected to go up an additional 27%.

"No one has tried to dominate the Chinese food category in the past," says Greg Schroeder, an analyst with Fulcrum Global Partners in New York. "It has the potential of becoming a category killer and building a brand similar to what Outback has in steaks, Starbucks has in coffee, and Krispy Kreme has in doughnuts."

SHOULD YOU BUY? The stock has been nearly as appealing to investors as P.F. Chang's fare has been with diners. Shares have jumped about 78% since January of last year, closing around $56 on Jan. 29. So, if you had bought 1,000 shares back then, today you'd be nearly $25,000 richer, at least on paper. Here's the question whose answer you won't find in any fortune cookie: Should you still buy the stock?

Analysts are still bullish on P.F. Chang's future, even though the consensus view on the Street is that its valuation is too high -- about 37 times projected 2002 earnings -- given the likelihood that its earnings growth will decline as the company expands. The chain, which operated 62 full-service restaurants under the "P.F. Chang's China Bistro" name and two casual-dining "Pei Wei Asian Diners" at the end of its third quarter, plans to open 13 to 15 more bistros and 8 to 10 more diners this year.

Lynne Collier, restaurant analyst and vice-president at investment firm Stephens Inc. in Dallas, projects earnings growth will slow to about 29% in 2002, vs. about 36% for 2001. If you're looking for short-term gains, it's probably better to wait for the stock to drop some, suggests Collier, who has cut her investment rating to neutral from outperform on valuation concerns. "If I had a three- to five-year investing horizon, I would own it," says Schroeder. "If I had a shorter horizon, I might wait." The company declined to comment for this story.

FEW RIVALS. P.F. Chang's long-term potential is strong, analysts say. Aside from the independent Chinese eateries found in most American cities, P.F. Chang's faces few if any national rivals in its niche. Publicly traded Benihana (BNHN) serves Japanese cuisine. Main Street & Main (MAIN), the largest franchisee of T.G.I. Friday's restaurants, operates a handful of Bamboo Club eateries. But analysts say Bamboo Clubs are more pan-Asian than strictly Chinese. And "P.F. Chang's is better proven in their ability to duplicate success in a lot of geographic areas," says Mark Sheridan, an analyst with Johnson Rice in New Orleans.

Analysts also agree that P.F. Chang's is unlikely to suffer the fate of so-called "eatertainment" restaurants, such as troubled Planet Hollywood, which is struggling to maintain its relevance in a cutthroat biz. Customers often go to these theme restaurants once to see what the hype is about, but many never return, analysts say.

P.F. Chang's is different, they say: The average diner's bill is $18, and the eateries get plenty of repeat business because they serve quality food at reasonable prices. Zagat, the national restaurant rating service, gives the chain's Los Angeles-area bistros a 20 rating on a 0 to 30 scale, putting it in its "very good to excellent" category. The same review says "sure, it's a formula, but a nice one."

MORE THAN A FAD? Thanks in part to its growing reputation, the typical P.F. Chang's restaurant is also near the top of the restaurant industry in terms of sales volume, analysts say. Units average around 7,000 square feet and generate $5.4 million in annual sales, translating into sales of more than $750 per foot, Schroeder says. Only the Cheesecake Factory (CAKE) has a higher sales productivity measure, he adds.

"Along with the Cheesecake Factory, I put P.F. Chang's as the highest quality in terms of restaurant-industry growth stories," says Collier. "I don't think they have a faddish quality. The concept works over the long term." Schroeder says he expects P.F. Chang's to continue adding 14 to 15 new bistros a year, reaching its target of 125 to 150 units by 2006.

Behind the chain's growth plan is solid management, many analysts believe. At the end of the third quarter, the company had virtually no debt -- only about $2 million -- and net cash of about $32 million, enough to keep it on the fast track, says Sheridan. P.F. Chang spends on average about $2.2 million to open up new bistros, which are often located in suburban areas and malls.

FICKLE INDUSTRY. Instead of selling franchises and earning royalties from them, P.F. Chang's retains ownership of its outlets. But the company has a partner model, which typically requires the restaurant operator, chef, and regional manager to invest in the enterprise in return for a share of the cash flow. "The system allows them to attract and retain the best people in the industry," says Sheridan. "The [managers] think like owners."

Of course, there are some risks. The restaurant industry is fickle, subject not only to customers' whims but also to fluctuations in the cost of food and labor, among other factors. What's more, P.F. Chang's stock is actually quite volatile, given that about half of the 10 million shares in the public float were sold short. That means a lot of investors out there are betting that the shares are overpriced for a variety of reasons, including the challenges the company faces in building a national Chinese restaurant chain, says Schroeder.

It also means that the stock can spike dramatically on good news, since any share-price increase can force short-sellers to buy to cover their positions. "[The chain] can't grow so fast forever," says Sheridan. "But it has maintained a higher rate of growth than was expected."

So if you have a long-term investing horizon, you might want to get a serving of what analysts call one of the most promising new restaurant chains on the scene right now, especially if the price dips. But if you're looking for some quick gains, you might be better off treating this hot stock like a red chili pepper -- with extreme care. Wahlgren covers financial markets for BusinessWeek Online in New York


China's Killer Profits
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