Equity Analysis and Valuation of P.F. Chang’s China Bistro
Brett Schroeder
Brett.Schroeder@ttu.edu
Gates Enoch
Gates.Enoch@ttu.edu
Jd Benton
Jd.Benton@ttu.edu
Drew Williams
Drew.Williams@ttu.edu
Rosemary Musoke
Rosemary.Musoke@ttu.edu
1|Page
Contents
EXECUTIVE SUMMARY............................................................................9 INDUSTRY ANALYSIS ............................................................................................... 12 ACCOUNTING ANALYSIS ........................................................................................... 14 FINANCIAL ANALYSIS .............................................................................................. 16 VALUATION ANALYSIS ............................................................................................. 19 COMPANY OVERVIEW...........................................................................22 INDUSTRY OVERVIEW..........................................................................24 FIVE FORCES MODEL ............................................................................26 RIVALRY AMONG EXISTING FIRMS .............................................................................. 28 Industry Growth Rate ...................................................................................... 28 Concentration of Competitors ........................................................................... 32 Differentiation................................................................................................. 35 Switching Costs............................................................................................... 37 Scale Economies ............................................................................................. 38 Fixed To Variable Costs.................................................................................... 40 Excess Capacity .............................................................................................. 43 Exit Barriers .................................................................................................... 46 THREAT OF NEW ENTRANTS ...................................................................................... 47 Economies of Scale ......................................................................................... 47 First Mover Advantage ..................................................................................... 49 Access to Channels of Distribution and Relationships.......................................... 49 Legal Barriers.................................................................................................. 50 Conclusion...................................................................................................... 51 THREAT OF SUBSTITUTE PRODUCTS ............................................................................ 52 Relative Price and Performance ........................................................................ 52 Customer’s Willingness to Substitute................................................................. 53 Conclusion...................................................................................................... 54 BARGAINING POWER OF CUSTOMERS ........................................................................... 54 Differentiation................................................................................................. 55 2|Page
Price Sensitivity............................................................................................... 55 Number of Customers...................................................................................... 57 Importance of product for costs and quality ...................................................... 59 Volume per buyer............................................................................................ 60 Switching Costs............................................................................................... 60 Conclusion...................................................................................................... 61 BARGAINING POWER OF SUPPLIERS ............................................................................. 62 Switching Costs............................................................................................... 62 Differentiation................................................................................................. 63 Importance of Product for Costs and Quality ..................................................... 63 Number of Suppliers........................................................................................ 64 Volume Per Suppliers....................................................................................... 65 Conclusion...................................................................................................... 65 INDUSTRY CLASSIFICATION GIVEN FIVE FORCES ............................................................. 66 ANALYSIS OF KEY SUCCESS FACTORS .................................................67 DIFFERENTIATION .................................................................................................. 68 Superior Product Quality .................................................................................. 69 Superior Customer Service ............................................................................... 70 Investment in Brand Image.............................................................................. 71 Conclusion...................................................................................................... 72 COST LEADERSHIP ................................................................................................. 73 Economies of Scale ......................................................................................... 73 Efficient Production ......................................................................................... 75 Research and Development and Brand Advertising............................................. 77 Tight Cost Control System................................................................................ 78 Conclusion...................................................................................................... 79 COMPETITIVE ADVANTAGE ANALYSIS .................................................79 SUPERIOR PRODUCT QUALITY ................................................................................... 80 SUPERIOR CUSTOMER SERVICE .................................................................................. 81 PRODUCT COST ..................................................................................................... 81 3|Page
CONCLUSION ........................................................................................................ 82 ACCOUNTING ANALYSIS ......................................................................83 KEY ACCOUNTING POLICIES ................................................................84 TYPE ONE ACCOUNTING POLICIES .............................................................................. 85 Economies of Scale ......................................................................................... 86 Superior Customer Service ............................................................................... 88 Superior Product Quality .................................................................................. 90 TYPE TWO ACCOUNTING POLICIES .............................................................................. 91 Defined Contribution Plan ................................................................................ 91 Goodwill ......................................................................................................... 92 Operating Leases ............................................................................................ 93 ASSESS DEGREE OF ACCOUNTING FLEXIBILITY ..................................94 OPERATING/CAPITAL LEASES .................................................................................... 95 BENEFITS AND PENSION PLANS .................................................................................. 97 GOODWILL........................................................................................................... 98 RESEARCH AND DEVELOPMENT................................................................................... 98 EVALUATE ACTUAL ACCOUNTING STRATEGY .......................................99 OPERATING/CAPITAL LEASE ...................................................................................... 99 DEFINED CONTRIBUTION PLANS ................................................................................100 GOODWILL..........................................................................................................101 RESEARCH AND DEVELOPMENT..................................................................................101 CONCLUSION .......................................................................................................101 QUALITY OF DISCLOSURE ..................................................................102 QUALITATIVE ANALYSIS ....................................................................103 SUPERIOR PRODUCT SERVICE/QUALITY .......................................................................103 DEFINED BENEFITS PLAN ........................................................................................104 BUSINESS SEGMENTS .............................................................................................104 GLOBAL BRAND DEVELOPMENT .................................................................................105 ECONOMIES OF SCALE ............................................................................................106 OPERATING LEASES ...............................................................................................106 4|Page
QUANTITATIVE ANALYSIS..................................................................107 SALES MANIPULATION DIAGNOSTICS ..........................................................................108 Net Sales/Cash from Sales ..............................................................................109 Net Sales/Inventory (raw)...............................................................................110 Net Sales/Inventory (Change) .........................................................................111 Net Sales/Net Account Receivables ..................................................................113 Net Sales/Unearned Revenues.........................................................................113 Net Sales/Unearned Revenues (change)...........................................................115 Net Sales/Warranty Liabilities ..........................................................................116 Sales Diagnostics Conclusion ...........................................................................116 EXPENSE MANIPULATION DIAGNOSTICS .......................................................................117 Asset Turnover (raw)......................................................................................118 Asset Turnover (change).................................................................................119 CFFO/OI (raw) ...............................................................................................121 CFFO/OI (change) ..........................................................................................122 CFFO/NOA (raw) ............................................................................................124 CFFO/NOA (change) .......................................................................................125 Total Accruals/Sales (raw) ..............................................................................126 Total Accruals/Sales (change) .........................................................................128 Pension Expense/SG&A...................................................................................129 Other Employment Expenses/SG&A .................................................................130 Expense Diagnostics Conclusion ......................................................................130 IDENTIFY POTENTIAL RED FLAGS......................................................131 OPERATING LEASES ...............................................................................................131 UNDOING ACCOUNTING DISTORTIONS.............................................133 OPERATING LEASES ...............................................................................................133 FINANCIAL STATEMENTS .........................................................................................139 Balance Sheet ................................................................................................140 Balance Sheet Restatement Evaluation.............................................................145 Income Statement..........................................................................................146 5|Page
Conclusion.....................................................................................................150 FINANCIAL ANALYSIS, FORECASTING, AND ESTIMATING COST OF CAPITAL
ESTIMATION.......................................................................................151 FINANCIAL ANALYSIS ........................................................................152 CURRENT RATIO ...................................................................................................154 QUICK ASSET RATIO ..............................................................................................156 ACCOUNTS RECEIVABLE TURNOVER ............................................................................157 DAYS SALES OUTSTANDING .....................................................................................159 INVENTORY TURNOVER RATIO ..................................................................................161 DAYS’ SUPPLY OF INVENTORY ...................................................................................163 WORKING CAPITAL TURNOVER .................................................................................165 CASH TO CASH CYCLE ............................................................................................167 CONCLUSION .......................................................................................................169 PROFITABILITY RATIO ANALYSIS .....................................................170 GROSS PROFIT MARGIN ..........................................................................................171 OPERATING EXPENSE RATIO ....................................................................................172 OPERATING PROFIT MARGIN ....................................................................................174 NET PROFIT MARGIN .............................................................................................176 RETURN ON ASSETS...............................................................................................178 ASSET TURNOVER .................................................................................................180 RETURN ON EQUITY ..............................................................................................182 CONCLUSION .......................................................................................................184 CAPITAL STRUCTURE RATIO ANALYSIS .............................................185 DEBT TO EQUITY RATIO .........................................................................................185 TIMES INTEREST EARNED ........................................................................................187 DEBT SERVICE MARGIN ..........................................................................................189 Z-SCORE ............................................................................................................191 INTERNAL GROWTH RATE........................................................................................193 SUSTAINABLE GROWTH RATE ...................................................................................195 CONCLUSION .......................................................................................................197 6|Page
FINANCIAL FORECASTING .................................................................198 INCOME STATEMENT ..............................................................................................198 As Stated Income Statement...........................................................................201 Restated Income Statement ............................................................................206 BALANCE SHEET ...................................................................................................212 As-Stated Balance Sheet .................................................................................215 Restated Balance Sheet ..................................................................................219 STATEMENT OF CASH FLOWS....................................................................................224 ESTIMATING COST OF CAPITAL .........................................................229 COST OF EQUITY ..................................................................................................229 SIZE-ADJUSTED COST OF EQUITY ..............................................................................235 ALTERNATIVE COST OF EQUITY .................................................................................236 COST OF DEBT .....................................................................................................237 WEIGHTED-AVERAGE COST OF CAPITAL (WACC) ..........................................................239 METHOD OF COMPARABLES ......................................................................................241 Trailing Price to Earnings (P/E)........................................................................242 Forward Price to Earnings (P/E).......................................................................244 Price to Book (P/B).........................................................................................245 P.E.G Ratio ....................................................................................................246 Price to EBITDA .............................................................................................248 Enterprise Value to EBITDA.............................................................................249 Price to Free Cash Flow ..................................................................................251 Conclusion.....................................................................................................252 INTRINSIC VALUATION MODELS .......................................................252 DISCOUNTED DIVIDENDS MODEL...............................................................................254 DISCOUNTED FREE CASH FLOWS MODEL .....................................................................256 RESIDUAL INCOME MODEL.......................................................................................259 As Stated Residual Income Sensitivity Analysis .................................................261 Restated Residual Income Sensitivity Analysis...................................................262 LONG RUN RESIDUAL INCOME MODEL.........................................................................263 7|Page
As Stated Long Run Residual Income Model .....................................................265 Restated Long Run Residual Income Model ......................................................267 ABNORMAL EARNINGS GROWTH MODEL ......................................................................268 As stated Abnormal Earnings Growth Sensitivity Analysis ...................................270 Restated Abnormal Earnings Growth Sensitivity Analysis....................................272 APPENDIX...........................................................................................275 TRIAL BALANCES (ON NEXT PAGE) ............................................................................275 PROFITABILITY RATIOS ..........................................................................................283 CAPITAL STRUCTURE RATIOS ...................................................................................285 GROWTH RATE ....................................................................................................286 REGRESSIONS ......................................................................................................288 METHOD OF COMPARABLES ......................................................................................313 INTRINSIC VALUATION MODELS (SEE NEXT PAGE) .........................................................316 8|Page
Executive Summary
Analyst Recommendation: SELL (Overvalued)
PFCB – NasdaqGS (6/01/2010) $43.48
52 Week Range $33.19 ‐ $43.48 Revenue 1,228.18 Million Market Capitalization 1,004.56 Million 23.104 Million Shares Outstanding Book Value per Share As Stated As Stated 14.51 14.26 Return on Equity 13.90% 12.04% Return on Assets 6.68% 4.48% Cost of Capital
Estimated Adj. R² Beta Size Adj. Ke 3 month 0.3926 1.113 12.91% 1 year 0.3925 1.111 12.89% 2 years 0.393 1.113 12.91% 5 years 0.394 1.116 12.93% 10 years 0.3939 1.116 12.93% As Stated 4.76% 11.30% 10.70% 6.62% Restated N/A 12.53% 11.04% 11.83% Backdoor Ke WACCbt WACCat Cost of Debt 9|Page
Lower Bound Center Value Upper Bound Ke 7.17% 11.23% 17.06% Size Adj. Ke 8.87% 12.93% 18.76% WACCbt 7.03% 11.30% 14.35% Financial Based Valuations
As Stated
Trailing P/E
$
51.48
Forward P/E
$
109.03
Dividends to Price
Restated
N/A
$
88.44
N/A
N/A
Price to Book
$
44.53
$
43.74
P.E.G Ratio
$
17.90
$
14.07
Price to EBITDA
$
42.56
$
56.06
EV/EBITDA
$
51.12
$
67.34
Price to FCF
$
36.18
N/A
Altman Z-Score
2005
2006
2007
2008
2009
Initial Scores
7.80
5.53
3.94
3.45
4.28
Adjusted Scores
4.30
3.48
2.45
2.50
3.23
As Stated
Restated
Discounted Dividends
$
28.47
N/A
Free Cash Flows
$
98.63
N/A
Residual Income
$
23.00
$
19.11
Long Run Residual Income
$
26.09
$
22.09
Abnormal Earnings Growth
$18.73
$15.21
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11 | P a g e
Industry Analysis
P.F. Chang’s Bistro competes in the Restaurant industry, but more specifically the
up-scale restaurant industry. The firm establishes high quality food from which the
ingredients are shipped from all parts of the world so they can provide their customers
with a great authentic Chinese cuisine. P.F. Chang’s competitors are comprised of The
Cheesecake Factory, O’Charley’s Steak Houses, and Chipotle Mexican Grill. The one
aspect of business in which all companies compete on in this industry is superior
customer service and high quality food.
The first step we took in determining the positions of each firm and their relative
forces that drive competition and profits was to complete Porter’s Five Forces Model.
This allowed us to view each company and how well they position themselves within
the industry to gain market share and increase profits. The table below provides the
data that was accumulated throughout the industry and company analysis.
PF Chang's Competitive Force
Rivalry Among Existing Firms:
Level of Competition
Moderate-High
Threat of New Entrants:
Low
Threat of Substitute Products:
High
Bargaining Power of Customers:
High
Bargaining Power of Suppliers:
Low
The above table provides evidence that the rivalry among existing firms is
moderately high to high. This is caused by price competition and the need to expand
businesses throughout the country and partially overseas. The overall industry
competitiveness helps the individual firm’s lower prices and to compete against one
12 | P a g e
another on market share. This creates a high degree of rivalry among existing firms in
the restaurant industry. The threat of new entrants tends to be very low in this
particular industry mostly due to the opening costs and creativity it takes to open a new
style of restaurant and compete with the already existing firms. The government
regulates the number of industries and provides standards for the quality of goods
produced to customers. In the restaurant industry, restaurants must obtain certain
licenses and permits in order survive in this industry. Firms in this industry maintain a
competitive advantage over its competitors by following these rules and regulations.
The threat of substitute products is very high in the restaurant industry which is
mostly caused by customers not willing to spend their income on up-scale restaurants
and fine dining experiences. In the restaurant industry the main focus is cost cutting
strategies, overall quality of service, and differentiation from competitors. In the
restaurant industry the threat of substitute products is high and switching costs are low
which makes the market very volatile. The bargaining power of customers in the
restaurant industry tends to be very high as well. Although individual customers can do
little to influence the price and quality of particular restaurants, the customer base is
able to exert pressure on firms within the industry; if a firm’s prices are too high or the
quality is lacking, discerning consumers will avoid the firm altogether, causing a failure
of the firm. The last five force is bargaining power of suppliers, which is very low in the
restaurant industry. The reason is that there is a large plethora of suppliers with very
little differentiation between products. If a company is upset with the quality or pricing
of its purchases with a supplier, it can easily look around for another supplier to step in
and fill its needs. The restaurants will drive prices down to increase revenue and
profitability with its bargaining leverage it has on its suppliers.
Overall, the restaurant industry or the up-scale restaurant industry is very
competitive within the existing firms, but does not show any threat to new entrants
entering the industry. In order to make it in this industry it is shown that these
companies must adopt and maintain a mixture of cost leadership strategies and product
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differentiation. This allows each firm to fully utilize their resources and compete at the
highest level possible so they can make sure profits increase in the future.
Accounting Analysis
P.F. Chang’s key accounting policies can begin to give us some insight into the
true financial positioning that they have within the restaurant industry. With the GAAP
policies in place, there is a push toward uniformity in the financial workplace, but there
is still room for managers to be flexible with the reporting of numbers and level of
disclosure of information presented. This flexibility though can be taken advantage of
and sometimes abused by managers if not closely watched. Managers have the
capability of easily distorting accounting numbers to the point that they can make the
company show whatever they want to. This can make the true valuing of a company
difficult and does not show true transparency. A way to not have such a vague view of
a company, one can look at the type one and two accounting policies to determine
useful ways to restate distortions in financial statements.
Type one key accounting policies are directly tied with the disclosure key success
factors of the firm. P.F. Chang’s competes on differentiation and cost leadership within
the restaurant industry. The type one key accounting policies for P.F Chang’s are
economies of scale, superior customer service, and superior product quality. The
success level and the way that these policies are implemented is a direct link to how a
firm’s success. For the most part, P.F. Chang’s does a good job in disclosing information
regarding type one policies, the level of disclosure is fairly high in this area. As always,
more literature could have been added but we do not feel as though P.F. Chang’s was
trying to hide any information.
Type two key accounting policies are the items on the financial statements that
are commonly distorted by managers of a firm. The type two policies that we looked at
in P.F. Chang’s are defined contribution plan, goodwill, and operating leases. As stated
14 | P a g e
earlier GAAP allows flexibility in these areas, and it is allowed as long as it does not
alter the financials to a high level. For P.F. Chang’s operating leases were the only item
that was needing to be restated.
The next step in accounting analysis is to look at a firm’s accounting strategy.
This is the way that a firm uses the flexibility to show the kind of numbers that they
want to report. There is two ways of reporting: aggressive strategy or conservative
strategy. Aggressive firms will understate liabilities and overstate assets to increase
their equity and net income. In contrast, conservative firms will overstate liabilities and
understate assets, which decrease equity and net income. The ability to identify which
strategy a firm is using will allow investors and analysts to have a more transparent and
clear view of the firm’s true value. After looking at P.F. Chang’s statements, we
concluded that they are taking an aggressive accounting strategy. The only real
distortion was through the use of operating leases to keep liabilities off the books. The
level of disclosure on this matter is high but that still does not take away from the fact
that these items needed to be restated to get a better picture of the firm financially.
Evaluating the financials of a firm can give us the big picture of a firm but may
not be a fair representation of how the firm is truly operating. To get this the quality of
disclosure on the firm as a whole must be evaluated. A firm can either have a low level
of disclosure of information or can have too much irrelevant information, both of which
could be used to hide the useful information. After assessing P.F. Chang’s level of
disclosure, it is apparent that the information is moderate to low in the area of
disclosure.
Identifying potential red flags is the key step in overall accounting analysis. This
is the method of deciding what items will be restated in a company’s financials to make
the value more transparent. In P.F. Chang’s the only red flag that we found was the use
of operating leases to decrease the value of liabilities. We then rested the financials to
show the capitalization of operating leases. After this restatement, we compared the
two sets of financials, as stated and restated, and it was obvious that the numbers were
15 | P a g e
being distorted. The restated financials then gave us a more clear view of the true
financial strength of the company.
Financial Analysis
There are three major steps to complete when evaluating the financial status of
a firm. They are financial analysis, forecasting, and estimating the cost of capital. The
financial analysis is completed by using various ratios. The ratio analysis can be utilized
to determine the firm’s value in comparison to its competitors and the industry
averages. We will use liquidity, profitability, and capital structure ratios to forecast P.F.
Chang’s income statement, balance sheet and statement of cash flows. By using these
comparisons, we are able obtain a basis for making forecasts of future performance.
Forecasting for a firm is when ratios are completed in the financial analysis and add
industry intuition, knowledge, and estimations to show the possible future financial
status of the firm. Once this is completed, the forecasting is used to estimate the cost
of capital. The cost of capital will be estimated by utilizing the Capital Asset Pricing
Model, and the cost of dent will be calculated by using the stated interest rates. The
before and after tax Weighted Average Cost of Capital will be valued using the cost of
debt and cost of equity estimations. The chart below will include results from all
liquidity ratios for P.F. Chang’s Bistro.
Ratio
Liquidity Ratio Analysis
Trend
Current Ratio
Quick Asset Ratio
Inventory Turnover
Days’ Supply of Inventory
Accounts Receivables Turnover
Days Sales Outstanding
Cash to Cash Cycle
Working Capital Turnover
Overall
Performance
Slightly Decreasing
Underperforming
Steady
Average
Steady
Outperforming
Steady
Outperforming
Slightly Decreasing
Slightly Underperforming
Slightly Increasing
Slightly Underperforming
Steady
Slightly Outperforming
Slightly Decreasing
Underperforming
Slightly Decreasing
Underperforming
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Based on the liquidity ratio analysis, P.F. Chang’s has maintained a slightly
decreasing trend for the past five years for all ratios and has underperformed the
industry as a whole. These ratios describe how quick and accessible P.F. Chang’s can
generate or receive cash. The next set of ratios is the profitability ratios.
Profitability Ratio Analysis
Ratio
Gross Profit Margin
Operating Profit
Margin
Net Profit Margin
Asset Turnover
Return on Assets
Return on Equity
Trend
Performance
Restated
Performance
Slightly
Increasing
Outperforming
N/A
Average
Slightly
Underperforming
Average
Outperforming
Underperforming
Average
Underperforming
Slightly Outperforming
Increasing
Steady
Steady
Slightly
Decreasing
Slightly
Decreasing
Slightly
Increasing
Underperforming
Overall
Based on the profitability ratios, P.F. Chang’s has still been slightly decreasing in
their ratios for the past five years, but look to be outperforming the market as a whole
for the profitability ratios. The restated ratios look to be underperforming the market
as a whole.
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Capital Structure Ratio Analysis
Ratio
Trend
Performance
Restated
Performance
Debt to Equity
Slightly Decreasing
Slightly Outperforming
Underperforming
Times Interest Earned
Slightly Increasing
Underperforming
Underperforming
Debt Service Margin
Steady
Underperforming
N/A
Altman's Z-Score
Slightly Increasing
Slightly Underperforming
Slightly Increasing
Internal Growth Rate
Slightly Increasing
Slightly Outperforming
Slightly Underperforming
Sustainable Growth Rate
Increasing
Outperforming
Slightly Outperforming
Overall
The capital structure ratios for P.F. Chang’s have showed a positive trend for the
past five years and seem to be underperforming the market as a whole. The restated
performance shows to be underperforming the market as well.
To get a clear picture of the future financials, we forecasted ten years out on the
income statement, balance sheet, and the statement of cash flows. We started with
the income statement, because it is the most important of the financials when
determining the future profitability of the company.
P.F. Chang’s fiscal year ends on December 31st, which allows us to receive the
first quarterly report of 2010. This gives a more precise starting point for the sales
forecast in year 2010. To start, we looked at the fourth quarter sales for 2009 as a
percentage of total revenue in 2009. This amount came out to be roughly 25% of total
revenues in 2009. The next step was to take the first quarter of 2010 and multiply it by
four to come up with 2010 total sales. Since P.F. Chang’s sales have been decreasing
over the past few years, we determined that a growth rate of 1.06% would justify the
sales in 2010.
Due to the effects of capitalizing operating leases, P.F. Chang’s Balance
Sheet must be evaluated on an as-stated and restated level. Some of the balance
sheet accounts, such as current assets and current liabilities, are not affected by the
capitalizing of operating leases. However, since some other balance sheet accounts are
18 | P a g e
affected, it follows that the future forecasts of these accounts must be done on an asstated and restated level.
The statement of cash flows is the final forecasted financial statement, which
revolves around the cash in and out flows of a firm. The statement of cash flows is
comprised of cash flows from operating activities (CFFO), cash flows from investing
activities (CFFI), and cash flows from financing activities (CFFF). In order to obtain
projected sales, we had to determine the growth rate of sales by using net income as a
percentage of sales. We concluded that net income would remain that same as in the
as-stated income statement. We utilized the same rate in forecasting net income on the
income statement, which is the same rate as the as stated. For the years of 2007 –
2009, the percent of sales of net income was volatile; we then proceeded to review the
average. We took an average of the as stated net income, which was 3.57 % and
utilized 3.7% of projected total sales as our first line item, which is how we calculated
net income.
Valuation Analysis
After the industry, accounting, and financial analyses are done, we are then able
to perform a valuation analysis. When doing a valuation analysis, an analyst position
must be taken, this is the percentage more or less than the observed price that would
consider a firm’s stock overvalued or undervalued when running valuation models. We
chose to use a 10% analyst position as we felt this would be the most reliable and
consistent results. If a 5% position is used this could be too small of a variance to be
considered under or overvalued, and 20% we felt would give too much leeway to fair
pricing valuation. With P.F. Chang’s an observed price of $38.34 on June 1, 2010 means
that any price less than $39.13 P.F Chang’s stock would be considered overvalued and
any price greater than $47.83 P.F. Chang’s stock would be considered undervalued. The
two different techniques to performing a valuation analysis are method of comparables
and intrinsic valuation models.
19 | P a g e
The first valuation analysis we performed was through the method of
comparables. This is by using various industry ratios to compare to P.F. Chang’s and
create an adjusted price per share for each. This method is unreliable in one way due
to the fact that outliers of the industry must be thrown out of some ratios because it
would distort the overall industry average. Although these ratios are unreliable and
untrustworthy, many people in the valuation industry use them so it is useful to run the
models regardless. The method of comparables told us that P.F. Chang’s for the most
part is undervalued as six of the twelve models ran showed this. For each model, that
we were able to, we ran as stated and restated numbers. The trailing price to earnings
ratio was only on an as stated basis and calculated a price per share of $51.48, a
number that is undervalued but not significantly. The forward price to earnings ratio
had P.F. Chang’s severely undervalued with as stated and restated price’s per share of
$109.03 and $88.44 respectively. We were unable to run dividends per share ratio, as
none of our competitors paid out a dividend. The price to book ratio had the closest
prices per share to our observed price with the as stated and restated numbers being
$44.53 and $43.74. The most overvalued numbers we came up with was the P.E.G.
ratio which takes the price to earnings ratio and divides it by the future growth
opportunities, the respective price’s per share were $17.90 and $14.07. The price to
earnings before interest, taxes, depreciation, and amortization (EBITDA) gave us price’s
per share of $42.56 and $46.06 for as stated and restated. The enterprise value to
EBITDA showed price’s per share for as stated and restated of $51.12 and $67.34. The
last model ran was price to future cash flow which only had an as stated price per share
of $36.18. Many of these ratios had P.F. Chang’s stock price as undervalued but as said
earlier this method is very unreliable.
The intrinsic valuation models have great explanatory power and can influence
an analyst’s recommendation greatly. These models take into account forecasted
financial numbers and discount these numbers back to present value to give time
consistent implied prices. The intrinsic valuation models we used were discounted
dividends, free cash flows, residual income, long run residual income, and abnormal
20 | P a g e
earnings growth. The discounted dividends and free cash flow models are considered
flawed because they only take in individual aspects of a firm that may not be of the
most influence, such as dividend streams and free cash flows. The discounted dividends
model for the most part had P.F Chang’s as overvalued and negative values in the
sensitivity analysis where the growth rate was larger than the cost of equity. The free
cash flows model did not have a consistent census of the value of P.F. Chang’s with
valued ranging from $30.08 to $726.98. This model does have P.F. Chang’s fairly valued
in some situations but the variance with the numbers can lead us to believe that the
free cash flow model is inconsistent.
The residual income model has the highest explanatory power of all of the
valuation models with an R2 percentage that can reach 90%. This is largely influenced
by the fact that the residual income is the only model to take into account the firm’s
current book value of equity. Also, the residual income model uses a benchmark income
calculated by using this book value of equity times the cost of equity. The residual
income model was run for both the as stated and restated financials for P.F. Chang’s,
and in every case in the sensitivity analysis, using various cost of equity’s and negative
growth rates, the firm’s price was considered overvalued. The only way that the firm
would be fairly stated is with a cost of equity below 7.17%, which is unreasonable and
very improbable.
The last valuation we ran was the abnormal earnings growth model, which
similarly to the residual income has a very high explanatory and is a substantial
influence on the analyst recommendation. Like the residual income the abnormal
earnings growth uses a forecasted benchmark net income, but in a different way by
multiplying the previous year’s net income by one plus the cost of equity. This is not
taking the book value of equity into account. In almost every combination of cost of
equity an negative growth rates the abnormal growth earnings considers P.F. Chang’s
to be overvalued, similar to the residual income. With both of these models showing an
overvalued share price, consistently, we have determined that overall P.F. Chang’s is
overvalued.
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Company Overview
P.F. Chang’s China Bistro, Inc. was incorporated in January 1996 as a Delaware
corporation. The company offers a harmony of taste, texture, color and aroma by
balancing the Chinese principles of fan and t’sai, which mean “balance” and
“moderation”.(P.F. Chang’s Bistro 10-k). The meals are prepared with the highest
quality and freshness of foods delivered from special regions in china. The company
owns and operates a total of 197 P.F. Chang’s Bistros and 106 casual Pei Wei
restaurants. The company objectives are to develop and deliver high quality meals with
great customer service, resulting in repeat business. The dining experience is one of
high sophistication and satisfaction. In order to achieve these objectives, P.F. Chang’s
China Bistro strives to offer this high quality cuisine while providing a memorable
experience through superior customer service.
P.F. Chang’s China Bistro represents a more upscale, high class environment
that every family can enjoy. The meals are served a traditional Chinese way where the
meal is brought out in large portions for the whole family or party to enjoy. The food is
prepared by a Mandarin Wok cooking style which sears in all the spices and herbs,
allowing the customer to have a flavorful and distinct type of cuisine. P.F. Chang’s also
operates another restaurant called Pei Wei. Pei Wei offers a more casual style
environment in which the food items are placed on a standard menu with items ranging
anywhere from $6 to $10. This style of restaurant also operates in the United States
and represents just under a quarter of P.F. Chang’s total sales at 23%.
The company has historically placed both Bistro and Pei Wei’s in high traffic high
volume areas where customer volume is at its greatest. Metropolitan areas have been
a great location for both types of restaurants. The location of the Bistros is often
placed near malls, entertainment properties, strip centers, and accessible high class
regions of the United States. P.F. Chang’s currently leases all of their properties and
does not plan on owning any real estate in the future.
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P.F. Chang’s competes in the restaurant industry with Cheesecake Factory, O’
Charley’s, and Chipotle Mexican Grill. These companies all compete in the restaurant
industry and provide upscale high quality cuisines like P.F. Chang’s. The companies
within this industry strive to compete on food quality, superior customer service, and
the price per product. To obtain high volumes of sales, P.F. Chang’s utilizes its research
and development to come up with new distinct food items and menus regularly.(PFCB
10-k). Below are a couple charts that represent the sales volume for P.F. Chang’s and
Pei Wei restaurants.
Net Sales by P.F. Chang's China Bistro (in thousands $) 2005 2006 2007 2008 2009 P.F. Chang's China Bistro 675,204 756,634
849,743
919,963 925,321 Pei Wei 131,634 175,482
234,450
278,161 302,858 Total 806,838 932,116
1,084,193
1,198,124 1,228,179 Based on the above values, P.F. Chang’s Bistro provides most of the revenue
brought in by the company. Although Pei Wei operates through smaller more quick
style of restaurants, they do provide around 20% of the overall company revenue. The
2009 fiscal year results conclude that there was a 2.5% increase in revenue rising up to
$1.2 billion. This could have been caused by the increase in restaurants opened up
during the fiscal year 2009. Bistros that were opened during 2009 produced revenues
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of a little more than $13 million, while the Pei Wei’s that opened in 2009 produced
revenues of more than $6.5 million.
Industry Overview
PF Chang’s is in the ever fast growing restaurant industry, which is projected to
spike from 2.5 percent to 4 percent of the U.S. gross domestic product during 2010.
(National Restaurant Association) The restaurant market has steadily grown since 1970,
due to an increasing volume in share of the food dollar. The industry is projected to
captivate 49 percent of the food dollar in the coming year. The restaurant industry is a
very fragmented industry in that the top 50 biggest restaurants only hold 20 percent of
the market share. There are over 945,000 current locations, with two major divisions.
The two primary divisions are full service restaurants and limited service eating places
which include quick service establishments. There are a few underlining differences
between full service and quick service. Quick service usually has the customer pay for
the product before they receive it, and full service allows the customer to pay after the
fact. In full service restaurants, waiters take orders, serve the meal, wait on drink
orders, and pick up and process the check. Quick service has no waiters/waitresses and
typically has the customer self serve on drinks and extras throughout the meal.
Typically most quick service restaurants are “fast food” however, they also include
casual restaurants which offer a higher quality food without the table service. Industry
revenue is roughly evenly split between full service restaurants and quick service
restaurants. Annual sales average for full service restaurants is 833,000 dollars. The
annual sales average for quick service restaurants is 694,000 dollars. (National
Restaurant Association)
Demand is driven by demographics, personal taste, and consumer income.
Profitability of individual companies varies, so companies compete on different levels.
Quick service restaurants rely on high volume sales and efficient operations, while full
service restaurants focus on high-margin items and effective marketing. Personal taste
24 | P a g e
has a large part to do with whether a restaurant is successful or not. Not only does the
establishment have to concentrate on the taste of the food produced, but with the
“going green” and “healthier living” era hitting the United States hard, they have to
worry about the type of ingredients used to make the product. Over 55 percent of
adults said that they are more likely to visit a restaurant that offers food grown or
raised in an organic or environmentally friendly way. Also, 73 percent of adults
surveyed said that they have been trying to eat healthier at restaurants now, then they
did two years ago. (National Restaurant Association)
Restaurant Sales
1970‐2010
(Billions of Current Dollars)
$600.00
$500.00
$400.00
$300.00
$200.00
$100.00
$0.00
1970 1980 1990 2000 2010
25 | P a g e
Five Forces Model
The main force behind any firm is to function in a way that will increase
shareholder’s wealth. This is directly tied to increasing profit margins which leads to
managers to focus on this as a main goal for the firm to prosper and see longevity.
Different industries, though can, sustain various profit levels to remain successful which
leads to interesting questions left up to the business managers. The Five-Forces model
is widely accepted as the basis for answering many of these questions by giving insight
into the industry analysis and business strategy development. This model can be
beneficial to an existing or potential investor to gain a better understanding of the
industry in which the firm operates. The five elements will enable us to examine the
restaurant industry as well as their profitability as a whole. The Five-Forces model
shows that there are two separate factors that affect a firm’s profitability: the actual
and potential competition to a firm and the bargaining power of suppliers and buyers.
The competition aspect can be split up into three different subcategories which are
rivalry among existing firms, the threat of new entrants, and the threat of substitute
products. While only one of these is actual competition, the risk and possibility of the
other two factors makes all three challenging for managers. All of these factors create
an industries make-up and shape’s how a firm will price its products.
The level of competition an industry has is a huge component to a firm’s success
in the market. If there is a great amount of rivalry then a firm will be more reactive to
the market rather than proactive due to the volatility of the customer. The threat of
new entrants affects this as well; if an industry is easily entered then prices need to be
carefully selected to maintain a level of profitability. Also, substitute products play a role
in competition that allows customers to move away from a firm’s product which can
decrease profitability and create unexpected negative effects on a firm. The second part
of the model deals with the bargaining power of suppliers and buyers. To maximize this
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relationship a firm needs to be in balance with both sides. In a perfect world a firm
would have complete control over the input or buyer market as well as the output or
seller market, but economically this proves to be untrue. On the supplier side there is
competition between firms to gain business which goes back to the first aspect of the
Five-Forces model: the more firms in an industry the more options the supplier has to
get the best available prices. On the buyer side, a firm must choose the best prices,
products, and availability to reach the consumer in the most profitable manner.
Consumer selection is such a narrow window that all aspects must be in line to have the
best possible success.
Overall, the Five-Forces model shows us that when entering an industry there
are three levels of competition: High competition which involves many firms and does
not allow much room for variance from the standard pricing of products, mixed
competition which has some form of both high and low competition elements, and low
competition which allows companies to specialize in one or few products permitting
them to control their prices and markets. All of these aspects of the Five-Forces model
come together to measure the profitability of an industry or firm.
PF Chang's Competitive Force
Rivalry Among Existing Firms:
Level of Competition
Moderate-High
Threat of New Entrants:
Low
Threat of Substitute Products:
High
Bargaining Power of Customers:
High
Bargaining Power of Suppliers:
Low
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Rivalry Among Existing Firms
Rivalry among existing firms measures the amount of competition in an industry.
When firms face a low demand in the industry, price competition will occur and the
level of competition will increase at a high rate. At the opposite end, when firms in an
industry tend to remain at a constant level of demand they must compete on market
share in order to maximize profits. By analyzing the competition of the industry, one
may conclude that a particular firm gains an advantage over others by adjusting or
adapting to the economy and the industry it operates in.
A few key aspects to analyze when dealing with industrial competition of existing
firms are:
•
Growth rate within each firm and industry
•
Switching and fixed- variable costs
•
Differentiation
•
Concentration of competitors and
•
Exit barriers.
By combing all of these characteristics, one firm can improve its efficiency and
become more profitable over time.
Industry Growth Rate
The industry growth rate affects the rivalry among existing firms, because if the
industry is growing rapidly then firms within the industry don’t need to obtain market
share from each other to grow. The industry growth rate helps business analysts
perform conclusions on where the industry is headed in the future, and how each firm
must react in order to compete and have majority market share over the others. In a
high growth industry, firms can have an advantage by attracting new consumers and
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developing new products to attract these consumers. In a low growth industry, firms
must achieve maximum profitability by taking away consumers from other firms in the
industry. Pricing competition occurs when the growth rate of an industry is low. When
measuring the growth of the restaurant industry it is important to note that the higher
quality of food, atmosphere, and customer service - the greater the profits will be in the
future.
The food service business is the third largest industry in the country. It accounts
for over $240 billion annually in sales. The independent restaurant accounts for 15% of
that total. The average American spends 15% of his/her income on meals away from
home. This number has been increasing for the past seven years. In the past five years
the restaurant industry has out-performed the national GNP by 40%.
(virtualrestaurant.com)
In the restaurant industry a great way to grow as a company and produce high
returns is to franchise the business one owns. When it comes to growth, the big
barrier for any restaurateur is always capital. Since the franchisee provides the initial
investment in the restaurant, growth can occur at a much lower cost. Opening up new
and more innovative restaurants allows the company to expand across greater
boundaries and gain a new group of customers. This also creates an opportunity for a
new manager to step in and add more creative ideas for the restaurant.
(entrepreneur.com)
Within the restaurant industry there are many types of cuisines that compete
against one another. The type of companies in the industry we are valuing consist of a
more upscale, semi formal dining experience with high quality means and superior
customer service.
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Total Sales (in thousands $) P.F. Chang's Bistro O'Charley's The Cheesecake Factory Chipotle Mexican Grill Total Industry Sales 2003 539,917 753,740 773,835 314,027 2,381,519
2004 706,941 864,259 969,232 468,579 3,009,011
2005 809,153 921,329 1,182,053 625,077 3,537,612
2006 932,116 978,751 1,315,325 819,787 4,045,979
2007 1,084,193 969,497 1,511,577 1,085,047 4,650,314
2008 1,198,124 930,317 1,606,406 1,331,968 5,066,815
2009 1,228,179 879,909 1,602,020 1,518,417 5,228,525
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Annual Sales Growth
2005
2006
2007 2008 2009
12.63%
13.19%
14.03% 9.51% 2.45%
6.19%
5.87%
‐0.95% ‐4.21% ‐5.73%
Cheesecake Factory 18.00%
10.13%
12.98% 5.90% ‐0.27%
Chipotle Mexican Grill 25.04%
23.75%
24.45% 18.54% 12.28%
Industry 14.94%
12.56%
13.00% 8.22% 3.09%
P.F. Chang's Bistro O'Charley's 31 | P a g e
In terms of net sales for the industry and competitors P.F. Chang’s, Cheesecake
Factory, and Chipotle Mexican Grill control most of the market share, but have
seemingly been decreasing over the past few years. O’Charley’s Restaurant franchises
many of their businesses creating revenue from those venues. This could explain why
their net sales are considerably lower than the others. Over the past two years
O’Charley’s has received revenues from the franchisees in amounts of $900,000 and
$800,000 respectively.
With the recent recession, it seems that the industry has held its own and has
not been affected too badly by it. Many customers have changed their ways of eating
thus creating less demand for the upscale restaurants. Although net sales have risen in
terms of the past five years, the restaurant industry is looking for new ways to redeem
themselves and create better cuisines for each individual customer. If the company can
be franchised like O’Charley’s, growth becomes more powerful and allows the company
to gain revenues off something other than restaurant sales.
Concentration of Competitors
The degree of concentration in an industry is dependent on the number and size
of the firms. This influences the extent to which firms in an industry can regulate
pricing and other competitive moves.
•
If there is one dominant firm within the industry, it will be the “price leader”
which other firms will base their price off of.
•
Two or three equally sized firms can cooperate with each other and avoid
destructive price competition.
•
While a fragmented industry will face severe price competition.
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Concentration within the restaurant industry is very low with regards to new
restaurants opening up all over the United States. Consumers are looking to spend
more money out at restaurants then cooking at home themselves. The level of price
competition varies among the industry due to the quality and class of the
restaurants. Many different types of restaurants such as steak, Chinese, American,
Mexican, and Italian pay different prices for these different foods, which causes
price competition to somewhat decrease. Although reasonable prices are what
restaurants strive to give their customers, many consumers are fully aware of what
they are going to pay before walking in to these businesses.
Since the industry focuses mainly on prices and food quality, many companies
have ventured in to the market in hopes to create a well established profitable
restaurant. Furthermore, the opportunity of new entrants can cause a threat to
existing restaurants in terms of market share and customer satisfaction. Below
represents the market share for P.F. Chang’s and its existing competitors.
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In terms of market share relative to sales it seems that The Cheesecake Factory
has majority of shares, but Chipotle and P.F. Chang’s Bistro have consistently held
their own for the past few years. Since restaurants charge different prices for their
different products this could be factored in to Cheesecakes net sales. Also
considering that Cheesecake Factory operates a bakery inside each restaurant this
can lead to higher revenues. In 2009 the bakery represented 15% of Cheesecake
Factory’s revenue while 14% in 2008. (CAKE 10-K) For instance, P.F. Chang’s
Bistro has an average ticket price of $21.00 per person including alcoholic
beverages. Cheesecake Factory has average sales around $19.00 in 2009. Since
Chipotle is a more get in get out kind of restaurant, their meals tend to be a little
less expensive. Here is a pie chart better representing the market share for P.F.
Chang’s and its competitors in 2009.
Chipotle Mexican Grill and The Cheesecake Factory have controlled most of the
market share in the past few years resulting in great return for their companies. It
seems as if O’Charley’s is struggling to gain market share, but the restaurant’s the
company owns tends to be more of a casual diner with less elegant foods for a
lower price. This has allowed O’Charley’s to take consumers away from the other
three competitors, in result, making price competition amongst firms a bit more
intense throughout the industry.
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Differentiation
The extent to which firms in an industry can sustain a competitive advantage on
price is dependent on how much each firm can differentiate their products and services
from another. Similar products make it easy for a customer to switch from firm to firm
on a pure price basis. Switching costs will also affect a customer’s willingness to switch
firms. High switching costs will yield less price competition, while low switching costs
will yield high price competitions.
If two restaurants in the same industry have similar products available to its
consumers than price competition between these two firms increases. On the other
hand if restaurants in the same industry have different products and services, the
competition becomes less price sensitive, and the firms compete on product quality and
superior customer service. P.F. Chang’s for instance uses high quality ingredients
shipped over from china, and the restaurant uses a variety of very distinct herbs and
spices to give the business its own flavor different from its competitors. O’Charley’s
owns and operates three different types of restaurants ranging from American food to
steak houses. These products are offered in a wide range of restaurants around the
United States, so this would mean O’Charley’s would need to compete on price
considering their product is not very differentiated from its competitors. Chipotle
Mexican Grill strives on “food with integrity” more importantly serves food for a low
price, but of very high quality (Chipotle 10-k).
“We believe our restaurants are recognized by consumers for offering value with
menu items across a broad array of price points and generous food portions at
moderate prices. This year, we introduced new menu items and categories at our
restaurants, further enhancing the variety and price point offerings to our guests”
(Cheesecake factory 10-k). P.F. Chang’s Bistro creates new products through its
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research and development to add amore unique meal to the menu. “As a result of our
extensive research and development efforts, we periodically change our menu. For
example, during 2009 the Bistro introduced Chang’s for two, a prix-fixe menu offering a
four-course meal for two people for $39.95 (P.F. Chang’s Bistro 10-k). This company
had differentiated its products by offering a full course meal, something the competition
has not offered to its customers.
Another means of differentiation comes through the type of service or
atmosphere the company offers. Chipotle Mexican Grill for instance offers four main
items that are prepared right in from of the customer in a timely manner. For
customers looking to get a high quality quick meal, Chipotle offers this service that its
other competitors do not. The Cheesecake Factory and P.F. Chang’s Bistro strives on
creating superior customer service within a well designed and sophisticated
atmosphere. “Our restaurants’ distinctive contemporary design and decor create a high
energy,
non-chain image and upscale ambiance in a casual setting. Whenever possible, outdoor
patio seating is incorporated in the design of our restaurants, allowing for additional
restaurant capacity, as weather permits, at a comparatively low occupancy cost per
seat” (CAKE 10-k). This can be part of Cheesecakes differentiation strategy by offering
a high quality atmosphere for customers who seek a nice evening out to eat.
Conclusion
Within the restaurant industry differentiation in products and services play a
huge role. The degree of differentiation tends to be high for many reasons. One
reason is the type of foods each company serves to its clients and the level of quality
each restaurant prepares its food. Also the atmosphere allows the various companies
to differentiate themselves from others through their designs and concepts throughout
the restaurants. Many consumers will decide where to eat based solely on the
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atmosphere the business offers. Last, the service that each restaurant provides to its
customers can differentiate themselves from the other competitors. For instance, P.F.
Chang’s Bistro strives to provide superior customer service for its clients, making the
experience a memorable one with hopes of having repeat customers.
Switching Costs
Switching costs for firms is the cost incurred when a firm decides to discontinue
its operations in the current industry and enter into another. In the restaurant industry,
firms require a great deal of construction and maintenance costs when designing a new
restaurant. If a company were to stop operations and need to exit the industry and
enter a new one, it would be very costly and therefore requiring the firm to cut prices
to compete with the other firms. When the switching cost is high, a firm will spend a
large sum of money on raw materials which will make troublesome to switch from one
industry to another, because they will incur a lot of expenses. Vice versa, lower
switching costs will, however, lead to firms switching to another industry without
spending a lot of money on raw materials. When switching costs are low, firms will
engage in price competition because the risk can be low, allowing firms to easily enter
and exit the market. Low switching cost indicates that a firm will use fewer expenses to
produce products in another industry.
Businesses in the restaurant industry or more specifically the upscale finer
restaurants design their restaurants with superior decorations and experienced staff.
All the natures of the business require a great amount of preopening costs within the
first two months, and need great sales in order to gain back those costs. If a company
were to close down operations, they would need to get rid of all the kitchen supplies,
restaurant seating tables and all renovations they made would need to be taken down
and sold off. This makes the switching costs very high for a restaurant and to enter
into a totally new industry would make it difficult. There are not many supplies or
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equipment in the restaurant industry that would be available to the business to use in
another industry.
Overall the switching costs for the restaurant industry are very high can create a
price competition between existing firms. This causes each firm to cut costs in order to
get rid of the entire old inventory the restaurant once used.
Conclusion
With regards to the restaurant industry, switching costs are relatively low
resulting in a price war between firms and their competitors. This allows the customer
to choose the restaurant he or she feels solely on a pure price basis. Also if the quality
is better at one restaurant compared to another, clients can easily choose a different
route due to the wide range of restaurants available. If a restaurant fails the costs
associated with getting out of business tends to be low as well considering the input
costs to starting the business is relatively low as well.
Scale Economies
In any industry, a firm must research and evaluate the learning curved involved
with each product, so they can determine the possibility of whether they have the
resources available to increase sales and gain market share. If there is a steep learning
curve or there are other types of scale economies in an industry, size becomes an
important factor for firms in the industry (Business Analysis & Evaluation text). Firms
that achieve high learning economies thus are more likely to gain market share and
increase revenues.
In the restaurant industry the size of a firm can play a major role in terms of
customer volume, but in many circumstances small businesses have controlled a large
portion of market share due to brand loyalty, ingredients, and overall customer service.
Below is a graph representing the total number of assets for each firm and their
competitors.
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As shown above The Cheesecake Factory and Chipotle Mexican Grill have
significantly more assets than the other firms, yet the industry still competes with one
another. Chipotle Mexican Grill in terms of the size of restaurants is substantially
smaller in size compared to the other firms, but they have opened more restaurants
than the others, and created a product of their own. According to Chipotles 10k,
“Chipotle Mexican Grill operates 956 restaurants in over 35 states throughout the U.S.,
it also plans on opening 120 to 130 additional restaurants in 2010”. (CMG 10k) In
comparison to P.F. Chang’s 197 full service Bistro restaurants and 166 casual Pei Wei
restaurants.
Conclusion
Most firms in the restaurant industry are looking to increase their research and
development of new and improved menu items creating a higher learning curve, which
then will help each firm increase market share and revenue. This will lead to increased
price competition within the industry. For example, as a result of P.F. Chang’s extensive
39 | P a g e
research and development efforts, the restaurant has been able to periodically change
their menu. (PFCB 10k) The restaurant now offers a daily Happy Hour from 3-6pm, with
special on drinks and appetizers. The new addition to the menu will allow P.F. Chang’s
to compete with other restaurants that have a Happy Hour special or with restaurants
that do not have this special, which further increase sales and market share to the firm.
Fixed To Variable Costs
The ratio of fixed to variable costs can be a determining factor in the level of
price competition and profitability. If the ratio of fixed to variable costs is high, firms
have an incentive to reduce prices to utilize installed capacity. This causes the industry
to become more competitive, thus creating price competition. On the other hand if a
firm or industry can maintain a low fixed to variable costs ratio and control the costs of
the firm, the industry has less incentive to engage in price competition.
For example, The Cheesecake factory leases many of their operations, resulting
in a fixed cost every month for payments. If the company had reduced sales for a year,
which Cheesecake Factory did, they would need to cut costs to maintain costs control.
“As a percentage of revenues, other operating costs and expenses increased to 24.7%
for fiscal 2008 versus 23.4% for fiscal 2007. This increase was primarily due to deleveraging of fixed costs due to lower average weekly sales at our restaurants as well
as higher utility rates” (CAKE 10-K). This caused the firm to cut prices and ultimately
engage in price competition with the other firms.
In order to calculate the fixed to variable costs ratio, we need to collect
information from each firm in the industry. First, we need to calculate total cost of
goods sold by subtracting cost of goods sold from the current period by the cost of
goods sold in the previous year. Next is to divide that total by sales in the current year
minus sales from the previous years. This number will then be multiplied by sales in
the current year to form total variable costs for that period. After that we calculate the
total fixed costs by subtracting variable costs from total costs. With these two amounts
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we can then figure the ratio for each firm and the industry. Below is the data collected
and calculated:
P.F. Chang's Bistro Cheesecake Factory O'Charley's Chipotle Mexican Grill 2005 2.954 3.136 2.376 2.103 2006 2.812 3.003 2.875 2.244 2007 2.384 2.826 0.196 1.715 2008 2.889 1.505 4.413 1.610 2009 34.979 ‐0.813 1.605 3.737 41 | P a g e
Fixed to Variable Costs Ratio
P.F. Chang's Bistro Cheesecake Factory O'Charley's Chipotle Mexican Grill 2005 3.105 3.251 2.804 6.977 2006 4.023 2.506 3.118 8.143 2007 4.299 2.610 6.785 7.342 2008 3.036 1.041 ‐14.459 5.868 2009 4.817 ‐1.778 3.023 14.283 42 | P a g e
Fixed to Variable Costs Ratio (operating costs)
Based on the above results, the industry has a relatively high fixed to variable
costs ratio due to the large amount of fixed costs relative to variable costs. This once
again creates price competition within the industry and firms therefore reduce their
menu prices. As seen in the graph above, P.F. Chang’s Bistro had a tremendous
amount of fixed costs in 2009 possibly due to the amount of leasing agreements made
in that period. In 2009 Cheesecake Factory had a very low ratio because of the deleveraging of the company in order to sell more products. Overall, the industry is very
consistent in terms of fixed to variable costs and all compete on prices for their
products.
Excess Capacity
In terms of meeting demand for products in an industry, excess capacity is the
overall level of production produced beyond the consumers demand. It is important to
keep excess capacity low, as inventory expenses and unsold products can cause a
decrease in net income.
Since the restaurant industry receives meals on a moderate basis, the demand
for the company’s product is carefully measured and the amount of food supplies is
ordered on a timely basis. For instance, P.F. Chang’s Bistro receives food and
ingredients in a timely manner. “We negotiate short-term and long-term contracts
depending on demand for the commodities used in the preparation of our products”
(P.F. Chang’s Bistro 10-k). For most upscale causal restaurants, the inventory for food
is measured and brought in to the restaurant as needed for each week of operations.
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One problem in the restaurant industry results from a business opening up a new
restaurant in a new location, but does not have the high volume of customers
surrounding the location to enjoy the product. This does not mean the quality or
service is under rated, but more specifically due to the location the restaurant was
placed was not well populated. In order for firms to maintain and control excess
capacity, they must create a healthy infrastructure and monitor and forecasts sales for
the future. This can create a more precise inventory count and not allow the
companies to overstock on their food products resulting in a loss of money.
One way of measuring an industry’s excess capacity would be to take the firms
total sales and divide those figures by their Property, Plant, and Equipment. This will
indicate if a firms fixed costs are producing positive returns and creating profits. The
lower the ratio, the more excess capacity exists, therefore resulting in a price war
amongst competitors.
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Cheesecake P.F. Chang's Bistro O'Charley's
Factory Chipotle Grill 2005 2.33 N/A 1.93 1.83 2006 2.21 2.10 1.79 2.02 2007 2.08 2.22 1.75 2.19 2008 2.28 2.25 1.86 2.27 2009 2.46 2.39 2.03 2.38 With regards to the chart above, the restaurant industry has experienced a
positive trend in the sales/PP&E ratios which have resulted in a good amount of excess
capacity. This means that the company’s in this industry are able to produce a
sufficient amount of materials to meet the demands of their consumers. The companies
listed above have consistently held the same ratio for the past five years.
Conclusion
Excess capacity has shown to exist in the restaurant industry especially for the
upscale more casual restaurants like the firm listed above. This shows that these firms
are competing on price to gain customer volume. P.F. Chang’s Bistro has shown the
most consistent ratio of all competitors, while Cheesecake Factory has produced the
lowest ratio. This could explain why most of the businesses in the restaurant industry
have charged on average the same price for their meals.
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Exit Barriers
Sometimes in an industry, firms will decide to leave. Whenever this happens
there are relative costs associated with this choice. These costs and regulations are
known as exit barriers (Book P. 2-3). Often times the most costly exits are those from
industries where specialization is the key success factor involved in a firm. To exit there
must be a liquidation of the company and all of the company’s assets. Again, with a
specialized firm some of the assets may be difficult to liquidate. On the other hand, in a
highly competitive market a firm’s material liquidity may be one of relative simplicity
and the regulations may be minimal.
The restaurant industry is one of moderate exiting. For the most part many of
the firms are not going to have much specialized equipment which allows the sale of
these tools and appliances to be quick. The main problem that restaurants can run into
when exiting is the lease agreements or ownership of buildings in which the business is
run. Encountering all of those possible complications with property can prove to be very
costly.
Conclusion
For the overall competitiveness of the restaurant industry, the rivalry among
existing firms tends to be moderately high. Firms within this industry focus on
competing prices, product quality, and customer service. The firms listed above all
share the same goals and compete against one another for those specific goals. The
overall industry competitiveness helps the individual firm’s lower prices and to compete
against one another on market share. This creates a high degree of rivalry among
existing firms in the restaurant industry.
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Threat of New Entrants
Firms of any industry should not limit their concentration on existing competitors
of that industry, but must also concentrate on new/potential firms entering the industry.
A firm that can easily enter a market could have a profound effect on the existing firm’s
profitability due to an increase in competition that will further increase rivalry amongst
the firms in that industry. In the result of an increase in competition, new entrants can
impose a threat on prices and market share. In the restaurant industry is highly
competitive, it is very easy for firms to enter and be successful in an industry as well as
to exit and be unsuccessful. An upscale restaurant such as P.F. Chang’s strives on its
quality in food, customer service, and restaurant atmosphere (dine-in experience) which
makes it difficult for entrants to easily enter the industry. Factors such as economies of
scale, first mover advantage, relationships, and legal barriers determine an industry’s
threat of new entrants.
Economies of Scale
Economies of scale deal with the choice of new entrants: either investing in a
large capacity that may not be used right away or investing in small capacity.
Economies of scales states that unit cost is reduced as the size of production increases.
A successful firm in an industry is the one, which can produce high quantities of
products using a lower cost per unit. This is how a firm can earn the highest profit and
competitive advantage to its competitors. The new entrants to the industry would be
faced with the difficult task of maintaining economies of scale unlike the existing firms.
This is due to the fact that firms have to invest in producing innovative products and
higher quality ingredients, which will make them more competitive than existing firms
by increasing the market share. If a firm decides to enter, it will be faced with cost
disadvantage in competing with the incumbents in the industry. Fixed and variable costs
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are the two main costs that are affected, with variable cost depending on the number
of units produced.
The two largest firms in this industry, in terms of casual dining currently
Cheesecake Factory with 161 restaurants and $1,046,751,000 in total assets and
Chipotle with 956 restaurants and $961,505,000 in total assets. Although P.F. Chang’s
is not that the largest firm in the industry, “it plans to open three to five Bistro, Pei Wei
restaurants this year, but is considering opening 10 to 15 of its smaller Pei Wei
locations next year.” (WSJ) Since Cheesecake factory and Chipotle are top competitors
they are able to set prices/costs in the industry.
Total Assets
(thousands)
2009
2008
2007
2006
2005
P.F. Chang's
652,150
667,363
622,630
514,045
474,859
Cheesecake
1,046,751
1,142,630
1,145,753
1,039,731
926,250
O'Charley's
462,255
520,262
648,983
688,638
687,610
Chipotle
961,505
824,985
722,115
604,208
392,495
Factory
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First Mover Advantage
The first mover advantage states that firms can gain an advantage by entering
into a market prior to its competitors. Early entrants or market leaders might set
industry standards that will prevent the future entrants from entering into the market.
These standards might include first mover firms from acquiring scarce government
licenses to operate in regulated industries.
In the restaurant industry, obtaining first mover advantage is moderately low.
Established restaurants have already built relationships with its customers. Considering
that the restaurant business is highly diverse with a wide array of different types of
foods and prices it’s rather difficult to gain an advantage over an existing restaurant.
According to the Cheesecake Factory’s 10k,” The sizes of our restaurant trade areas
vary by location, depending on a number of factors such as population density;
demographics; retail, business, entertainment and other traffic generators; and
geography. As a result, the opening of new restaurant could impact the sales of one or
more of our existing restaurants nearby” (CAKE 10k) An opening of new restaurant
could have an impact on sales if the restaurant has established name or if it’s a
franchise. As mentioned early, it would be difficult to compete against a restaurant that
has developed clientele and provides a different type of food/way of service.
Access to Channels of Distribution and Relationships
Limited capacity in the existing distribution channels and high costs of developing
new channels can act as powerful barriers to entry. (Palepu) Firms trying to enter a
competitive industry could be faced with barriers that they must overcome. Established
firms in an industry have existing relationships distributors and suppliers that are
contract based. According to P.F. Chang’s 10k, “their supply chain management
function provides their restaurants with high quality ingredients at competitive prices
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from reliable sources. Consistent menu specifications, as well as purchasing and
receiving guidelines, ensure freshness and quality.”(PFCB 10k) In the restaurant
industry, upscale restaurants must maintain a positive relationship with their suppliers
in order to fulfill the high need for quality ingredients and supplies to conduct their
business at the level to sustain a competitive advantage over its competitors.
Many restaurants in this industry have negotiated short-term and long-term
contracts in order to secure the demand for the many ingredients and supplies needed
to prepare their products. For commodities such as produce, they mainly utilize
distribution market advantage which is comprised of numerous food distributors
throughout the nation. Restaurants benefit from using distribution market advantage
because the vegetables needed to produce their dishes are perishable and are required
on a daily basis, having close contact with suppliers is vital for survival in this industry.
Items that are highly important to the firm are contracted annually in order insure
stable prices and availability. For example, P. F. Chang’s outsources it Asian’s specific
spices sauces directly from Hong Kong, China, Taiwan and Thailand. (PFCB 10k) In this
industry, firms must have a developed network of suppliers and must sustain positive
relationship in order to ensure that they the firm can obtain all ingredients supplies
needed to conduct their business.
Legal Barriers
Legal barriers are patents, copyrights, or regulations that limit or prohibit a firm
from entering industries. Standards enforced by the government might be costly for a
new firm to enter into the market. These standards may be hard to follow; or are costly
to the ones who are trying to use economies of scale to achieve a competitive
advantage over its competitors. These government standards are sometimes aimed by
the government to reduce the number of firms in an industry in order to reduce the
competition among firms in an industry, which might harm the consumers. Also,
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standards set by industries are aimed at reducing the number of firms entering an
industry or it might be aimed at offering the right product quality to the consumers.
Restaurants in this industry have a competitive advantage over its competitors due to
the standards set by the government, which makes it complicated for new firms to
enter. These include payment of money to the government, and also making sure that
the firm is able to produce the right quality of goods and services to the consumers.
The restaurant industry is subject to numerous laws and regulations such as
licensing and regulation by various governmental authorities, which includes but is not
limited to safety, health, sanitation and alcohol and beverage control, building and fire
agencies in the state or municipality in which the restaurant is located. (CHUX 10k) For
example, most restaurants require a business license in order to conduct business, if
there is any difficulty in obtaining the license it could possibly affect the opening of a
new restaurant. Also, restaurants must obtain permits to in order sell and provide
alcoholic averages in the restaurant as well to extend the hours in which they can sell
the beverages. If a restaurant does not obtain a license to sell alcohol they could be
forced to close the business and furthermore lose profit.
Conclusion
The Threat of new entrants does not play a major role in this industry. Since the
above factors affect other firms from entering the industry, the level of threat is low.
The main reason is due to the fact that P.F. Chang’s and its competitors are upscale
restaurants with a diverse menu and developed clientele. As mentioned earlier,
establishing good relationships with distributors enables a timely deliverance of
ingredients or supplies need to conduct business. The government regulates the
number of industries and provides standards for the quality of goods produced to
customers. In the restaurant industry, restaurants must obtain certain licenses and
permits in order survive in this industry. Firms in this industry maintain a competitive
advantage over its competitors by following these rules and regulations.
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Threat of Substitute Products
The threat of substitute products exists in any market whether it is easily
recognizable or not. A substitute product may not be something that is in the same
form as other products but simply is a product that serves the same function.
Substitutes are a challenge facing any new firm looking to enter an industry with a high
degree of competition. In such a highly competitive industry like the restaurant
business with so many identifiable brands, it is hard to keep customers loyal due to the
sheer volume of restaurants there are. This leads firms to focus on efficient pricing
strategy and, brand recognition. It has led many firms to try and separate themselves
with new and innovative products. It still remains though the restaurant business is one
centered on cost leadership. This is a result of high competition and very small
switching costs.
Also, in the restaurant business one huge threat of substitution is the resurgence
of the grocery store. With the economic situation the way it is, people are looking to
save money in every facet of their lives which includes eating more at home and not
going out to restaurants. This leads restaurants to focus on building feelings of brand
loyalty and treating the meal out as more of an experience than just a meal.
Relative Price and Performance
In any profit-based industry, firms are looking to gain an edge over competitors
by offering the best product at the most reasonable price. This pertains to the
restaurant and grocery store businesses completely. If a customer feels that he/she is
getting a satisfying product but at a price that is not reasonable or vice versa they will
pursue other substitutes, which means that relative price and performance must both
be in balance to maximize profitability. In the restaurant industry it is mainly split up
into two segments: full service and quick service.
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In the full service segment, quality is the key to retaining customers. One of the
success factors is quality of service. How well the customer is being treated is the main
key to having repeat guests. If someone does not feel as though they are being treated
respectfully then they will not come back. Another factor is the quality of food. This is
important because if a customer is not getting enjoyable food at a restaurant then the
chances of substitution to a grocery store or cooking at home is greatly increased. The
last aspect is the price of the meal. This may be the easiest way to turn on/off a
customer from a full service restaurant. Expectations are made before a person steps
through the door of a restaurant and if those expectations are not met then satisfaction
can be quickly erased. When quality of service, quality of food, and price all come
together it creates an environment of pleasure and therefore increases the number of
customers and increases overall profitability.
The quick service segment is mainly geared on price and ease of process. When
going to a quick service restaurant generally the prices are lower than a full service
restaurant due to the fact that the customer are not being waited on. Simplicity is a key
factor in this environment. Customers want to get their food in a timely manner and
generally speaking do not want to be at the location for an extended amount of time.
Drive-through windows show this as customers choose to not leave their vehicle when
ordering and receiving their meals. The quality of service and food is important but in
this segment it may take a back seat to the smoothness of operations.
Customer’s Willingness to Substitute
The threat of switching costs for customers is low in the restaurant industry. The
amount of competition and number of marketing channels make it relatively simple for
a customer to switch segments and suppliers. Differentiation, cost cutting strategies,
and quality of services are the major factors in pleasing new customers and retaining
existing customers. In both segments finding a new outlet would take a minimal
amount of time. In 2009 “almost half of quick-service operators reported increases in
sales while fine dining had a whopping 62 percent of operators experiencing
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plummeting sales (Odesser-Torpey).” This causes brand loyalty to be rare because if
costs are not reasonable to the customer the ease of transfer is quick. Although brand
loyalty is hard to find, the major restaurants that are successful have some form of
recognition that plays into this success and longevity.
Another aspect of switching costs is in the grocery store industry. Switching costs
are low in this area as well. Generally speaking it is less expensive to go to a store and
purchase food than to go somewhere and have someone else prepare it. The amount of
funds spent on gas driving to a different restaurant every night can cause a consumer
to switch to grocery stores. On the other hand people value time. When buying foods at
a grocery store and cooking it, there is shopping, preparation, and clean up time that all
goes into this process. This goes back to what was talked about earlier in the ease of
the process to go to a restaurant.
Conclusion
In any industry, there will be the threat of substitute products. What matters is
to know what a firm’s key factors to success are and how to best retain customers. In
the restaurant industry the main focus is cost cutting strategies, overall quality of
service, and differentiation from competitors. In the restaurant industry the threat of
substitute products is high and switching costs are low which makes the market very
volatile.
Bargaining Power of Customers
Every business, regardless of industry, relies on customers to purchase their
products or services so that they will, potentially, turn a profit. Customers may be
businesses, the general public, or a combination of the two. Within the restaurant
industry, the customer base is comprised of the general public: individuals or groups of
individuals.
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When discussing the bargaining power of customers, we are talking about the
ability of the customer to put the firm under pressure. This has a lot to do with the
price sensitivity of the customer. When price is an issue to the customer, a firm must
take that into consideration. Likewise, when price has little effect on customers, this
must also be taken into consideration.
Differentiation
Differentiation among products refers to how close a particular product is to its
next competitor. For instance, within the computer industry, there is little product
differentiation between Dell’s and HP’s consumer laptops. They are essentially the
same, and perform the same tasks.
Within the restaurant industry, no significant differentiation among products
exists. Sure, there are different types of cuisine being served, but each restaurant is
serving a meal at a certain price. A customer can just as easily walk across the street
to a competitor and essentially get the same thing: a meal. The small amount of
differentiation occurs with the service within the industry. Each restaurant has their
own image and reputation for service and quality. This reputation is what differentiates
each firm from the next one.
Price Sensitivity
Consumers are also sensitive to price, and want to get the best deal for the
lowest amount. Therefore, casual dining establishments have engaged in different
promotions in order to entice customers. This enticement indicates that consumers are
willing to consider alternatives within the industry itself. However, there are little to no
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switching costs to the consumer when choosing a restaurant, since it is mostly personal
preference, and no two restaurants are exactly alike within the casual sit-down dining
segment. Further, when considering the industry as a whole, there are different
segments which appeal to different consumers: high-end sit-down dining, casual sitdown dining and fast food. Each segment represents a different cost to the consumer,
trending downward from high end to fast food. Therefore, it follows that consumers
will choose a certain segment based on personal preference, time constraints and price.
Within each segment, consumers many times base their decision on price. It follows
that firms in the industry will set prices comparable to each other, and attempt to
undercut each other (within their particular segment) in order to drive consumers to
their particular brand. According to a recent Gallup poll, consumer spending is on the
rise, with 47% of Americans stating they have been spending less money in recent
months, compared to 57% in February of this year.
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Number of Customers
Important to any industry is the customer base for which the industry draws.
The number of customers can influence the customer’s bargaining power with the firms
in the industry.
Within the restaurant industry, the number of customers is practically limitless.
However, each sub-category caters to a different clientele. The number of customers
frequenting the high-end restaurants is much smaller than casual dining and fast food.
The number of customers is dictated mostly by the economic outlook and consumer
spending patterns within the target market. As consumer spending increases, as shown
above, more individuals are willing to spend more at a casual dining experience versus
eating at home or eating fast food. Gas prices also play a major role in the number and
volume of customers coming in to full-service restaurants. According to a recent
survey, 57.7% of Americans said they would have to cut back on discretionary spending
as soon as gas prices reach $3.00 a gallon (BeemerReport.com). An increase in gas
prices tends to decrease the amount of consumer discretionary spending, as consumers
spend what would have been discretionary spending on gas.
(GasBuddy.com)
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In addition, many individuals seek lower cost alternatives to full service
restaurants during periods of high gas prices. If gas prices remain steady, and
spending patterns continue (as shown above), consumer discretionary spending may
rise.
(Bloomberg BusinessWeek)
As shown by the graph above, the Consumer Services industry performance is
closely tied with the S&P Consumer Discretionary Index. This means that the number
of customers within the industry is closely related to the economic outlook and the
amount of “extra” funds customers have to spend on “luxuries.” Due to the large
number of customers, it would seem logical to say that customers have high bargaining
power based on the number of customers. However, the number of customers with
significant influence over the industry is practically nonexistent. Yes, there are many
customers, but the buyers are fragmented: no one single buyer or group has a
significant influence over the industry. The contradiction comes when evaluating
customer buying power as either individual customers or the entire customer base. An
individual customer holds very little bargaining power, yet the whole customer base
holds a large amount of bargaining power.
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Importance of product for costs and quality
Consumers are constantly looking to achieve the maximum benefit for the least
amount of money. If the price and quality are not comparable, then customers will not
purchase the product. Therefore, it follows that customers have some bargaining
power in terms of product cost and quality.
Consumer expectations are tied to brands and preference. Many brands are tied
to certain tastes and quality levels. When consumers make the choice to dine out, there
are a myriad of different choices. The majority of consumers, when committed to a
certain price range, base their final choice on personal taste and brand recognition.
When a decision is made based on brand recognition, consumers expect the same
quality across the board for the same brand. Major restaurant chains must maintain
the same standards of quality and preparation across all restaurants and franchises in
order to meet consumer expectations and to ensure some form of brand loyalty. (10-K,
PFCB, CAKE, CMG, CHUX). In addition, when consumers make the decision to step up
in price from a quick service restaurant to a full service restaurant, there is an
expectation of higher quality food. As prices go up, consumer expectations rise as well,
making restaurants commit to quality foods and service. A customer also has some
bargaining power in regard to quality of food in that the customer may elect to send a
poor quality dish back, or ask for a refund. Usually, this interaction leads to the
customer receiving a new dish or a refund of the purchase. However, the restaurant
reserves the right to refuse these types of gratuities. This type of understood
interaction increases the bargaining power of the customer by ensuring that the
restaurant maintains the quality of their food.
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Volume per buyer
Many industries have discounts for customers who order products in large
quantities. Within the restaurant industry, the volume at which products are bought
has virtually no effect on the bargaining power of the consumer. In some instances,
discounts may be given to a customer ordering large quantities, but this usually
happens with quick-service restaurants, such as pizza companies. In the full-service
environment, there is no bargaining power in terms of volume, as prices are set and are
non-negotiable; a consumer ordering one entrée will pay the same price per entrée as
the consumer ordering three. Volume discounts do not typically apply to the general
consumer within the full-service restaurant industry. In some instances, volume
discounts can occur with catering or private bookings, but these are usually set prices,
dictated by the company themselves.
Switching Costs
Switching costs refers to the cost of switching to a comparable product, either
within the same industry or switching to an alternative industry. The number of close
alternatives and substitutes dictates the relative bargaining power customers have on
firms.
Within the restaurant industry, consumer switching costs low. Many different
alternatives exist, sometimes clustered right next to each other. In addition, substitutes
outside of the restaurant industry, such as take-home meals from grocery stores, can
dictate the amount of customer traffic. When considering different alternatives, factors
such as price, wait times, and convenience are considered. If an individual consumer
goes into a restaurant and discovers a long wait time, they might weigh the alternatives
of going to another restaurant. However, if the particular restaurant has a good
reputation for quality and service, the individual may wait in line for a table. In
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addition, the permeation of substitutes outside of the industry, namely frozen meals
available at grocery stores, adds to the substitution choice for consumers. The bottom
line: bargaining power is high for the customer, and restaurants must keep customers
happy by providing good customer service and prices.
Conclusion
Customers of the restaurant industry, when taken as a collective, have a high
level of relative bargaining power. Although individual customers can do little to
influence the price and quality of particular restaurants, the customer base is able to
exert pressure on firms within the industry; if a firm’s prices are too high or the quality
is lacking, discerning consumers will avoid the firm altogether, causing a failure of the
firm. In order to continue functioning, firms in the restaurant industry must focus on
customer service, quality and value to ensure a continued supply of customers.
Therefore, it follows that the pressure created by customers manifests itself as price
wars between firms in the industry, in a continued battle for market share and
revenues.
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Bargaining Power of Suppliers
The bargaining power of suppliers is based upon the supply and demand model
of economics. Suppliers are basically a firms’ distributor who sells goods or raw
materials to a firm at certain prices. Suppliers gain power and the upper hand when
there are a limited amount of companies and substitutes available to their customers.
The degree of importance to the customers business is also a key factor. The higher the
importance, the more leverage and power the supplier obtains.
Switching Costs
Switching cost is the fixed cost incurred by a buyer when doing business with a
supplier. The cost is directly related to the amount of alternatives and variable prices
between alternatives. The switching cost for the industry is going to be low due to the
large amounts of suppliers and substitutes available. There is a broad area of food
markets and sources to choose to purchase from if a supplier decides to raise prices or
quality of product deteriorates.
PF Chang's has a non-exclusive contract with Distribution Market Advantage. The
non-exclusive aspect of the contract is significant to the switching cost, because if the
switching cost were high, the contract would most likely be exclusive. “We believe that
competitively priced alternative distribution sources are available should they become
necessary. (PFCB 10k) The most important items are contracted annually to ensure
availability. PF Chang’s Asian-specific ingredients are outsourced directly from Hong
Kong, China, Taiwan, and Thailand. They have an extensive network of suppliers in that
region to keep switching costs low. The supplier in this industry has a generally low
bargaining power, which means PF Chang’s has a relatively low switching cost and most
of the bargaining power.
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Differentiation
The higher the level of product differentiation, the higher the level of bargaining
power the supplier has. In this industry there are very few ways to differentiate a
product. The bargaining power of the supplier stays relatively low, compared to the
consumer, because of the ability to obtain materials elsewhere.
There is really no differentiation of product between one chicken to another
besides organic or non-organic. Under both factors, there are many different options to
purchase either one. The same goes for all other food in the industry. Because of this,
suppliers must compete on quality of service, timeliness, and cost. Therefore, the
suppliers do not have the upper hand in bargaining prices and stipulations with the
purchasers.
Importance of Product for Costs and Quality
Product costs and quality in the food industry is of the upmost importance. The
determining factors between one restaurant and another, is the quality and pricing of
the food. In order to compete on these factors, restaurants must be able to find the
best quality foods for the cheapest prices possible.
There is usually some volatility in the food market. For example, if the corn crop
in the United States had a bad year, then the corn prices would rise due to scarcity.
This would in turn cause the prices of feed for farmers of chicken and beef to rise. In
turn, the farmers would have to pass the cost they incurred to the restaurants when
purchasing the beef and chicken. This is why most firms in the restaurant industry
negotiate short-term and long-term contracts depending on the demand for the
commodities. Contracts can range in time from anywhere between two and twelve
months.
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The quality of the product is just as important as the price. The suppliers must
obtain a high quality product, especially in the restaurant industry, because there are
many standards and regulation that must be met by the FDA in order to obtain
operating licenses.
Number of Suppliers
There are a large number of raw food suppliers in the United States. The large
number of farmers and ranchers give the raw food suppliers very little bargaining
power. There is very little difference between one rancher and the next ones final
product most of the time. The only way they can compete is with price. Since the
switching costs are low, this allows the restaurants to search for the best possible price
or “shop around” until they find the best deal available. This is a huge disadvantage for
the suppliers. According to Chipotle’s 10k, “maintaining the high levels of quality we
expect in our restaurants depends in part on our ability to acquire fresh ingredients and
other necessary supplies that meet our specifications from reliable suppliers. We
purchase from various suppliers, carefully selected based on quality and their
understanding of our mission, and we seek to develop mutually beneficial long-term
relationships with them. We work closely with our suppliers and use a mix of forward,
fixed and formula pricing protocols. We've tried to increase, where necessary, the
number of suppliers for our ingredients, which we believe can help mitigate pricing
volatility and supply shortages, and we follow industry news, trade issues, weather,
exchange rates, foreign demand, crises and other world events that may affect our
ingredient prices.” (CMG 10k) Also when restaurants seek specialty goods from
suppliers oversees or for commodities, the supplier will also have a low bargaining
power due to the limited amount of suppliers who provide the specialty good. Even
though the suppliers have very little bargaining power, the restaurants don’t have much
either, due to government regulation of commodities.
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Volume Per Suppliers
When determining relative bargaining power, the volume of suppliers plays a
large factor. The restaurant industry is a very large industry housing over 945,000
current locations. An industry this large needs a very large base of suppliers. The large
companies in the industry will usually try to lower costs by buying in bulk or signing
contracts with suppliers in order to lock in prices. At Chipotle, raw materials are not
purchased directly from farmers or other suppliers but they do have selected and
approved all of the suppliers from whom ingredients are purchased for our restaurants.
Distribution centers purchase ingredients and other supplies from suppliers we select
based on our quality specifications, and purchase within the pricing guidelines and
protocols we have established with the suppliers. (CMG 10k) Chipotle will increase the
number of additional distribution centers as the restaurant expands in size. Overall,
there are many different options on suppliers so the bargaining power of the suppliers
is generally on the lower side.
Conclusion
Taking all five of these factors into consideration, there is no doubt that the
suppliers of the restaurant industry have very little bargaining power. The reason is that
there is a large plethora of suppliers with very little differentiation between products. If
a company is upset with the quality or pricing of its purchases with a supplier, it can
easily look around for another supplier to step in and fill its needs. The restaurants will
drive prices down to increase revenue and profitability with its bargaining leverage it
has on its suppliers.
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Industry Classification Given Five Forces
Porter’s five forces model has been implemented in order to understand the
overall level of competition within the restaurant industry. Since the restaurant industry
is very large in terms of number of units and size of each company, we narrowed the
industry down to the more upscale finer restaurants. These restaurants; P.F. Chang’s,
Cheesecake Factory, O’Charley’s, and Chipotle Mexican Grill all compete on price,
product quality, and superior customer service.
Competition among existing competitors or firms in the industry is very high in
regards to the prices each company charges and the market share each company is
trying to gain. The switching costs, economies of scale, and exit barriers make this
industry a very competitive one and especially within the four firms listed above. The
threat of new entrants in terms of small “mom and dad” restaurant is high, because
anyone can invest their money into opening a new restaurant, but trying to gain market
share away from the existing firms is very low. The restaurants listed above have spent
many years in the industry and have gained market share over that time period. This
makes it difficult for a newly opened business to control the industry or take away
market share from the existing firms.
Threat of substitute products is very high in the restaurant industry considering
the tough economic times in the recent years, but also the availability of new grocery
store locations. Many people can choose to stay home and eat rather than spend the
money to have a night out to eat. If a customer feels as if the restaurant industry is
raising prices there is more incentive to go down the street to the local grocery story
and gather food for the house at a much cheaper price. Bargaining power of customer
which includes any persons that dines out to eat is very high in the restaurant industry.
Customers have the power to dictate prices relative to the competition, because if the
prices are too high, the customer will go elsewhere for a cheaper price. Customers are
very price sensitive and will demand lower prices or take their business elsewhere.
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Bargaining power of suppliers is low in the restaurant industry due to the wide variety
of suppliers that do business with these firms. Certain firms get there foods and
ingredients from different parts of the country, but if one supplier cannot provide or
decides to raise their prices, the firms can go elsewhere for their menu items.
The overall competitiveness of the restaurant industry in regards to the five
forces model is moderate to moderately high. All factors above result in the
competitiveness of the industry and are only increasing with the quality of restaurants
and food each existing firm and new entrants provide.
Analysis of Key Success Factors
The main goal of all firms across the board is to create shareholder wealth. The
way a firm creates shareholder wealth lies within the firm’s ability to accumulate
competitive advantages over the other firms. There are two basic ways that firms
accomplish gaining a competitive advantage. The first is cost leadership. “Cost
leadership enables a firm to supply the same product or service offered by its
competitors at a lower cost.”(Text Book 2-9) There are multiple ways to obtain cost
leadership including economies of scale, economies of learning, economies of scope,
efficient production, simple product design, efficient organizational process, and lower
input costs. This strategy is typically implemented when the product is similar for all
firms and has a basic product. The second strategy is differentiation. “A firm following
the differentiation strategy seeks to be unique in its industry along some dimension that
is highly valued by customers” (Palepu 2-9). A firm can add to its differentiation by
providing superior service, product quality, product bundling, product variety, and
flexible delivery timing.
Most firms try to concentrate on either cost leadership or differentiation, but it is
noted that a firm still needs to pay attention to both strategies. Many firms even
combine to have a mix between competing on both strategies. In the restaurant
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industry specifically, firms use a mix between differentiation and cost leadership. The
reason is restaurants all serve food, which is a basic product. In order to retain
customers, restaurants must compete on price. As described above, a firm may use
cost leadership to lower product price and increase revenue. On the other hand,
restaurants try and create a certain type of “atmosphere” that is enjoyable to a large
consumer base to attract customers as well as having a high product quality. The way a
firm obtains these tasks is by using differentiation.
Differentiation
Generally speaking, differentiation is the strategy of a firm that sets it apart
from their competitors. Within this strategy there are different implementation
approaches that can help achieve differentiation. As discussed earlier, the five-force
analysis gives us a description on the competitiveness of an industry as a whole, while
cost leadership and differentiation strategies are intended to show firms how to best
gain competitive advantages amongst their individual industry. “While successful firms
choose between cost leadership and differentiation, they cannot completely ignore the
dimension on which they are not primarily competing.” (Palepu 2-9) In the restaurant
industry cost leadership is the main focus amongst firms but to maximize profitability
any business must focus somewhat on both aspects. We have found some key factors
in differentiation that in the restaurant industry can prove to be useful to firms. These
have been shown to be superior product quality, customer service, and investing in
brand image.
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Superior Product Quality
In any industry, for the most part, if a firm’s product is superior to their
competitors then a firm will be able to differentiate itself from all the rest. This is no
different in the restaurant industry and is actually shown to be a very critical point in
judging a firms competitive advantage. For example, at the Cheesecake Factory, the
menu is comprised of all natural chicken with no added hormones, premium beef that is
Certified Angus, fresh fish that is either longline or hook & line caught whenever
possible, cooking oils that contain no trans fat according to United States Food and
Drug Administration Food Labeling Guidelines, and produced that is mainly sourced
directly from premium growers. (CAKE 10k) The restaurant also offers organic coffee
and tea. The cheesecake factory is a good example of how restaurants in the casual
dining industry focus on superior product quality as compared other firms in this
industry. When a consumer goes to a restaurant they are expecting the product to be
worth the price they are going to pay. Sandy Beall, CEO of Ruby Tuesday, stated that
“consumers will focus less on price, price, price and more on food quality” (USA Today).
The restaurant industry is very fickle in the fact that just one bad meal or visit to a
particular restaurant could cause a customer to not return. This is why quality is such a
huge factor in the restaurant industry.
Another side of product quality is that the customer expects the food that a
restaurant produces to be uniform no matter which location they go to. If a customer
attends two different locations of a firm and receives un-similar products, this can easily
sway their opinion of the business. Consistency is key in the restaurant industry. A firm
is more likely to have repeat customers if they know that they are going to be getting
the same food experience time and time again. In the restaurant industry superior
product quality is a major factor because customers are choosing a firm on many
different reasons, but the main one being the actual product that they are providing.
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Superior Customer Service
Superior customer service in any industry can be a great competitive advantage
and can allow firm’s to differentiate themselves in an industry. Customer service is
highly valued due to the fact that the restaurant industry is geared to pleasing the
consumer. Nick Shepherd, CEO of Carlson, when questioned on the TGI Friday’s $5
sandwich and salad promotion, stated “Like most promotions, the short-term economics
were tough, but the long-term payoff comes from highly satisfied guests who become
valuable loyal guests, which is critical for the health of our brand and franchises.” (NY
Times). With such a high price competition, customer service is one of the traits that
can set a firm apart from all the rest. At Chipotle, customer service is key factory in
regarding to retaining customers and gaining recognition. According to Chipotle’s 10k,
Consistent with our emphasis on customer service, we encourage our restaurant
managers and crew members to welcome and interact with customers throughout the
day. (CMG 10k) Having employees interact with their customers allows them to develop
relationships and also to ensure loyalty. It also shows the importance of customer
satisfaction, which is a highly important factor to customers when deciding if they will
return to the restaurant. The top firms in the industry will not hold back in pleasing the
customer in whatever means necessary. Re-preparing a meal, refunding money, and
offering discounts are just a few of the different ways to achieve outstanding customer
service. These methods can vastly improve a firm’s competitive advantage in the
restaurant industry.
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Investment in Brand Image
Brand imaging is an invaluable resource that firms in any industry can realize. A
brand image is accomplished by developing a consistent theme in the customers mind
through advertising and marketing. This image can create a feeling of loyalty over time
and can increase the amount of repeat customers for individual firms in an industry. In
the restaurant industry brand imaging is very crucial through various outlets. According
to William Neuman of the New York Times, “Forced by the recession into deep
discounting, the chains are going beyond traditional advertising to get the word out.”
(NY Times). Through this advertising and brand imaging, customers can get a notion of
the quality of a restaurant. Brand imaging plays a huge role in any industry by causing
customer loyalty. As stated by Nick Shepherd in the previous paragraph, investment in
customer service results in an investment in brand image. If the customer comes away
satisfied, it is likely that they will return to the same chain, and advertise their
experience through word-of-mouth. All of the major firms in the restaurant industry
have some form of an image that differentiates them from the competition. This image
is then projected upon the consumer which leads to increased sales and overall
profitability. O’ Charley’s revenues are heavily based on brand marketing and
advertising, compared to the other restaurants in this industry.
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Note: Cheesecake Factory’s Advertising expense for 2005 and 2006 was
Immaterial (CAKE 10-K).
Conclusion
Product quality, customer service and brand image clearly differentiate a firm
from others within a particular industry. The competitive advantage arising from these
elements allows customers to draw clear distinctions between different firms. In fact,
within the restaurant industry, firms are rewarded for excelling in these categories,
earning prestige among competitors. In 2009, Restaurants & Institutions awarded the
29th Consumers’ Choice in Chains award to P.F. Chang’s China Bistro and The
Cheesecake Factory (BusinessWire.com, 2009). The Consumer’s Choice in Chains is a
survey of 3,000 consumers, who rate chain restaurants on eight customer-satisfaction
attributes: food quality, menu variety, value, service, atmosphere, cleanliness,
reputation and convenience (BusinessWire.com, 2009). According to Dan Hogan,
publisher of Restaurants & Institutions’, “[The award] sends a powerful message to the
industry and beyond, for which these restaurants have earned continued business and
guest loyalty.” Although the restaurant industry primarily competes using cost
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leadership strategies, these differentiation strategies play a major role in the success of
firms within the industry.
Cost Leadership
Firms within the restaurant industry, when looking at the most basic level, all sell
the customer food. The industry as a whole is very fragmented, which means no one
restaurant owns a huge percentage of the market share, consumers have no switching
costs, and on the most basic level there is very little product differentiation. These
factors all feed into the high level of price competition for the industry. In order to
compete with other firms, restaurants must implement cost leadership to their
advantage.
Economies of Scale
The restaurant industry is no different from any other industry in that economies
of scale are important. Economy of scale is when one can reduce cost per unit from
increased production. This comes in to play when trying to gain market share in a
highly price competitive market. If the firm can cut costs and offer a good at a lower
value, market share is soon to follow. One of the restaurant industries biggest cost is
their raw materials. This is a cost that all competitors have to take. If it were possible to
increase market share to where the firm would receive a lower price on the same good
as its competitors, the firm would gain a huge competitive advantage. For example, the
bigger the restaurant gets, the more chicken it needs to order. Because of this, the
more chicken it orders, the better prices the firm receives. The trend in the restaurant
market has been expand, expand, expand. Cheesecake Factory, Chipotle, and P.F.
Changs have all opened new stores every year for the past five years. The following
charts, shown below, represent the geographical location of each firm’s restaurants
across the United States.
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( Data for Charts taken from PF Changs 10-K, Cheesecake Factory 10-K, and Chipotle 10-K)
Efficient Production
The restaurant industry produces the same meals, millions of times a year. The
industry can cut costs using efficient production strategies. This basically says that the
firm will allocate resources in the most efficient way possible. If don’t properly, profit
and market share will follow.
The restaurant industry is also subject to guest traffic increases and decreases.
When a recession hits and guest traffic decreases, the firm will need to cut costs
somewhere to maintain its quality of service that its customers are use to. To offset the
lack of sales, restaurants can discover more efficient ways of operation. Whether or not
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the firm can become more “efficient” could determine whether the firm survives the
recession or not. This is why efficient production in the restaurant industry is so
important.
Another way the restaurant industry manages production is through the
management of labor. Many firms within the restaurant industry experience high labor
costs due to the number of employees at each establishment. For example, Chipotle’s
labor costs from 2007 to 2008 rose by $61.588 million. Now, restaurants are
attempting to cut the costs of labor in order to save money and increase profitability.
One way the industry has cut back on labor charges has been the reduction of actual
employees, as shown by the graph below.
(WSJ)
Firms are scaling back on the number of employees, and are ramping up the hours and
duties of those who remain.
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One specific example of a way the restaurants compete on efficiency is the Open
table seating reservations that allow customers to book reservations on line. This
system is very efficient and has been catching like wild fire amongst restaurants since
opening in 1999.
Research and Development and Brand Advertising
Within the cost leadership structure, firms tend to focus on not spending money
on research and development, and in some cases of the restaurant industry, businesses
spend little money on brand advertising as well. This is just another factor to why cost
leadership companies maintain such a tight cost control system.
In the restaurant industry, firms do not invest in research and development and
if so, very little money goes towards that fund. New menu items are cheap to create
and allow available to the customers. Although, since some restaurants do engage in
research and development to better their menu or change the atmosphere of the
restaurant, it tends to be for a one year period. Overall the industry does little research
and development, therefore leading to decrease expenses at the end of the accounting
period.
Brand advertising is a bit more complex. Since the restaurant industry must
showcase their products and get their name out to customers through TV, radio,
newspapers, and magazines, money is spent in to doing so. This is very true for the
industry as a whole, but in terms of the more upscale restaurants, they try to advertise
their products through word of mouth. “We believe that word-of-mouth advertising is a
key component in driving guests’ initial trial and subsequent visits, and that creating a
great experience for guests will always be the ultimate marketing vehicle” (P.F. Chang’s
Bistro). Word-of-mouth is a major advertising technique for the more upscale
restaurants, because of their superior product quality and fantastic customer service
they all strive for. The Cheesecake Factory also relies on repeating customer to get
their name out in the public. “Our operational excellence continues to be a highly
effective approach to attracting and retaining customers. Accordingly, we have
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historically relied on our reputation as well as our high profile locations, media interest
and positive “word of mouth” to retain and grow market share rather than using
traditional paid advertising” (CAKE 10-k).
Through little research and development costs along with a low costs of brand
advertising, firms in the restaurant industry save their money to invest in more
operations or expand globally. Also since the industry is very price competitive, the
firms save their money in case they need to cut costs for any particular reasons.
Overall, this industry combines many of the cost leadership strategies with
differentiation strategies, making it a mixture of strategies for creating competitive
advantage.
Tight Cost Control System
Companies in an industry who focus on cost leadership strategies look for a way
to achieve superior performance. There are many ways to achieve cost leadership,
including economies of scale and scope, efficient production, and efficient
organizational processes. (Palepu & Healy 2-9) If these firms can maintain a cost
leadership strategy they will experience high returns and profitability. These companies
have a tight cost control system where they spend money only when they need to and
invest only when necessary. Recently, some restaurants, facing a hike in minimum
wage requirements, have found creative ways to cut costs. At some of Darden
Restaurant’s LongHorn Steakhouses, servers are required to share tips with bartenders,
hosts and table busers in an attempt to cut labor costs (WSJ). Firms with tight cost
control systems know what they need, know what they have, and know what they can
do without. All levels of cost leadership ultimately lead to tighter cost control systems.
In the restaurant industry, firms have a mixture of cost leadership strategies and
product differentiation, but for the most part maintain a tight cost control system. This
is due to the little research and development companies spend each year and the
efficient production methods the industry offers. This is why P.F. Chang’s Bistro,
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Cheesecake Factory, O’Charley’s, and Chipotle Mexican Grill can sustain high profitability
and keep costs down for future expectations.
Conclusion
Overall the industry has created a mixture of both cost leadership strategies and
differentiation strategies that allow the firm to engage in different types of competitive
strategies. The more upscale restaurants in the industry spend little money on designs
and concepts they do not need, resulting in a tight cost control system for the firms.
This allows the companies to save money and in the long run create higher returns and
more profits for future periods.
Competitive Advantage Analysis
In the restaurant industry, both differentiation and cost leadership play important
roles in sustaining a competitive advantage over its competitors. P.F. Chang’s is a
mixture of both cost leadership and differentiation, but with a stronger emphasis on
differentiation. In order for a firm to succeed, the firm must identify the features of the
product; meet the customers’ needs, and lower the cost of a differentiated product so
that it is lower than what the customer is willing to pay. Competitive advantage analysis
is utilized to determine if the firm is taking the proper actions to attain a competitive
advantage. By obtaining a competitive advantage, the firm is able to outperform its
competitors and become in leader in the industry. “The restaurant business is intensely
competitive with respect to food quality, price-value relationships, ambiance, service
and location, and many existing restaurants compete with us at each of our locations”
(PFCB 10k) P.F. Chang’s competes on superior product quality, superior customer
service, and price.
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Superior Product Quality
Products must be of high quality to meet the increasingly high standards of the
market in this industry. The consumers’ lives and well-beings are dependent on the
product. Through superior quality products, customers are able to get a high level of
satisfaction. For example, chefs at P.F. Chang’s are trained to produce distinctive
Chinese cuisine using tradition recipes from the major culinary regions of China updated
with a contemporary twist. (PFCB 10k) P.F. Chang’s also ensures quality products by
maintaining a good relationship with their suppliers in Hong Kong, China, Taiwan, and
Thailand. These suppliers provide a variety of ingredients needed to create quality
Chinese cuisine. Today, consumers are concerned with personal wellness and eating
healthy. P.F. Chang’s restaurants are appealing to customers who have healthy eating
habits by offering a wide variety of vegetarian/specialty dishes. For example, all of the
dishes offered at P.F. Chang’s are MSG and gluten free. “Restaurants are responding
with revamped kids' menus, healthier food and kids-eat-free nights. Such moves are
tricky to do well because restaurants must appeal to young palates while addressing
parents' health concerns.” (WSJ) Recently, P.F. Chang’s and Cheesecake factory have
created the first kid’s menu. According to the Wall Street Journal, parents felt that P.F.
Chang’s was not a child-friendly restaurant due to the fact that they did not have a
menu for children. “The new menu includes such entrees as the Baby Buddha's Feast,
which contains steamed or stir-fried snap peas, carrots and broccoli, and kids' lo mien,
or egg noodles stir-fried with chicken.” (WSJ) Most dine in restaurants that offer a kid’s
menu provide foods, such as chicken fingers and hot dogs, but P.F. Chang’s has
continued to provide quality Chinese cuisine with a little twist that is appealing to
children. The production of quality products gives the company a competitive advantage
over other firms. Moreover, firms in the restaurant industry offer several varieties of
products to customers. The continued introduction of different varieties of products by
the firms in the industry also gives them a competitive advantage over other firms from
different industries.
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Superior Customer Service
Like other firms in the industry, P. F. Chang’s takes measures to improve
customer service relations. One of P.F. Chang’s main goals is to create a loyal customer
base that generates a high level of repeat business and provides superior returns to
their investors. (PFCB 10k) In order to fulfill that goal P.F. Chang’s will continue to
strive on providing quality Chinese cuisine in an atmosphere that is memorable to the
customer. Another tactic that P.F. Chang’s uses to maintain good relationships with
their customers is by encouraging the Chinese traditional way of dining and that is
family-style. By continuing to follow these tactics, P.F. Chang’s will be able to achieve
customer loyalty.
Product Cost
Product cost is another key determinant in sustaining competitive advantage
over its competitors. P.F. Chang’s competes on price, by offering a menu that is
appealing to the customer’s wallet. P.F. Chang’s is an upscale restaurant that has
entrées that go up $22.95. In today’s economy, many consumers want to save money
and budget their dining expenses by either cooking their own food or going to
restaurants that offer discounts. As mentioned earlier, P.F. Chang’s introduced Chang’s
for two, a prix-fixe menu offering a four course meal for two people for the price of
$39.95, this deal includes two soups, one starter, two entrées and two mini desserts, all
of which can be chosen from an extensive selection of signature dishes and guest
favorites. (PFCB 10k) P.F. Chang’s allows consumers to experience premium dining at
an affordable price. P.F. Chang’s ability to accommodate its customers by lowering or
applying discounts to their menu allows them to obtain a competitive advantage over its
competitive, hence gaining market share.
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Conclusion
P.F. Chang’s Bistro has competed in the restaurant industry for many years, and
by doing so they have gained human capital as well as a competitive advantage over
other firms in the industry. The company has strived to perfect their goods they proved
and excel in customer service over any other firm. P.F. Chang’s has positioned itself as
a mixture of cost leadership and differentiation. The company does insist on keeping
costs low as well as understanding what it takes to be a successful restaurant in this
industry. They have positioned themselves for great future earnings and profitability.
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Accounting Analysis
After completing a thorough industry analysis using the five forces model, the
next step is a formal accounting analysis to better assess the firm. Managers of a firm
often try to influence prospective investors by manipulating the firms accounting
numbers, or just by the amount of disclosure reported on the financial statements. For
this particular reason, the SEC (Securities Exchange Commission) has provided
guidelines and strict rules on the amount of information disclosure a firm must fairly
identify to future investors. Any company in the United States must obey the rules of
the SEC, but more importantly, the SEC governs smaller private sectors known as
GAAP, and FASB. These private sectors create and establish other accounting policies
firms must abide by.
In order to properly asses a firm, it is important to work through a formal
accounting analysis. A completed formal accounting analysis shows the firm in
actuality, because it takes out some of the distortions created by upper management of
the firm. There are six steps in performing this analysis, each one creating a better
opportunity to gain knowledge of the firm. The first step is to identify key accounting
policies within the firm. After configuring the key success factors from part 1, the key
accounting policies are implemented on how a firm measures the success factors from
an accounting basis. The second step in the analysis is to assess the accounting
flexibility of these step one policies. The amount of flexibility a firm can have is
determined by the GAAP rules there for regulated. Having a high amount of flexibility
can assist a manager in ways to better the information provided or be a more
informative firm. On the other hand, having little or no flexibility can prevent a firm
from presenting great factual information that could be more understanding. The third
step is to evaluate the firms accounting strategy. Given the amount of flexibility of a
firm, managers can either use this flexibility to present more knowledgeable information
or to distort certain items from the financial statements. Just by looking for changes in
accounting policies can give a better understanding of what strategy a firm may be
aiming for. The next step in the process is to evaluate the quality of disclosure. To gain
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a better perception on the quality of information disclosed would be to assess other
firms in the industry competing on the same product line. Since these firms have
considerable amount of flexibility, evaluate the firm to see if they are being fair to all
investors or hiding useful information one might find beneficial to the investment. The
fifth step in the process would be to identify any potential “red flags” in the accounting
statements. This step involves looking for changes in accounting numbers from year to
year. The fourth and fifth steps are used to assess the quality of the firm through the
information disclosed on the annual reports. For the last step in the analysis, investors
would undo any accounting distortions found throughout the reports.
Once the accounting distortions are identified and restated, the company’s
financial statements will show a more realistic picture of how they stack up to their
competitors. It is important to keep in mind that it is almost impossible to perfectly
undo these distortions with the limited knowledge the public has access to. However, it
still paints a better picture of the corporation than just viewing the skewed financials.
Key Accounting Policies
Key accounting policies of a firm help to get a better view of a firms actual
financial standing. Managers of the firms are entrusted with producing accurate
information because they have inside information that outsiders do not have access to.
They are basically given a basic accrual accounting framework to follow, and the rest is
judgment of the manager. There are benefits and disadvantages to this type of system.
The managers sometimes have incentives to distort profits by using biased assumptions
(Text Book, 3-2). A few agencies have risen due to the misuse of the manager’s power
with inside information. The Securities and Exchange Commission (SEC) is in charge of
setting accounting standards. The SEC relies on the Financial Accounting Standards
Board (FASB) and Generally Accepted Accounting Principles (GAAP) to set the
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standards. The uniform accounting standards reduces a manager’s ability to distort the
books; it doesn’t eliminate it. With the benefit also comes some negative repercussions
from the uniformed standard. “Accounting rules introduce noise and bias because it is
often difficult to restrict management discretion without reducing the information
content of accounting data” (Text Book, 3-5). Managers are only human, so some noise
comes from just sheer human mistake. All of these factors input into the actuality of
how factual a firms financial statements are.
In order to understand how a firm is producing their financial statements, it is
important to understand the key accounting policies. They are broken down into two
segments, which are Type One and Type Two. Type One key accounting policies are
related to the industry as a whole. Key success factors are intricately connected with
Type One key accounting policies. Type Two key accounting policies are more individual
firm specific based off a managers ideals and actions. This is the type that is linked with
the distortion or misrepresentation of financial statements. There is great economic
benefit to be held in distorting the financials at times. Completely understanding the
Type Two of the accounting policies would better prepare a potential investor to check
out the “fishy” parts of the financials. Putting the two accounting policies together will
give potential investors the best look into a firm’s financial state of being.
Type One Accounting Policies
Type Once key accounting policies directly link the firm’s financial disclosure to
the key success factors of the firm. P.F. Chang’s competes on differentiation and cost
leadership amongst their competitors. The Type Once accounting policies that P.F.
Chang’s has incorporated into their strategy is as follows; economies of scale, superior
customer service, and superior product quality.
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Economies of Scale
Keeping a tight costs control system is vital to success and competition in the
restaurant industry. Economies of scale is when a firm expands their markets share in
attempt to lower the cost per unit produced. Lowering the costs per unit of the
company’s product can result in higher earnings and ultimately increased profits. Firms
can do this by combining operations or simply by getting rid of unprofitable ones. In
the restaurant industry, not every restaurant opened is going to generate profits,
possibly due to bad locations, or just not a well-populated area for the restaurant.
These firms can combine businesses, or in our circumstances, get rid of a restaurant
that is not producing.
P.F. Chang’s decreased their costs for food, beverages, and packaging in 2009
partly due to the increase in price sales and the number of restaurants opened in 2009.
“In 2008, food costs increased as a percentage of revenue due to increased product
cost, primarily cheese, chicken and avocados, partially offset by menu price increases in
selected markets” (P.F. Chang’s Bistro 10-k). P.F. Chang's saw significantly higher costs
for many raw ingredients in 2008.
For the years ended December 31, 2007 2008 % % 2009 increase increase 2009 over 2008 7.90% Food, beverage and packaging $346.40 $431.90 $466.00 2008 over 2007 As a percentage of revenue 31.90% 32.40% 30.70% 24.70% 86 | P a g e
The table above shows the increases in price over the past three years to
compensate for the price of food, beverages, and packaging costs. These costs have
decreased over the past three years as a result from the price increase for menu items.
The cheesecake factory offers sales per square foot for each restaurant on average,
which has decreased over the past three years. “Average sales per productive square
foot (defined as interior plus seasonally-adjusted patio square feet) for restaurants open
for the full year were approximately $830 for fiscal 2009, $860 for fiscal 2008 and $920
for fiscal 2007”(CAKE10-k). This decrease in sales per square foot could have gone
down due to the bad economic times over the recent years, and the company is not
utilizing all the space they have available in each restaurant.
Below represent an analysis of average weekly sales for new restaurants opened
in 2005,2006,2007,2008, and 2009. Then we divided the number of units by the
average weekly sales to come up with the average weekly sales per newly opened
units.
P.F. Chang's Bistro number of units average weekly sales average weekly sales/unit 2005 2006 2007 2008 2009 18 20 20 17 8 80349 82327 86534 80875 98887 4463.83 4116.35 4326.70 4757.35 12360.88 Pei Wei Asian Diner 2005 2006 2007 2008 2009 23 27 32 25 7 average weekly sales 35,889 36,028 31,945 30,824 36,198 average weekly sales/unit 1560.39 1334.37 998.28 1232.96 5171.14 number of units 87 | P a g e
From above we can conclude that upon opening new restaurants, weekly sales
per unit has increased over the years. This indicates that P.F. Chang’s Bistro is creating
greater sales with their new locations, partly because the locations chosen are for
highly populated areas.
Overall, the restaurant industry tries to maintain cost control through economies
of scale. This allows the company’s to produce more products or generate more sales
through decreasing the price per unit at each restaurant. P.F. Chang’s has done so by
increasing prices on their menus, therefore driving food, beverages, and packaging
costs down. In addition, the new stores opened in the past five years have generated
increased sales per unit on a weekly basis. This shows the company has researched
and placed new restaurants in high profitable areas, and has exceeded expectations of
average weekly sales.
Superior Customer Service
In the restaurant industry customer service is very valuable, especially with the
amount of interaction that takes place between the employee and the consumer. The
focus of the restaurant business is to please the customer with a great time, and an
even better experience. This is very important in the restaurant industry because if the
customer isn’t happy with the service they receive, they are not very likely to return.
The restaurant industry is taking great strides to increase the level of service that is
provided. As well as the four week culinary training for all management positions, P.F.
Chang’s also requires a “four week training program that focuses on service strategies,
guest relations, and administration. “ (Chang’s 10-k) As well, all Pei Wei management
must take a three week training program “focusing on service strategies focused on
dine-in and take –away service, guest and employee relations, and administration.”
(Chang’s 10-k) With the situation of the economy, the inability to attract and maintain
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employee levels can create an adverse affect on customer service that is industry wide.
“Inability to recruit and retain qualified individuals may delay the planned openings of
new restaurants while high employee turnover in existing restaurants may negatively
impact customer service and customer relations, resulting in an adverse effect on our
revenues or results of operations.” (Chang’s 10-k)
As shown in the graph below, the industry trend for the last five years has shown
that labor costs are decreasing in percentage every year. This shows that companies
are not able to hire or pay employees as much as they used to. This can cause
frustration in the workplace and effect overall customer service.
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Superior Product Quality
Superior Product quality is a very important factor in the restaurant industry. The
customer is coming to a restaurant mainly for the quality of food that they are
receiving. If the quality is not kept up to a high standard then a firm could lose
potential and existing customers. In the restaurant industry as a whole, quality is a key
area that firms focus on and we believe that P.F. Chang’s is at the forefront of this
group. As mentioned earlier superior product quality is a key success factory in our
company. In P.F. Chang’s 10-k it describes some of the ways it is attained. “Our supply
chain management function allows us to utilize only fresh ingredients in our meals and
inventory is maintained at a minimal level. (Chang’s 10-k)” Keeping with the type of
meal received at P.F. Chang’s, the Asian-specific ingredients such as spices and sauces
are primarily brought in from Hong Kong, China, Taiwan, Thailand. This type of
attention adds to the value of the experience a customer encounters at P.F. Chang’s.
Along, with this is the eight-week management development program. All management
must go through this program with four of the weeks with the focus being on “culinary
job functions and culinary management. (Chang’s 10-k) Pei Wei has a similar program
with “six weeks of hand-on culinary functions and culinary management.” (Chang’s 10k) Overall, the level of disclosure for quality in the restaurant industry is moderate to
high. With food borne illness being a very big deal, it is necessary to pay close attention
to the quality of products.
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Type Two Accounting Policies
Type Two accounting policies are some of the most common overstated. They
are commonly overstated because they are the items on the financial statements with
the most accounting “flexibility”. A manager may use the flexibility to distort the
financials into a more favorable outcome. The managers may possibly distort the
following under the Type Two accounting policies; noncontributory defined benefit plan,
goodwill, post retirement benefits, operating leases, and research and development.
P.F. Chang’s upper management uses a great deal of operating leases, which in turn
distorts the financials. The following items, including operating leases, will be discussed
below for P.F. Chang’s Type Two accounting policies; defined contribution plan, and
goodwill.
Defined Contribution Plan
A defined contribution plan is a company retirement plan where the employee
chooses to defer a portion of their salary into the plan, and bears interest risk (Invst.)
They are promoted by the company to attract employees and reward the ones that stay
invested in the firm. A couple of defined contribution plans are 401K’s and 403b plans.
P.F. Chang’s uses 401k’s to compensate its employees.
Most 401k’s are used with a mutual fund being managed with stocks, bonds,
money market investments or a combination of the above. These plans are generally on
a pre-tax basis, which provides an advantage because all of the gains are tax-deferred.
This allows for maximum return over long periods of time. This kind of plan allows
companies to eliminate some of the liabilities in comparison to a defined benefit plan.
With the defined benefit plans employees can increase a monthly benefit plan that
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begins when the employee is no longer working and that is payable until death. This
kind of plan has many unknowns, which leads to greater liabilities as stated above. The
restaurant industry uses primarily defined contribution plans to compensate its
employees.
Goodwill
Goodwill, a highly intangible asset, is used to reflect the book value of entities
not directly associated with assets and liabilities. It reflects the chance to make higher
profits than would be derived from selling the tangible assets of the company. In other
words, goodwill reflects the company’s value beyond their asset value.
The basic goodwill formula is: goodwill= purchase price – fair market value of
net assets. When a company acquires another company, the merger eliminates the
goodwill written in the acquired company’s books, and is recalculated into the acquiring
company’s books.
Goodwill can only be impaired, not amortized. Instead of reducing a percentage
of the company’s goodwill over a certain period of time, goodwill is now valued as “fair
value”. Using present values of future cash flow, companies compare goodwill to their
carrying value (book value of assets added to goodwill minus liabilities). If the “fair
value” is less than the carrying value, then goodwill needs to be impaired. When
goodwill is impaired, it is just reduced to equal the value of the current carrying value.
In the end, goodwill is reported separately on the income statement and a new
adjusted value of the goodwill is recorded on the balance sheet.
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2005 2006 2007 2008 2009 P.F. Chang's Bistro 1.97% 1.62% 1.31% 1.30% 1.37% Cheesecake Factory N/A N/A N/A N/A N/A Chipotle Mexican Grill 5.21% 4.38% 4.43% 3.74% 3.45% O'Charley's N/A 20.12% 21.45% N/A N/A The chart above depicts the numbers for the formula to determine whether
goodwill needs to be impaired. P.F. Chang’s goodwill has been very consistent
throughout the five-year period researched above. The cut off is 20 percent, and P.F.
Chang’s was well under this every year since 2005. These numbers prove that goodwill
is immaterial and does not need to be restated on the financial statements.
Operating Leases
Current U.S. G.A.A.P policies allow for the accounting of leases under two
separate categories: capitalized leases and operating leases. There is no real pre-set
form dictating the use of one or the other in accounting for leases in the financial
statements. This loophole in accounting policies allows firms to choose which type of
lease accounting they use. Each type of lease accounting is accounted for in a different
way. Capitalized leases are treated like fixed assets: the value of the lease is
depreciated over the lifetime of the lease, and depreciation and interest expense are
recognized on the income statement. In contrast, operating leases are treated as
“temporary” assets, that is, the firm does not claim ownership of the assets, just the
use of the asset. In contrast to capitalized leases, operating leases are not reported on
the balance sheet, since there is no recognition of a future/current asset or
future/current liability. Payments are recognized as expenses only, which leads to an
overstatement of net income, since expenses are understated.
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Assets = Liabilities + Owner's Equity U U O Since G.A.A.P. provides firms flexibility when accounting for leases, many firms within
the restaurant industry, such as P.F. Chang’s, choose to use operating leases, as this
leads to “off-balance sheet financing” and a relative overstatement of earnings.
Assess Degree of Accounting Flexibility
The degree of accounting flexibility for a firm fluctuates from industry to
industry. The government strictly regulates some firms’ accounting policies while other
firms’ policies are only slightly regulated. This all dependent on what type of industry
the firm is in. The amount of flexibility a firm is able to utilize depends on GAAP as well
as other standards and regulations. FASB (Financial Accounting Standards Board, is the
firm that developed GAAP and determines what firms can do on financial statements as
far as flexibility goes. If there is high flexibility, a firm can determine how to represent
their current financial situation. This normally results in the firm presenting its self as
positively as possible. This is not always a good thing as it can often lead to a firm
misconstruing financial statements and misleading investors and others outside of the
firm. As a result of this, analysts must interpret firms with flexible accounting policies
differently than highly regulated firms. “If managers have little flexibility in choosing
accounting policies and estimates related to their key success factors, accounting data
are likely to be less informative for understanding the firms economics. Accounting
numbers have the potential to be informative, depending upon how managers exercise
this flexibility.” (Palepu) Firms in the restaurant industry utilize flexibility in terms of
operating/capital leases, defined pension plans, goodwill and research and
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development. In the following paragraphs, we will explore P.F. Chang’s ability to
exercise flexibility in terms of it key accounting policies.
Operating/Capital Leases
The Generally Accepted Accounting Principles and the Financial Accounting
Standards Board permit great flexibility for firms that hold both operating and capital
leases. The table below displays that P.F. Chang’s does not hold complete possession of
all of their assets; they actually have the preference of leasing them through either
capital or operating leases. Once a lease is signed, assets and liabilities are not
recorded on the balance sheet. They are recorded when payments are made. An
operating lease records no assets or liabilities on financial statements. On the other
hand, capital leases record lease assets and lease liabilities at the contract signing.
Under operating leasing, leases are treated as a rent expense. Through capital leasing,
the leased asset is recorded on the balance sheet and reflects its corresponding lease
obligations. P.F. Chang’s utilizes both operating and capital leases.
The following table shows our purchase commitments by category as of January 3, 2010 (in thousands): 95 | P a g e
Payments Due by Period Less Greater Than 1‐3 Total 1 Year 3‐5 Than Years Years 5 Years Long‐term debt $ 42,957 $ 41,236 $ 126 $ 128 $ 1,467 Operating leases 341,414 49,635 96,184 82,841 112,754 Capital leases 3,343 416 832 832 1,263 Purchase obligations 205,030 116,142 78,851 10,037 — Total $ 592,744 $ 207,429 $ 175,993 $ 93,838 $ 115,484 (Table was taken from PFCB’s 10k)
In order to impose whether a property will be classified as operating or capital
leased, P.F. Chang’s will evaluate each property prior to the beginning of each lease.
According to P.F. Chang’s, the restaurant accounts for tenant incentives received from
its landlords in connection with certain of its operating leases as a deferred rent liability
within lease obligations and amortizes such amounts over the relevant lease term.
(PFCB 10k) As for increases in rent, P.F. Chang’s utilizes the straight-line depreciation
method and records the total amount of rent payable during the contract period. The
difference between the straight-line rent and the minimum rents paid is recorded as a
lease obligation. Some leases contain certain limitations that are dependent on
restaurant sales volume, which requires an additional amount of rental payments.
At P.F. Chang’s the management can make judgments regarding the appropriate
term for each restaurant property which can affect the classification and accounting for
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a lease as capital or operating lease. These actions may create indifferent amounts of
depreciation, rent expense and amortization, which could be avoided if the assumed
lease terms were used. If P.F. Chang’s continues to make these judgments, assets and
net income will be overstated while expenses and equity will remain understated.
Assets
Liabilities
O
N
Stock
Holders
equity
U
Revenue
Expenses
Net income
N
U
O
Benefits and Pension Plans
P.F. Chang’s provides a great amount of information regarding pension plans.
Employees who have completed at least six months of employment and have attained
the age of 21 can qualify for the restaurant’s 401(k) defined contribution plan. The
401(k) allows employees to contribute to the plan and also allows for the firm to make
matching contributions. P.F. Chang’s, matches contributions in amounts equal to 25%
of the first 6% of employee compensation contributed, resulting in a maximum
contribution of 1.5% of participating employee compensation per year (subject to
annual dollar maximum limits). (PFCB 10k).The restaurant can only begin to match
contributions only when the employee has worked from P.F. Chang’s for at least one
year and has a minimum of 1000 hours. P.F. Chang’s discloses the exact percentage
that will be contributed to the employee’s 401(k) plan and provides a substantial
amount of information on the plan as a whole allowing the restaurant to have room for
flexibility.
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Goodwill
Goodwill arises when then the purchase price of an asset that is being
exchanged goes far beyond the fair market value. Goodwill is also referred to as
“buying hidden value”; it is an intangible asset that has an uncertain life is amortized.
The sum of goodwill can be determined by subtracting the fair market value of net
assets from the purchase price. According to the Generally Accepted Accounting
Principles, goodwill can only be impaired and not amortized. Firms are now required to
uphold the fair value of the reporting units, while using the present value of future cash
flows, and comparing it to their carrying value. If the fair value were found to be less
than the carrying value, the value of goodwill would need to be minimized in order for
the fair value to be equivalent to the carrying value. P.F. Chang’s does not provide
sufficient amount information on goodwill. P.F. Chang’s ratio of goodwill over Property
Plant and Equipment is less than 20%, which is rather low and will not be relevant to
the firm in terms of restatements. Provided that P.F. Chang’s only discloses the amount
of goodwill on its balance sheet and nowhere else, it is safe to say that this firm will
always have a small amount of flexibility in this section.
Research and Development
Research and Development is classified as an asset on the balance sheet, which
allows firms to plan potential growth by doing extensive research in order to develop
new products and improve operations. According to GAAP, the policy states that
Research and Development must be treated as an expense, which further results in an
overstated expenses and understated assets. In the restaurant industry, specifically
casual dining, research and development is not an important factor. P.F. Chang’s has no
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amount of research and development and therefore is less than 20% of operating
income. The importance of research and development is irrelevant to the firm.
Evaluate Actual Accounting Strategy
Accounting flexibility refers to allowing firms to strategize their use of accounting
flexibility in order to conceal or communicate the firm’s current economic situation or
performance. A firms accounting strategy can either be aggressive or conservative.
Firms that partake in conservative accounting will have an understatement in assets
and an overstatement in its liabilities, which will further decrease net income and
equity. In the contrary, firms who utilize aggressive accounting will understate its
liabilities and overstate its assets, which will decrease equity and net income. Having
the ability to identify a firm’s accounting strategies as either aggressive or conservative,
will allow investors or outsiders to be able to view the firms current financial position.
The firm’s financial statements will be transparent and fair. Firms have the option of
choosing the amount of information they want to disclose. Firms who display a nominal
amount of information on their financial statements are concealing information from
investors and outsiders, which can make it difficult to determine the firm’s value. In
order to obtain a clear picture of a firm’s performance, it is crucial to evaluate a firm’s
accounting strategies in order to determine its value.
Operating/Capital Lease
Operating and capital lease are major component of the restaurant industry. As
mention earlier, P.F. Chang’s does not hold complete ownership over its properties. P.F.
Chang’s has the preference of leasing through capital or operating leases. Although P.F.
Chang’s utilizes both operating and capital leases, operating leases accounts for the
majority of the leases on its balance sheet. P.F. Chang’s is aggressive in terms of their
operating leases. According to PFCB’s 10k, “For leases that contain rent escalations, we
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record the total rent payable during the lease term, as determined above, on a straightline basis over the term of the lease (including the rent holiday period beginning upon
our possession of the premises), and record the difference between the minimum rent
paid and the straight-line rent as a lease obligation. (PFCB 10k) Although P.F. Chang’s
utilizes aggressive accounting, the firm discloses a large amount of information in
regards to it capital and operating leases. Most firms in this industry use aggressive
accounting as their strategy.
2009 Lease % by Type
P.F. Chang's
Cheesecake
Factory
Chipotle
O'Charley's
Operating
Lease
99.17%
100.00%
100.00%
94.93%
Capital Lease
0.83%
-
-
0.05%
In the table above, it can be seen that P.F. Chang’s competitors are aggressive in
terms of their use of operating leases. As mentioned earlier, most firms in this industry
have a great amount of operating leases than capital leases or have no amounts of
capital leases. The Cheesecake Factory and Chipotle both have a zero amount of capital
leases.
Defined Contribution Plans
Unlike most firms, P.F. Chang’s discloses a minimal amount of information on its
defined contribution plan. P.F. Chang’s utilizes a 401(k) plan which allows employees to
contribute to the plan and also allows for the firm to make matching contributions. The
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firm specifically states the exact percentage limit and percent in matching contributions
that can be obtained through the plan. Although P.F. Chang’s is a low disclosure firm
with regards to its defined contribution plan, it allows outsiders to obtain a small picture
of its overall plan. As mentioned earlier, defined contribution plans eliminate some of
the firms liabilities compared to a defined benefit plan. Employees who utilize defined
benefit plans have the ability to increase their monthly plan until the employees are
longer working for firm or until their death. Defined contribution plans have many
unknowns which lead to increase in liabilities; therefore the firm utilizes aggressive
accounting in this section. P.F. Chang’s benefit plan is contributory and will not be
included in the restatements.
Goodwill
P.F. Chang’s ratio of goodwill over Property Plant and Equipment is less than
20%, which is low and will not be relevant to the firm in terms of restatements.
Research and Development
P.F. Chang’s research and development is less than 20% of operating income;
therefore irrelevant in terms of restatements.
Conclusion
After evaluating the firm’s accounting strategy, we have determined that P.F.
Chang’s has an aggressive accounting strategy. For the most part, P.F. Chang’s
discloses a great amount of information in regards to its operating and capital leases.
As for its defined contribution plans, P.F. Chang’s provides a minimal amount of
information, which can be difficult for investors and outsiders. In addition, P.F. Chang’s
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plan is contributory and will be irrelevant in terms of restating. The firm has a small
amount of goodwill, which is actually less than 20% of its P.P.E. Like many firms in this
industry, restaurants have either a small amount or no amount of research and
development. P.F. Chang’s does not have any research and development. Both goodwill
and R&D will not be of importance to the firm.
Quality of Disclosure
Evaluating a company’s financials can give us a “picture” of the value of the firm,
but this may not always be a fair representation of how the company is truly operating.
The level of disclosure a firm gives to the public allows analysts and investors to
perform a valuation but could be misconstrued due to the flexibility that companies
have with accounting standards. Under GAAP, companies have a great deal of leeway
to show the outside only what the managers want to show. Also, useful information can
be hidden amongst large amounts of irrelevant information. This means that firms may
not be as transparent as they are leading the public to believe. Firms can take two
approaches when it comes to the manipulation of financial statements.
One way a company can report numbers is very conservatively and show a clear
picture of how it is performing. These firms usually run their numbers as close to the
truth as possible, which gives analysts and investors a better idea of how to value the
firm. The second method is to report numbers very aggressively and have the best
reports for their company while following all of the necessary accounting standards.
This aggressive nature can lead to misrepresentation of asset values, liabilities, and
earnings. This distortion gives a false view of a company and possibly leads analysts
and investors to undervalue or overvalue the true assessment of a company.
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Qualitative Analysis
It is necessary to assess the quality of disclosure performance by companies.
The more information given in the financial documents provided by the firms, the easier
it is as an investor to see what’s really going on in the company. The firm may make
the factual evidence simple or very difficult to assess. There are certain requirements of
GAAP that firms must follow when disclosing information. As long as all the minimum
standards are met by GAAP, a firm is free to leave out anything they feel like, hide less
attractive data, and complicate matters with extra information not needed.
Page after page of data doesn’t always translate into great company disclosure.
Companies may add tons of irrelative information in order to make it difficult to extract
the important data. They might be doing this to falsify the feeling that they actually are
disclosing everything, when really they are leaving out the most important parts. The
key in assessing the quality of disclosure performance by companies is to know how to
separate the valid useful information from the extra noise.
Superior Product Service/Quality
P.F. Chang’s takes great pride in having excellent service and quality, which
leads to the disclosure of different methods of achieving this. The level of disclosure for
these techniques is very high and P.F. Chang’s does a great job of allowing themselves
to be transparent in this area. There are a few different ways that P.F. Chang’s achieves
this service and quality. With quality, the amount of disclosure on the distributor in
which they get their food is relatively high. There is also information on the culinary
training in which all management level employees must go through. With service, all
management level employees again must take a training course. This kind of
information is valuable to analysts and investors to see value in things that may not
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have been easily visible before. P.F. Chang’s does not try to hide, or not disclose this
information. The level of disclosure on this information is reasonably high.
Defined Benefits Plan
The level of disclosure on defined contribution plan for P.F. Chang’s and our
competitors was relatively good. With such a common plan as a 401k it is not hard to
believe that the disclosure of information is high. Although cheesecake factory does tell
all of the details describing their plan, they do not give the actual numbers per year
expensed, stating that they were insignificant. For the rest of the companies the
information on the numbers is very detailed. Also, the level of disclosure on the format
of the plans such as matching policies is very in-depth too. All relevant parameters are
in plain sight and are not hidden in large amounts of ramble. P.F. Chang’s recently
started offering a 401k plan to their employees in 2007. With this in mind and after
looking over all of the 10-k’s for our company and our competitors, P.F. Chang’s does a
great job of having equal amounts of information as the rest.
Business Segments
In any industry, having multiple business segments is always a good way for a
firm to expand its profitability and to reach more potential customers. With P.F.
Chang’s, there are two main business segments, P.F. Chang’s (Bistro) and Pei Wei.
These are the two main areas that are focused on. Recently though, there has been
some investments in the “brand development” section, mainly focusing on the
cooperation with Unilever to get a line of frozen foods out to the public. With the two
main segments, the level of disclosure is extremely high. Within almost every individual
section, it talks about the Bistro and Pei Wei individually, talking about how each is
different than each other. For example, when it talks about development in the 10-k, it
shows how many, what the total investment of capital should be, and the preopening
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costs for each store in each segment. This kind of information is shown throughout the
entire 10-k which allows someone dissecting the 10-k to have adequate knowledge on
both segments. Although the financial numbers for the two are generally integrated it
does give a few of the most important data for each throughout the 10-k such as
number of stores, costs and expenses, revenues, profits, capital expenditures, total
assets, and goodwill. This allows analysts and investors to get an overhead view of
each individual segment proportion relative to the corporation as a whole.
With the investment in the frozen food segments there is essentially no
information in the 10-k and this can be attributed to the partnership with Unilever. In
P.F. Chang’s conference call, a question is asked about this frozen food segment and
the response is as follows, “I’m going to be relatively silent on that. Our friends at
Unilever have asked us not to talk too much. We’re excited about it but they would like
to get everything in place…It’s going to cost us about $0.07 this year. We think next
year that investment will decline to about $0.03 maybe $0.04 next year and hopefully
go positive in 2011 so I know that’s not specific enough to your question but that’s
probably as much as I’m going to give you.” (2009 Quarter 3 analyst review and
conference call) This information shows that the partnership is in the process of being
completed, and they have a good idea of the returns will occur, but both P.F. Chang’s
and Unilever would like to stay relatively quiet until the progression is final.
Global Brand Development
Recently, P.F. Chang’s has entered into three development and licensing
agreements with partners to begin expanding restaurants into international locations.
The information and disclosure of this is minimal in the fact that they are not completed
with the development of these stores. It also states that P.F. Chang’s is continuously in
talks with various partners about opening up new restaurants in foreign sites. As time
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goes along, we believe that the disclosure of these international markets will increase,
but for now, it is very limited.
Economies of Scale
To reach the highest potential as a firm, in any industry, a firm would like to
achieve economies of scale. This idea is again that a firm wants to reduce costs by
increasing expansion. P.F. Chang’s operates in different segments but both segments
are relatively tied together in the financial aspect, as they are both restaurants. To see
how a company is progressing on this, we can look at items such as assets and PPE to
assess how this company is growing over a period of time. As far as P.F. Chang’s goes
within the 10-k, as I stated earlier we can look at the firm as a whole to see how this is
making progress. P.F. Chang’s discloses most of these numbers when they show their
balance sheets. As this is where a large quantity of this information comes from.
Overall, we can see how P.F. Chang’s is accomplishing economies of scale, and the level
of disclosure on this information is fairly moderate in comparison to our competitors.
Operating Leases
Overall, the level of disclosure on operating leases is relatively low. P.F. Chang’s
does discuss operating leases throughout their 10-k but it is fairly small. The extent that
is talked about is only the stipulations surrounding these lease obligations and the
amount of payments due by period. The information could be a lot more open when
talking about this section. In general, it could be helpful as we are analyzing P.F.
Chang’s to know why the choice was to do primarily operating leases versus capital
leases. If there were more literature, this would also allow us to better analyze the
riskiness of the firm as a whole.
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Quantitative Analysis
By running a quantitative analysis, one can better understand and capture
potential red flags for a firm in any industry. By performing an analysis for P.F. Chang’s
Bistro, certain ratios will bring out the possible accounting distortions managers have
chosen to provide. Two sets of diagnostic ratios will be performed to measure these
distortions. The first is sales manipulation diagnostics. These diagnostics include ratios
that compare net sales with cash from sales, account receivables, warranty liabilities,
unearned revenues, and inventory. After performing these ratios, we will better
understand what items are distorted in the financial statements and identify potential
red flags. This signifies whether managers are cooking the books and making earning
more than they really are, or if managers are taking a “big bath” meaning to
intentionally understate net earnings.
The second sets of ratios are derived from the expense diagnostics. These ratios
include; asset turnover, CFFO divided by OI, CFFO divided by NOA, total accruals
divided by change in sales, pension expense divided by SG&A, and other employment
expenses divided by SG&A. These ratios will provide evidence to whether or not P.F.
Chang’s in understating their expenses for any given year. By performing these ratios
for the past five years, we will recognize trends among the industry and realize how
distortive each firm’s accounting items really are.
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Sales Manipulation Diagnostics
When presenting the financial statements for any company, managers have the
option to present sales in many ways in order to manipulate the data. This can be a
major concern for investors, business partners, or customers in general. If more
generated sales mean that mangers can receive bonuses, stock options, or just make
the overall firm look better than it really is, managers will have more incentives to cook
the books and increase sales. Another way managers may distort information on the
books is by taking a “big bath”. If financial times are hard or the economy is on a
downward slope, and the public is already expecting terrible earning for a specific
company, managers will decrease sales and increase expenses. Although this looks bad
for the period completed, the public had already been expecting the worst so in the
long run the company has more earning than what they originally displayed, making the
overall business look better in the long run.
By providing these ratios for each competitor in the restaurant industry for the
past five years, one can spot trends or outliers in the industry. This can show
misrepresentations in accounting data or revenue sales for that specific firm. If a large
discrepancy from year to year is spotted, this is noted as a “red flag”. Red flags should
be checked into further to make sure that the proper steps have been taken to report
the right information. The ratios displayed in this section include; sales divided by
inventory, sales divided by cash from sales, sales divided by account receivables, and
sales divided by unearned revenues.
The raw ratios represent material based on changes from year to year. P.F.
Chang’s will be compared to the rest of its competitors in the industry to see where
they company lies in terms distorting financial items. This will also show us how big or
small the changes are from year to year within each company. The sales manipulation
diagnostics are presented below in raw and in change form.
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Net Sales/Cash from Sales
From this ratio, analysts can evaluate the performance in the collections of
accounts receivable. This can be seen by dividing the amount of sales made by the
actual cash received for performing these obligations. In the restaurant industry, with
the small amount of accounts receivable, this ratio is always going to be close to one
and will not ever have a very large variance. This is because in serving food to
customers there are no long-term obligations involved. With a constant ratio of one, we
did not feel that the change form ratio was necessary.
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2005 2006 2007 2008 2009 P.F. Chang’s 1 1 1 1 1 Chipotle 1 1 1 1 1 Cheesecake Factory 1 1 1 1 1 O'Charley’s 1.01 1.02 1.02 1.03 1.02 Industry Average 1.0025 1.005 1.005 1.0075 1.005 Net Sales/Inventory (raw)
The first ratio computed measures the generated sales of each firm compared to
the total amount of inventory on hand for that specific period. A firm would benefit the
most if its inventory is low and the sales generated are high. This means the company
is utilizing its inventory and getting rid of it more quickly. This ratio better analyzes
inventory turnover and how quick a firm can get their inventory in and out of the door.
The chart below represents the following ratio:
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2005 2006 2007 2008 2009 P.F. Chang's Bistro 233.792 220.254 233.210 243.027 232.126 Cheesecake Factory 61.826 63.313 62.831 49.994 72.157 O'Charley's 20.415 31.680 52.742 39.109 83.057 Grill 238.125 233.891 250.473 278.131 270.470 Industry Average 138.539 137.284 149.814 152.565 164.452 Chipotle Mexican This analysis indicates that there is a constant turnover rate for the firms. They
all stay around the same area, not jumping much from year to year. P.F. Chang’s and
Chipotles by far have the best ratios. This means that they do a better job turning over
their inventory after ordering it. Although the industries are pretty constant in the ratio
levels, there is an upward sloping trend from 2006 to 2007 and 2008 to 2009. The
industry as a whole, little by little, is becoming more efficient at turning over their
inventory on hand. In addition, since P.F. Chang’s ratio is so high, this could be a
potential red flag in terms of the managers overstating their revenues in 2007 and
2008, and possibly understating their return in 2009 due to the economic downturn.
Net Sales/Inventory (Change)
Along with the raw ratio, we have conducted a ratio that relates the change in
sales revenue from year to year to the inventory for that period. The size of the ratio
does not become a factor, only the sign changes for each company relates to the
manipulation of the financial statements.
111 | P a g e
2005 2006 2007 2008 2009 P.F. Chang's Bistro 29.533 29.056 32.712 23.110 5.680 Cheesecake Factory 11.131 6.415 8.157 2.951 ‐0.198 O'Charley's 1.265 1.859 ‐0.503 ‐1.647 ‐4.758 Chipotle Mexican Grill 59.618 55.552 61.233 51.560 33.211 Industry Average 25.387 23.220 25.400 18.993 8.484 P.F. Chang’s Bistro showed no sign changes, which could mean they have no
potential red flags causing distortions in there accounting standards. For the rest of the
industry, no real potential red flags come up except for O’Charley’s in 2007, 2008, and
2009, which could have been due to an increase in revenues with a drop in inventory.
Overall, the industry has sustained a positive change in terms of sales and inventory for
the past five years.
112 | P a g e
Net Sales/Net Account Receivables
This ratio is a very important ratio in terms measuring if the company is
collecting their money from revenues generated through that period. If the company
cannot collect their accounts receivables in a timely manner then their cash received
from their revenues generated decreases causing the ratio to be very low. A firm would
typically like to be paid in cash at the point of sale rather than collect the money at a
future date. If a company can collect their receivables in a timely manner, than that
account decreases causing an increase in the overall ratio. P.F. Chang’s Bistro does not
have an account for receivables so the sales that they generate are all comprised of
cash at the time of sale. Gift cards are the only source of accounts receivables for P.F.
Chang’s, but the way they account for this item is through operating costs of the firm.
The amount is not material enough for the firm to contribute a line item on the financial
statements, so therefore the ratio will not be included below.
Net Sales/Unearned Revenues
The ratio of net sales to unearned revenues measures how much of the service
or product has been earned in terms of total sales accumulated through the year. If
the service provided has not yet earned its money through the year, then the amount
unearned is listed as a liability on the balance sheet. The more money that has been
earned relative to the total amount of sales leads to a reduced ratio, which shows the
company has collected money for the service or product they provided. The more
unearned revenue the company has means more liability, which drives the ratio up
leading to a possible overstatement of net sales. P.F. Chang’s was the only company
listed that had an item for unearned revenues for the past five years. The chart is
shown below.
113 | P a g e
The ratio is decreasing from 2005 to 2009, which shows the company could
possibly be understating their revenues to make the firm look better in the long run.
Since the economy has been in a downfall for the past several years, the understating
of revenues decreases retained earnings, lowering the overall net income for that
period. This could be a potential red flag for P.F. Chang’s. The rest of the industry
does not have an account for unearned revenues; therefore, no comparisons will be
made.
114 | P a g e
Net Sales/Unearned Revenues (change)
The change form of the ratio will indicate if there are any possible red flags for
the company over the past five years. There were no sign changes for P.F. Chang’s
Bistro, which shows that there are no possible concerns resulting from the data. The
size of the ratio does not come into effect all we are looking for is a negative sign
change where there is not a direct correlation between sales and unearned revenues.
If more sales occur, there should be more unearned revenue to match the difference.
Vice versa, if sales decrease for a period, than so should the unearned revenues section
describing that the firm has collected more money over the year for the services
performed. Based on the above results, P.F. Chang’s does not have any concerns for
potential red flags regarding sales and unearned revenues. The other companies in the
industry did not accumulate unearned revenues on their financial statements, therefore
they were not calculated.
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Net Sales/Warranty Liabilities
In the ratio of net sales to warranty expense, the computation is comprised of
dividing net sales by warranty expense. This ratio tells analysts and investors the
amount of warranties expensed with relation to the total sales of the company. If this
ratio is high then the liability of a firm’s product down the road is very low. This is
because if the ratio is high then larger amounts of sales can be made with no warranty
expense. If the ratio is low, then the probability that a firm will be using more warranty
expense is greater because it does not take a significant amount of sales before
warranties would need to be expensed. In the restaurant industry, with no long-term
products, most firms will have little to no warranty expense. This is due to the fact that
customers come in to a restaurant, eat their food, and leave. The product has no longterm liabilities to the company. This allows restaurants expenses to be cut down as
well.
Sales Diagnostics Conclusion
There were very few ratios in this section that pertained to P.F. Chang’s Bistro.
The net sales divided by cash-to-cash ratio is calculated by dividing sales by total cash
less accounts receivables. Well since P.F. Chang’s does not have accounts receivables,
there ratio is a perfect one. The net sales divided by inventory ratio showed that P.F.
Chang’s had the highest ratio for the past five years. This means that they are getting
their inventory in and out the door in a timely manner. The company’s ratio was so
high that they get their inventory in and out in around a day and a half. That is
extremely well. The rest of the industry follows a trend with increasing inventory
turnover ratios, so there are no possible concerns or potential red flags. Like stated
above, P.F. Chang’s does not have account receivables so the next ratio, net
sales/Accounts receivables, is not calculated for the industry. The net sales/unearned
revenue was only calculated for P.F. Chang’s, because they are the only company that
has that line item. The ratio shows that the company is decreasing for the past few
116 | P a g e
years, possibly showing that they are understating their revenues or overstating
expenses. The company along with its competitors does not have any warranty
liabilities on their financial statements, so that ratio was not performed as well.
Expense Manipulation Diagnostics
Relative to the sales manipulation diagnostics, which measure the potential
effects of distorting net income by changing the amount of sales, expense manipulation
diagnostics show how the managers can manipulate net income through changing
expenses. Just like overstating sales, understating expenses increases net income and
shows the managers have chosen to distort the items on the income statement. On the
other hand, managers could have incentives to overstate expenses in order to decrease
net income making the financials seem worse than they really are. This is called taking
the “big bath,” so in the long run the company will seem better off than before. The
ratios that are involved in the expense manipulation diagnostics include; asset turnover,
CFFO divided by OI, CFFO divided by NOA, total accruals divided by change in sales,
pension expense divided by SG&A, and other employment expenses divided by SG&A.
By comparing P.F. Chang’s to other competitors in the industry, we can get a
better look at outliers or possible trends in the industry. All ratios will be provided in
raw form, to show the changes from year to year, and in a change form, which will
show positive or negative sign changes from year to year, which would show potential
red flags. The following ratios are performed below:
117 | P a g e
Asset Turnover (raw)
The ratio is calculated by diving net sales in the current year by total assets in
the previous year. If the ratio is low, this indicates that the company is not utilizing
their assets to generate greater profits. A high ratio lets us know the company is using
the assets provided to better generate sales and increase future profits.
2005 2006 2007 2008 2009 P.F. Chang's Bistro 2.110 1.963 2.109 1.924 1.840 O'Charley's 1.401 1.356 1.412 1.434 1.691 Cheesecake Factory 1.558 1.421 1.454 1.402 1.402 Chipotle Mexican Grill 1.896 2.089 1.796 1.845 1.841 Industry Average 1.741 1.707 1.693 1.651 1.694 118 | P a g e
Based on the above results there is a correlation between each of the firms in
the industry in the sense that they all react to the economy about the same. P.F.
Chang’s represents the highest asset turnover, which can conclude that they are
utilizing their assets well enough to generate profits. This can be from new store
openings placed in great locations to increase sales. There are no outliers or drastic
changes in the ratio, which can tell us that there are no potential red flags in distorting
net income on the financial statements. The slight increase in 2009 for O’Charley’s
could have been due to an overstatement in expenses, therefore driving net income
down for the 2009 period. This could potentially lead to a red flag in the financial
statements.
Asset Turnover (change)
The change in asset turnover measures the net sales divided by the change in
assets from the previous year. Once again, the size of the ratio is irrelevant, but the
sign changes are relevant. When looking at this ratio, the underlining substance is that
when increases in sales occur, there should also be increases in assets.
119 | P a g e
2005 2006 2007 2008 2009 P.F. Chang's Bistro 1.119 3.138 1.401 2.547 ‐1.976 O'Charley's 1.896 ‐52.297 0.246 0.304 0.869 Cheesecake Factory 1.273 1.171 1.851 ‐30.365 0.046 Chipotle Mexican Grill 2.490 0.920 2.250 2.400 1.366 Industry Average 1.695 ‐11.767 1.437 ‐6.278 0.076 Sign changes in this ratio create possible red flags and distortions on the
financial statements. P.F. Chang’s showed no negative sign changes, which means it’s
a good measurement, since they are utilizing their assets well. O’Charley’s creates a
possible red flag when they experienced a year of negative sign changes, beginning
with 2006, where they drastically fell off. This can create concerns for the accounting
120 | P a g e
practices that are taken into effect at that company. This states that O’Charley’s could
have understated their expenses for the period, causing the ratio to have a drastic
decrease in value. P.F. Chang’s still maintained an industry trend with no outliers or
possible red flags.
CFFO/OI (raw)
Cash flow from operations divided by operating income measures the amount of
income the firm is generating compared to the total amount of cash collected during
that period. Since operating income has many line items including most expenses, it is
a valid measurement to figure the amount of income brought in by the operating
activities.
121 | P a g e
2005
2006
2007
2008 2009
P.F. Chang's Bistro 1.775
2.256
2.700
2.662 2.460
Cheesecake Factory 1.281
1.403
1.445
1.941 2.674
O'Charley's 2.149
2.056
3.641
‐0.529 7.583
Chipotle Mexican Grill 2.498
1.672
1.358
1.600 1.280
Industry Average 1.926
1.847
2.286
1.418 3.499
Except for O’Charley’s, all the other firms in the industry do not show very
many changes that would raise a potential red flag. Every company for the most part
maintains a relatively high ratio providing more cash from the operating income section
on the income statement. O’Charley’s experienced a negative operating income in 2008
that drastically brought the ratio way down. This was caused by a $93 million goodwill
impairment charge. P.F. Chang’s had no years of outliers or potential red flags for the
raw form.
CFFO/OI (change)
When taking the change form of the CFFO divided by OI ratio, we can better
establish results for firms with potential red flags. The key differences we are looking
for are when the ratio dips negative for a period or periods. The ideal scenario is when
cash flows increase, so should the operating income for the same period.
122 | P a g e
2005
2006
2007
2008 2009
P.F. Chang's Bistro ‐0.066
‐2.316
‐4.009
1.282 1.626
Cheesecake Factory 0.507
0.632
3.795
‐0.384 ‐2.077
O'Charley's 0.458
1.815
0.808
0.088 ‐0.054
Chipotle Mexican Grill 1.517
0.845
0.937
3.253 0.780
Industry Average 0.604
0.244
0.383
1.060 0.069
P.F. Chang’s Bistro raises some concern for their first three years because they
all have negative ratios, which mean that for 2005-2006 the cash flow from operations
decreased while operating income increased. This states that P.F. Chang’s could have
understated their expenses leading to an increases operating income. Cheesecake
Factory and Chipotle Grill experienced an increase in ratio for the years 2007 and 2008.
This could be due to an overstatement of expenses ultimately driving operating income
down and cash flow from operations up.
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CFFO/NOA (raw)
Cash flow from operations divided by net operating assets presents how well the
company is using its plant, property, and equipment to generate cash flows for the
company. If the assets are not depreciated as needed, then the ratio will be much
smaller then what the company would like to have. This also indicates that a company
may be understating its expenses and therefore driving the ratio downwards.
2005
2006
2007
2008 2009
P.F. Chang's Bistro 0.314
0.293
0.265
0.267 0.322
Cheesecake Factory 0.271
0.208
0.186
0.197 0.250
O'Charley's 0.135
0.179
0.149
0.132 0.132
Chipotle Mexican Grill 0.227
0.256
0.297
0.339 0.410
Industry Average 0.237
0.234
0.224
0.233 0.278
124 | P a g e
Based on the above values, there is an industry trend between the companies
and no possible outliers exist or cause concern for potential red flags. Although they do
show a slight upward trend possible overstating their expenses, the industry is
increasing as a whole, so no possible threats occur.
CFFO/NOA (change)
In the change form of the ratio, the companies have still maintained a trend
within the industry and no real possible outliers exist. Each company did experience at
least one year of negative sign changes, which result from an unexpected decrease in
the ratio due to an understatement in expenses for that period. This also says that for a
negative sign change, assets are increasing relative to the cash flows from operations
decreasing.
125 | P a g e
2005
2006
2007
2008 2009
P.F. Chang's Bistro ‐0.015
0.196
0.148
0.475 ‐0.793
Cheesecake Factory 0.137
‐0.105
0.057
‐4.932 ‐0.388
‐0.610
‐46.792
0.646
0.451 0.131
Chipotle Mexican Grill 0.743
0.409
0.480
0.567 1.231
Industry Average 0.064
‐11.573
0.333
‐0.860 0.045
O'Charley's In 2006, O’Charley’s experienced a huge decrease in their ratio leading to a
large amount of assets that was not written off during that period and not enough cash
brought in from operating activities. Besides O’Charley’s the rest of the industry
possesses no concerns for distorting items on the financial statements.
Total Accruals/Sales (raw)
The next ratio, total accruals divided by sales represents how much or if the total
amount of accruals is supported by sales from the firm. This ratio will also indicate any
distortions on the financial statements relevant to these two items. The ratio is
calculated by subtracting net income from cash from operations to get total accruals.
Then divide that amount by total sales for the period and the ratio is complete. Any
increases in the ratio are explained by overstating expenses, and a sudden decrease in
the ratio indicates the company intended on understating their expenses for that
period. The reason being is that if there is a sudden decrease, then sales are decreasing
faster than total accruals. If this is the case, then a firm must be understating
expenses. The chart and graph representing the ratio are shown below:
126 | P a g e
2005
2006
2007
2008 2009
P.F. Chang's Bistro 0.087
0.097
0.098
0.092 0.094
Cheesecake Factory 0.066
0.054
0.057
0.073 0.096
O'Charley's 0.055
0.066
0.059
‐0.084 0.047
Chipotle Mexican Grill 0.064
0.076
0.070
0.090 0.088
Industry Average 0.068
0.073
0.071
0.043 0.081
Based on the above results, once again the industry for the most part has kept a
certain trend in regards to the ratio. This poses no possible concerns and includes no
outliers for the industry. P.F. Chang’s Bistro has maintained a consistent ratio for the
past five years, while O’Charley’s has once again experience a negative ratio in 2008.
This can be caused by a sudden decrease in net income for 2008. The company had a
negative income for that period so the total accruals were not supported by the sales
coming in for the company. For the rest of the industry, the companies have controlled
127 | P a g e
a steady ratio for the past five years, which means their company has accumulated
enough sales to support its total accruals.
Total Accruals/Sales (change)
The change form of the above ratio will indicate if the firm’s total accruals are
supported by the total sales for each period. There should be a direct correlation
between the two items in terms of if one increase, the other should increase with it and
vice versa. If there is not a direct correlation between the two values, the ratio results
in a negative number raising a potential red flag for that period. The results are
presented below:
128 | P a g e
2005
2006
2007
2008 2009
P.F. Chang's Bistro ‐0.124545063
0.158015
0.103277
0.039822 0.180336
Cheesecake Factory ‐0.026472951
‐0.04947
0.075322
0.324131 ‐8.52941
O'Charley's 0.064394603
0.234805
0.719257
3.467126 ‐2.36526
Chipotle Mexican Grill 0.039546831
0.115243
0.05348
0.177972 0.072529
‐0.011769145
0.114648
0.237834
1.002263 ‐2.66045
Industry Average Based on the above results, there is still an industry trend just like the raw form
of the ratio. P.F. Chang’s had a negative ratio in 2005, but very slight compared to the
decrease by O’Charley’s and Cheesecake Factory. This indicated that these two
companies’ understated their expenses for 2008 and 2009 resulting in a decreased
ratio, which means they could possibly be understating their expenses. Chipotle and
P.F. Chang’s consistently held a positive ratio for the past four years and maintained
their industry trend just as in the raw form of the ratio. For the other two companies
there could be some possible concerns in terms of distorting their financial data for
2008 and 2009.
Pension Expense/SG&A
The pension expense diagnostic ratio measures how much of the firms money is
going to employment pension plans or sales, general, and administration expenses.
This can provide information to investors and analysts to what the company does with
some of its free cash. An increase in the ratio indicates that the firm might be
understating their expenses for the year. If a sudden decrease in the ratio occurs, then
that could pose a possible red flag for the company overstating their expenses. P.F.
Chang’s Bistro has a defined contribution plan also known as a 401-K. This allows the
firm to benefit from expensing their money into a pension plan of defined benefit plan.
Therefore, we will not need to calculate a ratio for the rest of the competitors.
129 | P a g e
Other Employment Expenses/SG&A
This ratio is the last of the expense diagnostic ratios, and it measures the other
employment benefit costs other than the ratio above. It is then also divided by sales,
general, and administrative expenses. Once again, there are no expenses that P.F.
Chang’s provided for their employees benefit plans, therefore we will not need to
construct a ratio analysis for the rest of the industry.
Expense Diagnostics Conclusion
After performing all the expense ratios listed above, P.F. Chang’s showed
consistency in terms of flowing with the industry trend. The first ratio calculated was
the asset turnover ratio, which P.F. Chang’s showed the highest ratio and provided no
signs of potential red flags for sudden increases or decreases. The next ratio was CFFO
divided by OI, which provided information that P.F. Chang’s had shown some slight
increases in ratio size, but not enough to raise concerns. The change form of the ratio
showed three negative sign changes, which could show the company understated their
sales for three years. The CFFO divided by NOA ratio was calculated next. This ratio
provided the best results in which every company performed great results and all
followed an industry trend for the past five years. No possible concerns or potential red
flags were found. Total accruals divided by Sales, showed that P.F. Chang’s can
maintain their accruals in regards to their sales. Once again no possible threats
occurred. P.F. Chang’s only showed one ratio that raised concerns for potential red
flags and could be do due an understatement of expenses for those years.
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Identify Potential Red Flags
“Red flags” are indicators within the financials of a firm that should be
thoroughly checked out. Just because a company has a few red flags does not mean
that it is doing anything illegal, however it should raise some concerns from an
investor’s point of view. Red flags are a variety of different things that are usually
unexplained or unusual. Red flags range anywhere from unusual increases in
inventories in relation to sales, to large fourth quarter adjustments. All the numbers are
given in the 10-K of the firms to scan for these problems. Once found, it is important to
go through and restate the distorted balances. Investors will have a much clearer
picture of the value of the company after they have been restated. P.F. changes has a
few red flags in the change form,
Operating Leases
When a firm is very aggressive with its operating lease accounting, a few
distortions are created. If the sum of the present value of future lease payments is
larger than 10 percent of long-term debt, then the company is reporting inaccurate
information. In this case, they are understating their liabilities by capitalizing the leases.
The next step after calculating that it is above 10 percent is to restate the financials.
131 | P a g e
Operating Leases 2005
4014%
2006
1568%
2007
237%
2008
261%
2009
17752%
The chart above provides the calculation of the sum of present value of future lease
payments is larger than 10 percent of long-term debt. P.F. Chang's will need to restate
the financials to accurately evaluate the company’s financial position compared to their
competitors. Even though P.F. Chang's is well over the allotted 10 percent marker, it is
comparable to their competitors.
2009 Lease % by Type
Cheesecake
P.F. Chang's
Factory
Chipotle
O'Charley's
Lease
99.17%
100.00%
100.00%
94.93%
Capital Lease
0.83%
0.00%
0.00%
0.05%
Operating
132 | P a g e
On top of the firm being over the 10 percent marker, P.F. Chang’s also uses 99 percent
operating leases over capital leases. This is a very alarming number with the 10 percent
marker exceeded, which is a large red flag. As indicated in the second chart, the four
companies use 94 to 100 percent operating leases. P.F. Chang's is in need of restating
the financials due to the significant amount of liability left off the books with the firms’
aggressive stance on operating leases.
Undoing Accounting Distortions
After all the potential red flags have been identified, the next step is to take the
financial statements and sort out what is “junk” and restate through trial balances. This
allows investors and analysts to see the clear picture of the statements and not
distorted ones. By restating the financials, one can better understand where certain
items should belong and to the correct amount. From the section above, there is only
one distortive item on P.F. Chang’s financial statements and that is operating leases.
Since the operating leases have not been capitalized, the liabilities are understated and
no leases have been expensed. The following amortization tables below will give a
more clear view of how operating leases should be capitalized.
Operating Leases
Operating leases are a distortive item on P.F. Chang’s Bistro financial statements.
Operating leases should be capitalized and turned into assets, but the company does
not account for these expenses, so the liabilities are understated. It shows that P.F.
Chang’s takes advantage of the amount of flexibility given by not capitalizing their
leases. In order for any investor fully understand the nature of the business and where
they stand in the industry, a direct and clear picture should be made with the financial
statements.
Restating the financial in terms of operating leases requires the firm to capitalize
their fixed assets. The liabilities and assets are taken into account and formed by the
133 | P a g e
present value of all future payments to the lease. The firm should recognize expenses
for that period and take into account those costs each year. A discount rate is also
involved with capitalizing leases, and since P.F. Chang’s does not have capital leases,
there is not a set discount rate used. The discount rate or cost of debt we used for our
amortization was based off the present target value in which we would adjust the
interest rate each year more or less. The estimated future life of the capitalized leases
was 8, 9, and 10 years. The discount rate used was on average 11.5%. Provided all
this information, below represents the amortization tables and includes the overall
amount to capitalize lease agreements.
134 | P a g e
2005 (In Thousands of Dollars)
Interest Rate
Year
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
11.5%
Period
1
2
3
4
5
6
7
8
9
10
Payment
$ 23,680
$ 28,360
$ 30,017
$ 29,605
$ 29,600
$ 29,265
$ 29,265
$ 29,265
$ 29,265
$ 29,265
PV FACTOR
0.8969
0.8044
0.7214
0.6470
0.5803
0.5204
0.4667
0.4186
0.3754
0.3367
pv payment Period
BB
Interest
Payment
$ 21,237.67
1
$ 164,014.00 $ 18,861.61 $ 23,680
$ 22,811.64
2
$ 159,195.61 $ 18,307.50 $ 28,360
$ 21,654.23
3
$ 149,143.11 $ 17,151.46 $ 30,017
$ 19,154.27
4
$ 136,277.56 $ 15,671.92 $ 29,605
$ 17,175.82
5
$ 122,344.48 $ 14,069.62 $ 29,600
$ 15,229.98
6
$ 106,814.10 $ 12,283.62 $ 29,265
$ 13,659.17
7
$ 89,832.72 $ 10,330.76 $ 29,265
$ 12,250.38
8
$ 70,898.48 $ 8,153.33 $ 29,265
$ 10,986.89
9
$ 49,786.81 $ 5,725.48 $ 29,265
$ 9,853.71
10
$ 26,247.29 $ 3,018.44 $ 29,265
EB
$ 159,195.61
$ 149,143.11
$ 136,277.56
$ 122,344.48
$ 106,814.10
$ 89,832.72
$ 70,898.48
$ 49,786.81
$ 26,247.29
$ 0.73
Change in Loan
$ 4,818.39
$ 10,052.50
$ 12,865.54
$ 13,933.08
$ 15,530.38
$ 16,981.38
$ 18,934.24
$ 21,111.67
$ 23,539.52
$ 26,246.56
Depreciation
$ 2,368
$ 2,368
$ 2,368
$ 2,368
$ 2,368
$ 2,368
$ 2,368
$ 2,368
$ 2,368
$ 2,368
Total CL Expense
$ 21,229.61
$ 20,675.50
$ 19,519.46
$ 18,039.92
$ 16,437.62
$ 14,651.62
$ 12,698.76
$ 10,521.33
$ 8,093.48
$ 5,386.44 2006 (In Thousands of Dollars)
Interest Rate
Year
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
11.7%
Period
1
2
3
4
5
6
7
8
9
10
Payment
$ 17,913
$ 37,079
$ 37,725
$ 37,480
$ 36,929
$ 33,795
$ 33,795
$ 33,795
$ 33,795
$ 33,795
PV FACTOR
0.8953
0.8015
0.7175
0.6424
0.5751
0.5149
0.4609
0.4126
0.3694
0.3307
pv payment Period
BB
Interest
Payment
$ 16,036.71
1
$188,720.00 $ 22,080.24 $ 17,913
$ 29,718.14
2
$192,887.24 $ 22,567.81 $ 37,079
$ 27,068.85
3
$178,376.05 $ 20,870.00 $ 37,725
$ 24,076.14
4
$161,521.04 $ 18,897.96 $ 37,480
$ 21,237.42
5
$142,939.01 $ 16,723.86 $ 36,929
$ 17,399.37
6
$122,733.87 $ 14,359.86 $ 33,795
$ 15,576.87
7
$103,298.73 $ 12,085.95 $ 33,795
$ 13,945.27
8
$ 81,589.69 $ 9,545.99 $ 33,795
$ 12,484.58
9
$ 57,340.68 $ 6,708.86 $ 33,795
$ 11,176.88
10
$ 30,254.54 $ 3,539.78 $ 33,795
EB
$192,887.24
$178,376.05
$161,521.04
$142,939.01
$122,733.87
$103,298.73
$ 81,589.69
$ 57,340.68
$ 30,254.54
$ (0.68)
Change in Loan
Depreciation
$ (4,167.24) $ 1,791
$ 14,511.19 $ 1,791
$ 16,855.00 $ 1,791
$ 18,582.04 $ 1,791
$ 20,205.14 $ 1,791
$ 19,435.14 $ 1,791
$ 21,709.05 $ 1,791
$ 24,249.01 $ 1,791
$ 27,086.14 $ 1,791
$ 30,255.22 $ 1,791
Total CL Expense
$ 23,871.54
$ 24,359.11
$ 22,661.30
$ 20,689.26
$ 18,515.16
$ 16,151.16
$ 13,877.25
$ 11,337.29
$ 8,500.16
$ 5,331.08 135 | P a g e
2007 (In Thousands of Dollars)
Interest Rate
Year
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
14.0%
Period
1
2
3
4
5
6
7
8
9
10
PV Payment FACTOR pv payment
$ 42,242
0.8772 $ 37,054.39
$ 43,479
0.7695 $ 33,455.68
$ 43,776
0.6750 $ 29,547.55
$ 43,319
0.5921 $ 25,648.33
$ 42,462
0.5194 $ 22,053.43
$ 34,141
0.4556 $ 15,554.18
$ 34,141
0.3996 $ 13,644.02
$ 34,141
0.3506 $ 11,968.44
$ 34,141
0.3075 $ 10,498.63
$ 34,141
0.2697 $ 9,209.32
Period
1
2
3
4
5
6
7
8
9
10
BB
$208,634.00
$195,600.76
$179,505.87
$160,860.69
$140,062.18
$117,208.89
$ 99,477.13
$ 79,262.93
$ 56,218.74
$ 29,948.37
Interest
$29,208.76
$27,384.11
$25,130.82
$22,520.50
$19,608.71
$16,409.24
$13,926.80
$11,096.81
$ 7,870.62
$ 4,192.77
Payment
$ 42,242
$ 43,479
$ 43,776
$ 43,319
$ 42,462
$ 34,141
$ 34,141
$ 34,141
$ 34,141
$ 34,141
EB
$ 195,600.76
$ 179,505.87
$ 160,860.69
$ 140,062.18
$ 117,208.89
$ 99,477.13
$ 79,262.93
$ 56,218.74
$ 29,948.37
$ 0.14
Change in Loan
$ 13,033.24
$ 16,094.89
$ 18,645.18
$ 20,798.50
$ 22,853.29
$ 17,731.76
$ 20,214.20
$ 23,044.19
$ 26,270.38
$ 29,948.23
Depreciation
$ 4,224
$ 4,224
$ 4,224
$ 4,224
$ 4,224
$ 4,224
$ 4,224
$ 4,224
$ 4,224
$ 4,224
Total CL Expense
$ 33,432.96
$ 31,608.31
$ 29,355.02
$ 26,744.70
$ 23,832.91
$ 20,633.44
$ 18,151.00
$ 15,321.01
$ 12,094.82
$ 8,416.97 2008 (In Thousands of Dollars)
Interest Rate 14.0%
PV Year
Period Payment FACTOR pv payment Period
BB
Interest
2009
1
$ 48,053
0.8772 $ 42,151.75
1
$215,154.00 $30,121.56
2010
2
$ 48,411
0.7695 $ 37,250.69
2
$197,222.56 $27,611.16
2011
3
$ 47,070
0.6750 $ 31,770.91
3
$176,422.72 $24,699.18
2012
4
$ 45,852
0.5921 $ 27,148.06
4
$154,051.90 $21,567.27
2013
5
$ 42,706
0.5194 $ 22,180.16
5
$129,767.16 $18,167.40
2014
6
$ 36,115
0.4556 $ 16,453.51
6
$105,228.57 $14,732.00
2015
7
$ 36,115
0.3996 $ 14,432.90
7
$ 83,845.57 $11,738.38
2016
8
$ 36,115
0.3506 $ 12,660.44
8
$ 59,468.95 $ 8,325.65
2017
9
$ 36,115
0.3075 $ 11,105.65
9
$ 31,679.60 $ 4,435.14
Payment
$ 48,053
$ 48,411
$ 47,070
$ 45,852
$ 42,706
$ 36,115
$ 36,115
$ 36,115
$ 36,115
EB
$ 197,222.56
$ 176,422.72
$ 154,051.90
$ 129,767.16
$ 105,228.57
$ 83,845.57
$ 59,468.95
$ 31,679.60
$ (0.26)
Change in Loan
$ 17,931.44
$ 20,799.84
$ 22,370.82
$ 24,284.73
$ 24,538.60
$ 21,383.00
$ 24,376.62
$ 27,789.35
$ 31,679.86
Depreciation
$ 5,339
$ 5,339
$ 5,339
$ 5,339
$ 5,339
$ 5,339
$ 5,339
$ 5,339
$ 5,339
Total CL Expense
$ 35,460.78
$ 32,950.38
$ 30,038.40
$ 26,906.49
$ 23,506.63
$ 20,071.22
$ 17,077.60
$ 13,664.87
$ 9,774.37
136 | P a g e
2009 (In Thousands of Dollars)
Interest Rate 13.9%
PV Year
Period Payment FACTOR pv payment Period
BB
Interest Payment
EB
2010
1
$ 49,635
0.8780 $ 43,577.70
1
$205,259.00 $28,531.00 $ 49,635 $ 184,155.00
2011
2
$ 48,774
0.7708 $ 37,595.94
2
$184,155.00 $25,597.55 $ 48,774 $ 160,978.55
2012
3
$ 47,410
0.6768 $ 32,084.76
3
$160,978.55 $22,376.02 $ 47,410 $ 135,944.56
2013
4
$ 44,008
0.5942 $ 26,147.90
4
$135,944.56 $18,896.29 $ 44,008 $ 110,832.86
2014
5
$ 38,833
0.5217 $ 20,257.34
5
$110,832.86 $15,405.77 $ 38,833 $ 87,405.63
2015
6
$ 37,585
0.4580 $ 17,213.62
6
$ 87,405.63 $12,149.38 $ 37,585 $ 61,970.01
2016
7
$ 37,585
0.4021 $ 15,112.92
7
$ 61,970.01 $ 8,613.83 $ 37,585 $ 32,998.84
2017
8
$ 37,585
0.3530 $ 13,268.59
8
$ 32,998.84 $ 4,586.84 $ 37,585 $ 0.68
Change in Loan
$ 21,104.00
$ 23,176.45
$ 25,033.98
$ 25,111.71
$ 23,427.23
$ 25,435.62
$ 28,971.17
$ 32,998.16
Depreciation
$ 6,204
$ 6,204
$ 6,204
$ 6,204
$ 6,204
$ 6,204
$ 6,204
$ 6,204
Total CL Expense
$ 34,735.38
$ 31,801.92
$ 28,580.39
$ 25,100.67
$ 21,610.14
$ 18,353.76
$ 14,818.21
$ 10,791.21
137 | P a g e
138 | P a g e
Financial Statements
The financial statements of a company are released to show the “health” of the
company. However, many companies utilize loopholes within the GAAP structure to
inflate the net income of the company. In order to truly value a company, loopholes
need to be scrutinized and the financials should be restated in order to reflect the
accounting distortions, if any. Below are the Balance Sheets and Income Statements
for P.F. Chang’s from 2005 through 2009, as obtained from the required S.E.C. annual
filings. In order to evaluate the potential distortions and restate the balance sheet and
income statement, a trial balance was used, which can be found in the tables at the end
of this report.
A trial balance is an exceptionally useful tool when preparing the adjustments.
The trial balance allows one to input current financial data, enter any adjustments, and
ensure that the debit and credit accounts line up accordingly (balance out). The trial
balance found in the tables at the end of this report contains the as-stated financial
information for years 2005 to 2009, any adjustments for goodwill, research and
development, and operating leases, the restated financial information after
adjustments, and any carryover amount as a result of these adjustments.
Analysis of P.F. Chang’s annual reports showed significant use of operating
leases, no use of research and development, and a small amount of goodwill. Upon
ratio analysis, it was found that the ratio of goodwill over property, plant, and
equipment was consistently fewer than 2%, leading to the conclusion of goodwill being
immaterial to the overall financial statements, and thus does not need to be adjusted.
However, due to the significant use and large dollar amount, operating leases were
determined to be distortive to the financial statements, and thus have been adjusted in
the trial balance, and accounted for in the restated financials, as follows.
139 | P a g e
Balance Sheet
The balance sheet is a statement of a company’s assets, liabilities, and
stockholder’s equity, and displays the overall financial position of a company at that
particular moment in time. The following balance sheet financial information reflects
the as stated numbers and the adjusted numbers from Fiscal Year End 2005 to 2009.
The changes in values can be attributed to the distortion of numbers due to the use of
operating leases.
The first item that must be forecasted on the balance sheet is total assets. We
used net sales over total assets, which is the asset turnover ratio. After we calculated
the asset turnover ratio, we used it to forecast future total assets as a ratio of total
sales. It is very important to accurately forecast sales, because it is the driving factor
used to forecast everything else on the balance sheet. We used a five-year period and
averaged the asset turnover ratio. We found the average ratio is 1.98.
The next item that we forecasted on the balance sheet was the current assets.
We forecasted current assets by subtracting non-current assets from our already
forecasted current assets. To forecast our non-current assets, we multiplied total assets
by a constant 85.4%. We found that 85.4% was the proper value to use because the
value of non-current assets over the past five years has been around that value.
The next step was forecasting long-term assets. GAAP states that total assets
equals current assets plus long-term assets. Using this model, we subtracted are
already forecasted current assets from our forecasted total assets to forecast long-term
assets.
Next, we forecasted the line items in the balance sheet, which include property
plant and equipment (PP&E), inventory, and goodwill. We used ratios to forecast PP&E
and inventory. Goodwill was just a constant value over the past five years, so we used
that value for the forecast. Our inventory turnover ratio average was 60. We used this
140 | P a g e
to forecast inventory for the proceeding years. Next, we used property plant and
equipment turnover to forecast PP&E. We took forecasted revenues from the income
statement and divided it by property plant and equipment turnover ratio. We found
property plant and equipment turnover ratio to be 2.35.
Next, we forecasted current liabilities. We used the current ratio of .60 to find
current liabilities. We took the total current assets and divided it by the current ratio.
Stockholders’ equity was forecasted by taking 2009’s stockholders equity and adding
2010’s net income and then subtracting dividends for 2010. The dividends were
forecasted by using a set rate of 45 percent of NI. We know this isn’t typical, but it has
been stated in a couple of conference calls that this is how the firm will compute future
and current dividends. After finding total current liabilities and stockholders equity, we
could forecast total liabilities. We found our total long-term liabilities by subtracting
total current liabilities and stockholders equity from assets. After calculating long-term
liabilities, we just added long-term liabilities to current liabilities to get our total
liabilities.
141 | P a g e
142 | P a g e
As Stated Figures
Balance Sheet (In Thousands)
Assets 2005
2006
2007
2008
2009
Current assets:
Cash and cash equivalents
$ 31,948
$ 31,589
$ 24,055
$ 40,951
$ 63,499
Short‐term investments
$ 34,150
$ ‐
$ ‐
$ ‐
$ ‐
Restricted short‐term investments
$ 8,260
$ ‐
$ ‐
$ ‐
$ ‐
Inventories
$ 3,461
$ 4,232
$ 4,649
$ 4,930
$ 5,291
Prepaid and other current assets
$ 15,957
$ 28,995
$ 32,552
$ 51,643
$ 38,449
Total current assets
$ 93,776
$ 64,816
$ 61,256
$ 97,524
$ 107,239
Capitalized Leased Assets Rights
$ ‐
$ ‐
$ ‐
$ ‐
$ ‐
Property and equipment, net
$ 345,864
$ 421,770
$ 520,145
$ 524,004
$ 497,928
Deferred income tax assets
$ 1,938
$ ‐
$ ‐
$ ‐
Goodwill
$ 6,819
$ 6,819
$ 6,819
$ 6,819
$ 6,819
Intangible assets, net
$ ‐
$ 12,644
$ 22,004
$ 24,270
$ 22,241
Other assets
$ 18,265
$ 7,996
$ 12,406
$ 14,746
$ 17,923
Total Non‐Current Assets
$ 372,886
$ 449,229
$ 561,374
$ 569,839
$ 544,911
Total assets
$ 466,662
$ 514,045
$ 622,630
$ 667,363
$ 652,150
$ 13,850
$ 15,255
$ 17,745
$ 15,203
$ 19,825
LIABILITIES AND COMMON STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Construction payable
$ 6,463
$ 9,075
$ 11,319
$ 4,358
$ 1,600
Accrued expenses
$ 40,864
$ 55,848
$ 59,259
$ 71,162
$ 77,088
Unearned revenue
$ 15,281
$ 18,226
$ 25,346
$ 31,115
$ 35,844
Current portion of long‐term debt
$ 5,110
$ 5,487
$ 6,932
$ 5,753
$ 41,236
Total current liabilities
$ 81,568
$ 103,891
$ 120,601
$ 127,591
$ 175,593
Long‐term debt
$ 5,360
$ 13,723
$ 90,828
$ 82,496
$ 1,212
Capitalized Leases Liabilities
$ ‐
$ ‐
$ ‐
$ ‐
$ ‐
Lease obligation
$ 55,991
$ 71,682
$ 93,435
$ 113,178
$ 116,547
Other Liabilities
$ ‐
$ 1,909
$ 6,710
$ 14,691
$ 18,488
Minority interests
$ 29,845
$ 33,315
$ 17,169
$ 8,581
$ 4,961
Total Non‐Current Liabilities
$ 91,196
$ 120,629
$ 208,142
$ 218,946
$ 141,208
Total Liabilities
$ 172,764
$ 224,520
$ 328,743
$ 346,537
$ 316,801
Common stockholders’ equity:
Common stock, $.001 par value, 40,000,000 shares authorized* (see note)
$ 26
$ 27
$ 27
$ 27
$ 28
Additional paid‐in capital
$ 165,355
$ 174,101
$ 196,385
$ 206,667
$ 217,181
Treasury Stock* (see note)
$ ‐
$ (46,373) $ (96,358) $ (106,372) $ (146,022)
Other Comprehensive Loss
$ ‐
$ ‐
$ ‐
$ (755) $ (294)
Retained earnings
$ 128,517
$ 161,770
$ 193,833
$ 221,259
$ 264,456
Total common stockholders’ equity
Total liabilities and common stockholders’ equity
$ 293,898
$ 466,662
$ 289,525
$ 514,045
$ 293,887
$ 622,630
$ 320,826
$ 667,363
$ 335,349
$ 652,150
Common Stock Outstanding
26,397,366
25,373,019
24,151,888
24,114,107
22,911,054
Treasury stock ‐
1,397,261
3,240,943
3,634,979
5,064,733
143 | P a g e
Restated Figures
Balance Sheet (In Thousands)
Assets 2005
2006
2007
2008
2009
Current assets:
Cash and cash equivalents
$ 31,948
$ 31,589
$ 24,055
$ 40,951
$ 63,499
Short‐term investments
$ 34,150
$ ‐
$ ‐
$ ‐
$ ‐
Restricted short‐term investments
$ 8,260
$ ‐
$ ‐
$ ‐
$ ‐
Inventories
$ 3,461
$ 4,232
$ 4,649
$ 4,930
$ 5,291
Prepaid and other current assets
$ 15,957
$ 28,995
$ 32,552
$ 51,643
$ 38,449
Total current assets
$ 93,776
$ 64,816
$ 61,256
$ 97,524
$ 107,239
Capitalized Leased Assets Rights
$ 164,014
$ 164,826
$ 189,762
$ 194,291
$ 200,166
Property and equipment, net
$ 345,864
$ 421,770
$ 520,145
$ 524,004
$ 497,928
Deferred income tax assets
$ 1,938
$ ‐
$ ‐
$ ‐
Goodwill
$ 6,819
Intangible assets, net
Other assets
$ 18,265
$ 6,819
$ 6,819
$ 6,819
$ 6,819
$ 12,644
$ 22,004
$ 24,270
$ 22,241
$ 7,996
$ 12,406
$ 14,746
$ 17,923
Total Non‐Current Assets
$ 536,900
$ 614,055
$ 751,136
$ 764,130
$ 745,077
Total assets
$ 630,676
$ 678,871
$ 812,392
$ 861,654
$ 852,316
LIABILITIES AND COMMON STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
$ 13,850
$ 15,255
$ 17,745
$ 15,203
$ 19,825
Construction payable
$ 6,463
$ 9,075
$ 11,319
$ 4,358
$ 1,600
Accrued expenses
$ 40,864
$ 55,848
$ 59,259
$ 71,162
$ 77,088
Unearned revenue
$ 15,281
$ 18,226
$ 25,346
$ 31,115
$ 35,844
Current portion of long‐term debt
$ 5,110
$ 5,487
$ 6,932
$ 5,753
$ 41,236
Total current liabilities
$ 81,568
$ 103,891
$ 120,601
$ 127,591
$ 175,593
Long‐term debt
$ 5,360
$ 13,723
$ 90,828
$ 82,496
$ 1,212
Capitalized Leases Liabilities
$ 164,014
$ 176,410
$ 212,801
$ 202,121
$ 206,141
Lease obligation
$ 55,991
$ 71,682
$ 93,435
$ 113,178
$ 116,547
$ 1,909
$ 6,710
$ 14,691
$ 18,488
Minority interests
Other Liabilities
$ 29,845
$ 33,315
$ 17,169
$ 8,581
$ 4,961
Total Non‐Current Liabilities
$ 255,210
$ 297,039
$ 420,943
$ 421,067
$ 347,349
Total Liabilities
$ 336,778
$ 400,930
$ 541,544
$ 548,658
$ 522,942
Common stockholders’ equity:
Common stock, $.001 par value, 40,000,000 shares authorized* (see note)
$ 26
$ 27
$ 27
$ 27
$ 28
Additional paid‐in capital
$ 165,355
$ 174,101
$ 196,385
$ 206,667
$ 217,181
Treasury Stock* (see note)
$ (46,373) $ (96,358) $ (106,372) $ (146,022)
Other Comprehensive Loss
$ (755) $ (294)
Retained earnings
$ 128,517
$ 150,186
$ 170,794
$ 213,429
$ 258,481
Total common stockholders’ equity
Total liabilities and common stockholders’ equity
$ 293,898
$ 630,676
$ 277,941
$ 678,871
$ 270,848
$ 812,392
$ 312,996
$ 861,654
$ 329,374
$ 852,316
Common Stock Outstanding
26,397,366
25,373,019
24,151,888
24,114,107
22,911,054
Treasury stock ‐
1,397,261
3,240,943
3,634,979
5,064,733
144 | P a g e
Balance Sheet Restatement Evaluation
The as-stated and restated balance sheets shown above highlight the distortions
that are caused by the use of operating leases. By reclassifying operating leases under
capitalized leases, net capitalized lease asset rights increases, capitalized lease liabilities
increases, and retained earnings decreases.
By capitalizing the operating leases, an increase in assets and liabilities was
recognized on the restated balance sheet. For the years 2005-2009, the total amount
of assets, liabilities and owner’s equity reported on the balance sheet increased by
$164,014, $164,826, $189,762, $194,291, and $200,166, respectively (stated numbers
are in thousands). This increase can be attributed to the differences in the accounting
for leases. By capitalizing the operating leases, the balance sheets were altered to
show the lease asset rights as well as the future lease liabilities, as well as the decrease
in retained earnings due to the decrease in net income. The restated net income
showed that P.F. Chang’s was overstated by a cumulative amount of $48,428,000.00
from 2005 to 2009. They didn’t overstate 2005, however, 2006 was overstated by
$11,584.00, 2007 by $23,039,000.00, 2008 by $7,830,000.00, and 2009 by
$5,975,000.00.
145 | P a g e
Income Statement
The income statement shows a company’s revenues and expenses for a
particular year. The income statement is a valuable tool, which shows the overall
profitability of the firm for a particular year. The income statement is closed out every
year into the permanent retained earnings account, which means that at the beginning
of every year, the values in the income statement begin at zero.
When we calculated the income statement forecast, we first found the sales. This
is the most important part of forecasting the income statement, because every other
forecast falls in place behind it. P.F. Chang’s has a constant growth in sales from 2004
to 2009. We took this into account when forecasting future sales. We also took into
account the recession. After weighing the factors, we came up with a constant growth
rate of sales over the next ten years. For the first four we have an increase of 1.06%
for 2010, 3.08% for 2011, 5.00% for 2012, and a 7.05% for 2013. For the next six
years we used a constant rate of 10.00% increase in sales. To calculate our future
forecasts after we found our growth rate, we take the previous year’s sales and multiply
them by one plus the growth rate. This gave us our future forecasted sales.
The next step we took was to forecast cost of goods sold. We had a constant
cost of goods sold percentage of sales of around 27.00%. We decided to use 27.07%.
We then multiplied the 27.07% by each year of forecasted sales to find the forecasted
cost of goods sold.
Next, we forecasted gross profit. To do this we took our forecasted sales and
forecasted cost of goods sold. With the equation sales – cogs = gross profit, we
forecasted out our gross profit.
146 | P a g e
Next, we forecasted operating income. We did this by subtracting selling,
administrative, and impairment expenses from gross profit.
Finally, we forecasted our future net income. To find this we found our net profit
margin over the last six years. We decided on a profit margin of 3.7%. We decided on
this number because for three consecutive years, this margin has fallen. With the
recession still in full affect, we figured it is likely it will decrease next year. We held this
profit margin constant for the remainder nine years. To find net income, we took the
profit margin of 3.7% and multiplied it by the current years forecasted sales.
147 | P a g e
As Stated Figures
Income Statement
(In Thousands)
Revenues
2005
2006
2007
2008
2009
$ 809,153 $ 937,606 $ 1,092,722 $ 1,198,124 $ 1,228,179
Costs and expenses:
Restaurant operating costs:
Cost of sales
$ 224,634 $ 256,582 $ 299,713 $ 325,630 $ 326,421
Labor
$ 267,681 $ 310,113 $ 368,059 $ 396,911 $ 401,583
Operating
$ 122,742 $ 146,409 $ 173,993 $ 198,967 $ 203,859
Occupancy
$ 42,793
Total restaurant operating costs
$ 657,850 $ 765,561 $ 904,876 $ 991,317 $ 1,002,498
General and administrative
$ 39,181 $ 56,911 $ 66,968 $ 77,488 $ 82,749
$ 52,457
$ 63,111
$ 69,809
$ 70,635
Capitalized Operating Lease Expense
$ ‐
$ ‐
$ ‐
$ ‐
Depreciation of Capitalized Leases
$ ‐
$ ‐
$ ‐
$ ‐
Depreciation and amortization
$ 36,950 $ 44,863 $ 56,832 $ 68,711 $ 74,429
Preopening expense
$ 9,248 $ 12,713 $ 14,983 $ 8,457 $ 3,919
Partner investment expense
$ 4,800
Total Costs and Expenses
$ 748,029 $ 884,419 $ 1,041,647 $ 1,145,619 $ 1,162,966
$ 61,124 $ 53,187 $ 51,075 $ 52,505 $ 65,213
Income from operations
$ 4,371
$ (2,012) $ (354) $ (629)
Interest and other income (expense)
Interest Expense from Capitalized Leases
$ ‐
$ ‐
$ ‐
$ ‐
$ ‐
Interest expense
$ 10
Interest and other income
$ 1,851
Income before minority interest
$ 62,965 $ 54,502 $ 50,975 $ 49,143 $ 63,576
Minority interest
$ (8,227) $ (8,116) $ (4,169) $ (1,933)
$ 100 $ 3,362 $ 1,637
$ 1,315
Income before provision for income taxes
$ 54,738 $ 46,386 $ 46,806 $ 47,210 $ 63,576
Provision for income taxes
$ 16,942 $ 13,133 $ 11,563 $ 12,193 $ 18,492
Income from Continuing Operations
$ 37,796 $ 33,253 $ 35,243 $ 35,017 $ 45,084
Loss from Discontinued Operations, Net of Tax
$ ‐
Net income
$ 37,796 $ 33,253 $ 32,063 $ 35,017 $ 44,605
$ ‐
$ (3,180) $ ‐
$ (479)
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Restated Figures
Income Statement
(In Thousands)
Revenues
2005
2006
2007
2008
2009
$ 809,153 $ 937,606 $ 1,092,722 $ 1,198,124 $ 1,228,179
Costs and expenses:
Restaurant operating costs:
Cost of sales
$ 224,634 $ 256,582 $ 299,713 $ 325,630 $ 326,421
Labor
$ 267,681 $ 310,113 $ 368,059 $ 396,911 $ 401,583
Operating
$ 122,742 $ 146,409 $ 173,993 $ 198,967 $ 203,859
Occupancy
$ 42,793
Total restaurant operating costs
$ 657,850 $ 765,561 $ 904,876 $ 991,317 $ 1,002,498
General and administrative
$ 39,181 $ 56,911 $ 66,968 $ 77,488 $ 82,749
$ 52,457
$ 63,111
$ 69,809
$ 70,635
Capitalized Operating Lease Expense
$ (23,680) $ (17,913) $ (42,242) $ (48,053)
Depreciation of Capitalized Leases
$ 16,402 $ 18,872 $ 20,863 $ 23,906
Depreciation and amortization
$ 36,950 $ 44,863 $ 56,832 $ 68,711 $ 74,429
Preopening expense
$ 9,248 $ 12,713 $ 14,983 $ 8,457 $ 3,919
Partner investment expense
$ 4,800
Total Costs and Expenses
$ 748,029 $ 877,141 $1,042,606 $ 1,124,240 $ 1,138,819
$ 61,124 $ 60,465 $ 50,116 $ 73,884 $ 89,360
Income from operations
$ 4,371
$ (2,012) $ (354) $ (629)
Interest and other income (expense)
Interest Expense from Capitalized Leases
$ ‐
$ 18,862 $ 22,080 $ 29,209 $ 30,122
Interest expense
$ 10
Interest and other income
$ 1,851
Income before minority interest
$ 62,965 $ 42,918 $ 27,936 $ 41,313 $ 57,601
Minority interest
$ (8,227) $ (8,116) $ (4,169) $ (1,933)
$ 100 $ 3,362 $ 1,637
$ 1,315
Income before provision for income taxes
$ 54,738 $ 34,802 $ 23,767 $ 39,380 $ 57,601
Provision for income taxes
$ 16,942 $ 13,133 $ 11,563 $ 12,193 $ 18,492
Income from Continuing Operations
$ 37,796 $ 21,669 $ 12,204 $ 27,187 $ 39,109
Loss from Discontinued Operations, Net of Tax
$ ‐
Net income
$ 37,796 $ 21,669 $ 9,024 $ 27,187 $ 38,630
$ ‐
$ (3,180) $ ‐
$ (479)
149 | P a g e
Income Statement Restatement Evaluation The as-stated income statements and restated income statements show the
distortive effects of P.F. Chang’s use of operating leases to account for restaurant
property. This policy greatly distorts the net income of each progressive year. From
2006 to 2009, net income was overstated in the as-stated income statements by
$11,584, $23,039, $7,830 and $5,975, respectively (numbers are in thousands). The
overstatement of net income leads to an increase in retained earnings in each
accounting period. However, since operating lease’s present values are calculated each
year, the change in retained earnings does not carry over year-over-year.
In the restatement of the income statements, the interest from capitalized leases
and the depreciation of capitalized leases is expensed on the income statement,
resulting in a lower net income, and, as a result, a decrease in retained earnings.
Conclusion
The distortions in the as-stated and restated financial statements show the
effects of different choices in accounting practices. P.F. Chang’s choice to use
operating leases rather than capitalized leases allows them to keep lease liabilities off
the balance sheet, thus distorting the true amount of liabilities. This distortion of the
balance sheet leads to the conclusion that P.F. Chang’s is potentially less liquid than it
presents itself to be on the balance sheet. The distortion of the income statement is
also an important topic, as the use of operating leases leads to the earnings being
reported as potentially higher than they are. The restatement of the income statement
accounts for extra lease expense and interest expense, and thus decreases overall net
income. P.F. Chang’s use of operating leases can be attributed to the use of
aggressive accounting policies. When operating leases are capitalized, the resulting
effect is a reduction in stated net income for the year. This is a more conservative
accounting policy, as capitalizing operating leases accounts for lease expense on the
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income statement, rather than off-sheet accounting. The restatement of the financial
statements provides a more accurate picture of P.F. Chang’s business practices, and
allows for a more accurate valuation of the company. For a more detailed look at the
restatement of the financials, including how the figures are obtained, please see the
table of trial balances, including the adjustments and final figures, attached in the
appendices.
Financial Analysis, Forecasting, and Estimating Cost of
Capital Estimation
There are three major steps to complete when evaluating the financial status of
a firm. They are financial analysis, forecasting, and estimating the cost of capital. The
financial analysis is completed by using various ratios. The ratio analysis can be utilized
to determine the firm’s value in comparison to its competitors and the industry
averages. We will use liquidity, profitability, and capital structure ratios to forecast P.F.
Chang’s income statement, balance sheet and statement of cash flows. By using these
comparisons, we are able obtain a basis for making forecasts of future performance.
Forecasting for a firm is when ratios are completed in the financial analysis and add
industry intuition, knowledge, and estimations to show the possible future financial
status of the firm. Once this is completed, the forecasting is used to estimate the cost
of capital. The cost of capital will be estimated by utilizing the Capital Asset Pricing
Model, and the cost of dent will be calculated by using the stated interest rates. The
before and after tax Weighted Average Cost of Capital will be valued using the cost of
debt and cost of equity estimations. After this three-step procedure is complete, we will
now have the ability to value the firm’s present and future performance amongst its
competitors and industry.
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Financial Analysis
Financial analysis will allows us to evaluate a firm’s financial statements in order
to obtain the value of a firm. We will utilize these ratios because they produce smaller
and more comparable numbers, which makes it less difficult to draw conclusions about
a firm’s financial position. Liquidity, profitability, capital structure, and growth rate ratios
are the ratios that will be calculated for P.F. Chang’s and its competitors within the
industry. The liquidity ratios will allow outsiders to measure P.F. Chang’s and its
competitor’s ability to pay off its current liabilities. When computing the profitability
ratios, we will able to view P.F. Chang’s ability to generate profits compared to
expenses in a given period. In terms of capital structure ratios, we will have the ability
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to assess the level of risk associated with P.F. Chang’s and its competitors while with
growth ratios it allows us to determine its growth in relation to other firms in the
restaurant industry. By computing these ratios, we will not only be able to obtain a
better understanding of P.F. Chang’s current financial position but also a comparison to
its competitors and industry. The ratios can also be utilized to forecast and compare
numbers over a long period of time.
Liquidity Ratio Analysis
Liquidity ratios are metrics that help determine the ability of a company to pay
off its short-term liabilities. The higher the ratio, the higher the safety margin the
company has for paying off short-term debts. By calculating the liquidity ratios of P.F.
Chang’s, and of the competing industry, we are able to benchmark and compare the
firm’s liquidity to the overall industry. For our liquidity analysis, we are going to be
utilizing the following eight ratios:
Liquidity
1. Current Ratio
2. Quick Asset Ratio
3. Inventory Turnover
Operating Efficiency
4. Days’ Supply of Inventory
5. Receivables Turnover
6. Days Sales Outstanding
7. Working Capital Turnover
8. Cash to Cash cycle
It is important for a company to have the right amount of liquidity. When a
company has low liquidity, it is harder to payoff short-term liabilities. This can cause
several problems. One major problem that can come up when a company has low
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liquidity is the inability to obtain a loan. Financial institutions often base loan decisions
on a company’s ability to quickly generate cash. If a company cannot make consistent
monthly or annual payments, they probably will not get the loan. Another problem with
low liquidity may be that the company cannot pay its employees their annual salaries.
This can cause major problems for obvious reasons.
Most firms desire high liquidity ratios, but liquidity ratios that are too high can
also cause problems. When a company has unusually high liquidity ratios, it means the
company is not using its capital efficiently. The extra cash that is just sitting there can
be used for investing into the growth of the company. The right amount of liquidity can
enable companies to grow efficiently, pay off short-term debts, and acquire the desired
loans needed in order to operate.
Current Ratio
The first ratio we are going to analyze is the current ratio. To calculate this
ratio, we divided P.F. Chang’s, and the three benchmarked competitor’s current assets
by their current liabilities. This ratio tells us to what extent the company is able to pay
off its current liabilities with its current assets.
This ratio is important when trying to obtain a loan. Financial institutions use this ratio
to determine if the company will be able to meet their current payments. Banks
consider a ratio of 2:1 or more to be efficient for a loan, although usually a ratio over
1:1 is acceptable. A ratio of 2:1 means a company has twice the amount of current
assets than it does current liabilities. This is considered to me more than acceptable
when determining a company’s ability to pay off current debt. A 1:1 ratio is considered
acceptable because the company can still pay off its current debt with the value of its
current assets. The graph below represents the current ratio for all competitors.
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Based on the above graph we can see that the industry maintains for the most
part a very low current ratio. P.F. Chang’s and O’Charley’s have kept a very low current
ratio for the past five years. The two company’s average around a ratio of around .75,
and P.F. Chang’s even had a ratio of .495 in 2007. This says for every dollar of
liabilities that must be paid the following period, P.F. Chang’s has received half a dollar
in current assets. Since P.F. Chang’s is in the restaurant industry, most of their money
comes from cash flow from operations; they are being paid in cash at the time of sale,
so that money can be used to pay off the short-term debt. In 2005, Chipotle Mexican
Grill had a very low current ratio due to their size, but shot up in 2006 to a ratio
average above 2. This was caused by their major expansion in 2006 when they really
hit the market. Other than Chipotle’s high current ratio in 2006, the industry has kept a
similar pattern in regards to the company’s current ratios.
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Quick Asset Ratio
The quick asset ratio, sometimes called the acid test, is an alternative to the
current ratio. To calculate this ratio, a firm’s total cash, cash equivalents, short-term
investments, marketable securities, and accounts receivables are divided by its total
current liabilities. This ratio takes into account only the most liquid assets of a
company. By looking at only the most liquid assets of the company, inventory will be
excluded. This eliminates the possibility of a distortion in the financial position of the
company. Without inventory included in the amount of current assets, the ratio usually
becomes significantly smaller. This may be because a large part of current assets
comes from inventory. “Quick ratio is viewed as a sign of company's financial strength
or weakness (higher number means stronger, lower number means weaker)”
(investorwords.com). Usually a quick ratio of 1 or more is acceptable by most creditors.
The ratio results are as followed:
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From looking at the graph above, the industry has shown that most of the
companies have kept a quick ratio of below 1. This is not good when a company is in
need of cash quick and they cannot come up with the money fast enough. Creditors
might look at this as a bad scenario, but just like the current ratio, most of the
restaurants get their money through cash flow from operations. The one outlier of the
restaurant industry is Chipotle. They were such a small business trying to get started in
2004 and 2005, but then sold many available-for-sale securities, some up to $90
million. This brought their quick ratio way above 1 topping out mostly at 2.5. This says
that for every dollar of current liabilities owed, Chipotle has $2.45 to help pay. This is a
great number to many creditors, but the fact that the company has too much shortterm cash available, instead, they could be using it to invest back into the company for
future growth. P.F. Chang’s has shown to keep a very low quick asset ratio along with
a very low current ratio. Based on their numbers, P.F. Chang’s has still maintained a
trend with the industry for the past five years.
Accounts Receivable Turnover
Receivables Turnover Ratio = Sales/Accounts Receivable
The accounts receivable turnover ratio is one of the ways to measure how well a
firm is managing their working capital. The ratio is calculated by dividing the firm’s sales
by their accounts receivable. The higher the ratio the better, because this means the
firm is collecting its receivables at a fast rate. A low ratio means that payments are not
being collected efficiently, and that the firm would need to evaluate its credit policies to
find a way to speed up the process of collecting their receivables. Lower ratios might
represent that the company has a large amount of money stuck in accounts receivable.
For high liquidity purposes, higher collections are preferred.
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Receivables Turnover 2005
2006
2007
2008 2009
P.F. Chang's 129.3
75.6
68.8
48.2 77.9
Cheesecake Factory 145.8
113.0
133.2
128.1 141.1
77.2
66.4
56.3
40.7 51.2
Chipotle 324.7
169.2
202.1
365.6 318.8
Industry Average 169.3
106.0
115.1
145.7 147.3
O'Charley's P.F. Chang’s receivables turnover was very strong in 2005 and then took a turn
for the worse and proceeded to get worse every year until a small recovery in 2009.
They are under the industry average in every year and even under the two times under
the average a couple of years. I do not think that P.F. Chang’s ratio is that bad, I think
that Chipotle skews the industry average because they have such a high ratio compared
to all the other companies. Disregarding Chipotle, the other three firms are consistently
in the same range or ratios.
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Days Sales Outstanding
Days Sales Outstanding Ratio = 365/Receivables Turnover Ratio
Days’ sales outstanding (DSO) represents the number of days it takes the firm to
collect its debt. The ratio is an extension of the accounts receivable turnover ratio, and
is calculated by dividing 365 by the already calculated accounts receivable turnover.
The lower the number the better, because that means the firm is collecting its accounts
receivables at a fast pace. If the firm experiences a high ratio, this means that on a
daily average, its taking longer for the firm to collect the cash from its already made
sales. This can impose a problem because firms want to be liquid. The days’ sales
outstanding ratio has an inverse relationship with accounts receivables turnover ratio. If
a firm has a high accounts receivables turnover ratio, it will have a low days’ sales
outstanding ratio. Therefore, firms desire lower days’ sales outstanding ratios. The
reason a firm wants to have a low ratio because the lower the ratio, the less time it
takes the firm to collect cash from its sells. This also equates into a firm wanting to
become liquid.
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Days Sales Outstanding 2005
2006
2007
2008
2009
P.F. Chang's 2.823
4.829
5.305
7.576
4.681
Cheesecake Factory 2.504
3.230
2.740
2.849
2.586
O'Charley's 4.728
5.497
6.478
8.969
7.131
Chipotle 1.124
2.158
1.806
0.998
1.145
Industry Average 2.795
3.928
4.082
5.098
3.886
P.F. Chang’s has fairly consistent figures over the five year period researched.
They are constantly 1 point off the industry average. Even though they are doing a little
worse than their competitors are, it is not by much. In addition, like on the receivables
turnover, Chipotle skews the industry average because as a whole they are lower than
the other firms by two or three points every year.
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Inventory Turnover Ratio
The inventory turnover ratio is an important ratio when determining the
efficiency of a company is regards to cost of goods sold and inventory. It measures
how fast a company is selling its product. The ratio is calculated by dividing the
company’s cost of goods sold, by the amount of inventory. The equation for inventory
turnover is shown below.
Inventory Turnover = Cost of Goods Sold
Inventory
A high ratio suggests that the company was able to have high sales with low
inventory. This makes the company more liquid, because the inventory is converted into
cash quicker. A low ratio suggests that the company struggled with sales and had to
hold onto inventory for a longer period of time. This will lower the liquidity of a
company because the inventory takes longer to be converted into cash. The graph
below shows the inventory turnover ratio for P.F. Chang’s and its competitors.
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Within this ratio, all of P.F. Chang’s and its competitors cost of goods sold were
essentially the same which tells us that the gap in the graph can be attributed mainly to
all of the inventory stock. P.F. Chang’s and Chipotle kept relatively low numbers of
inventory in stock for the past five years. This is what allowed the turnover ratio to be
fairly high. This tells us that the liquidity of these two firms is high because as stated
earlier with a high ratio inventory is easily converted into cash. Cheesecake Factory and
O’Charley’s kept high levels of inventory in stock. This shows that the liquidity of these
two firms is low relative to competitors in the industry. Overall, P.F. Chang’s does a
good job in this area and remains consistent with the cost of goods sold for their
restaurants and the inventory that is kept in stock.
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Days’ Supply of Inventory
The days supply of inventory commonly referred to as D.S.I., involves the
previously calculated inventory turnover ratio. By dividing 365 by the value of the
inventory turnover ratio, we are able to see how long it takes a company to liquidate
their entire inventory. The equation is shown below.
Days’ Supply of Inventory =
365 Days
Inventory
=
When analyzing this ratio, the lower the value, the better the company is doing.
If a company takes fewer days to empty its inventory, inventory costs will be lower, and
cash inflows will be more often and more efficient. The Graph Below shows the day’s
supply of in inventory ratio for P.F. Chang’s and its competitors.
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2005
2006
2007
2008
2009
P.F. Chang's
5.62
6.02
5.66
5.53
5.92
Chipotle
4.74
4.96
4.56
4.05
4.40
Cheesecake Factory
23.04
22.74
23.05
20.26
20.55
O'Charleys
59.38
38.65
23.62
31.46
15.06
Industry Average
23.20
18.09
14.22
15.39
11.48
As previously mentioned, the lower the days supply of inventory ratio, the better
a company is operating with regards to inventory flow. In the graph, it shows that P.F.
Chang’s and Chipotle are both below the industry average for the past five years. This
is because both of their inventory turnover ratios were high. Cheesecake Factory is
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pretty close to the industry average. O’Charley’s has very high ratios in 2005, 2006, and
2008. This is due to the fact that inventory was very large in these years compared to
the rest of the industry. In 2009, it settles down and eventually reaches close to the
industry average. P.F. Chang’s does a fantastic job with inventory turnover which leads
to a great days of inventory ratio. This is from P.F. Chang’s having low inventory costs
consistently every year, which essentially leads higher efficiency.
Working Capital Turnover
The working capital ratio measures how efficiently a firm’s working capital is
managed in relation to sales volume. Working Capital is the amount of current assets
less the amount of current liabilities. The equation for working capital turnover is shown
below.
Working Capital Turnover =
Sales
=
Working Capital
With a high ratio, it shows that a company is making good use of its working
capital. In relation, the more productive a company is with working capital the higher
the sales will be. A smaller working capital turnover shows that a company is not being
as efficient with its working capital, and could be an early warning sign for a financial
downturn. The Graph below shows the working capital turnover ratio for P.F. Chang’s
and its competitors.
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P.F. Chang's
Chipotle
Cheesecake Factory
O'Charleys
Industry Average
2005
2006
2007
2008
2009
66.28
-24.00
-18.41
-39.85
-17.97
-25.98
7.03
8.45
9.92
7.77
27.90
33.15
-42.15
366.26
-56.74
-38.22
-38.33
-46.24
-29.21
-51.99
17.05
-5.54
-24.59
76.78
-29.73
Although P.F. Chang’s is fairly close to the industry average this is still not a good
sign. This is because the industry is negative for three of the five years that we
calculated. This shows that the industry as a whole is not being as efficient as one
would like. The relative efficiency and low number for working capital caused the jump
by Cheesecake Factory in 2008. P.F. Chang’s was negative four of the five years of
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calculation showing that the use of working capital in a positive manner has not been
accomplished. Although one would think this is a major flaw for P.F. Chang’s, it may not
be that way with the rest of the industry being negative or relatively low for the five
years.
Cash to Cash Cycle
The cash-to-cash cycle is a financial ratio used to measure the number of days it
takes for a firm to collect its accounts receivables and sell off its inventory. The ratio is
determined by adding both days sales outstanding and day’s sales inventory. The
formula below is utilized to measure the cash-to-cash cycle. Obtaining a short cash-tocash cycle is a positive indicator that the firm is performing.
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2005
2006
2007
2008
2009
P.F. Chang's
8.44
10.84
10.97
13.11
10.60
O' Charley's
64.11
44.15
30.10
40.43
22.19
Cheesecake Factory
25.54
25.97
25.79
23.11
23.14
5.86
7.12
6.37
5.05
5.55
25.99
22.02
18.30
20.42
15.37
Chipotle
Industry Average
The graph above illustrates P.F. Chang’s and its competitor’s cash-to-cash cycle. For the
years of 2005 through 2009, P.F. Chang’s along with Chipotle have had a lower cash-tocash cycle than the industry average. Both Cheesecake Factory and O’ Charley’s have
cash-to-cash cycles higher than the industry average. In 2009, it took 10.6 days to
convert cash from inventory sold into revenue. As mentioned earlier, having a shorter
cash-to-cash cycle is a positive indicator that a firm is performing well in terms of
inventory and accounts receivables. P.F. Chang’s ability to have a low cash-to-cash
cycle allows them to utilize the cash received from the sold inventory, to invest in
activities at a quicker rate than other firms in the industry.
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Conclusion
The liquidity ratio analysis for a company is used to evaluate how well a firm is
able to pay off its short-term debt and its general productivity. A level of liquidity is
necessary for a company to achieve longevity. After assessing P.F. Chang’s range of
liquidity ratios the company is not as strong as it would like to be in four different
areas. These are current ratio, asset receivable turnover, days sales outstanding, and
working capital turnover. Current ratio and working capital turnover are the two most
alarming due to the short term liabilities being the major factor that causes these two
ratios to be unfavorable. Accounts receivable turnover is not so much a focus because
there is only a small amount of accounts receivables, which can make this ratio seem
worse that it really is. The two ratios that are a strong point for P.F. Chang’s are
inventory turnover and days’ supply inventory. With the inventory turnover and days’
supply inventory, this is a major advantage in the restaurant industry with the inventory
as the center point of the business. The quick asset ratio is showing how quickly a firm
could pay off its short-term debt with very liquid assets. P.F. Chang’s is average in this
area, which shows that they could be performing at a higher lever but are not too far
off the industry average. Overall, P.F. Chang’s is average compared to the restaurant
industry with respect to the level of liquidity, shown by the previous ratios.
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Liquidity Ratio Analysis
Ratio
Trend
Performance
Current Ratio
Slightly Decreasing
Underperforming
Quick Asset Ratio
Steady
Average
Inventory Turnover
Steady
Outperforming
Days’ Supply of Inventory
Steady
Outperforming
Accounts Receivables Turnover
Slightly Decreasing
Slightly Underperforming
Days Sales Outstanding
Slightly Increasing
Slightly Underperforming
Cash to Cash Cycle
Steady
Slightly Outperforming
Working Capital Turnover
Slightly Decreasing
Underperforming
Overall
Profitability Ratio Analysis
As mentioned earlier, profitability ratios are utilized in order to evaluate a firm’s
ability to generate profit compared to its expenses in a given period. A firm with a high
profitability ratio is said to be in a better financial state than its competitors; therefore,
a higher value is preferred. The higher value is also an important indicator that the firm
is performing well in the industry. The ratios utilized to assess a firm’s ability to
generate profits include, gross profit margin, operating expense ratio, operating profit
ratio, operating profit margin, net profit margin, asset turnover, return on assets and
return on equity. The asset turnover, return on assets, and return on equity are
indifferent from the other ratios in that they utilize the previous year’s total assets and
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equity. P.F. Chang’s and its competitor’s profitability ratios are analyzed in the sections
below.
Gross Profit Margin
The gross profit margin is utilized to measure basic product profitability of a firm,
and is correlated with a firm’s revenue and cost of goods sold. The ratio assesses the
firm’s financial health by showing a percentage of money that is left over from revenues
after accounting for cost of goods sold. “This ratio looks at how well a company
controls the cost of its inventory and the manufacturing of its products and
subsequently passes on the costs to its customers” (bizfinance.com). The larger the
gross profit margin becomes, the better it is for the company. The ratio is calculated as
followed; Gross Profit Margin = gross profit (revenues-cost of goods sold) / net sales.
The results from the industry and companies are shown below.
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After viewing each company’s sales and gross profit, the ratios calculated all
showed some sort of trend for the past five years in which each company’s ratios have
remained pretty constant or slightly grown. P.F. Chang’s Bistro holds one of the highest
gross profit margins averaging around $.73 on the dollar. This shows that for every
dollar earned at their restaurant for their product, they actually only walk away with
about 73 cents on each dollar. This is not considered a bad gross profit margin since
most of the industry remains well below their average, and after all this is the
restaurant industry in which P.F. Chang’s is competing. O’Charley’s in 2007 had a drop
off in their gross profit margin, even though not material enough, this was caused by a
decrease in sales and not a enough decrease in cost of goods sold to match it. Overall,
the industry has sustained a gross profit anywhere from 68 cents on the dollar to 75
cents on the dollar.
Operating Expense Ratio
Operating Expense Ratio is the 2nd profitability ratio. Operating expense ratio =
(selling expenses + administrative expenses)/Sales. This ratio shows how well
operating expenses are turning into higher sales. If the ratio is high, that means that
operating expenses are not being used efficiently to help create more sales and efforts
should be taken to lower the expenses. The expenses for the ratio can be split into
fixed costs and variable costs. Since administrative costs are fixed costs - meaning that
it is a set amount each period - the firm can estimate this number for each period. The
selling expenses would represent the variable costs for each period since these costs
can change depending on the current period. Most of the time bigger is better when it
comes to profitability ratios, but when expenses are in the numerator of a ratio a
company wants to keep the number as low as possible. The percentages are shown
below for each company.
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Operating Expense Ratios
2005
2006
2007
2008 2009
P.F. Chang's 6.80%
7.76%
6.62%
7.01% 73.42%
P.F. Chang’s Restated 6.80%
7.76%
6.62%
7.01% 73.42%
36.58%
39.43%
39.83%
39.14% 39.28%
8.00%
6.06%
5.87%
5.37% 4.25%
Chipotle Mexican Grill 63.10%
61.27%
68.14%
67.57% 69.31%
Industry Average 28.62%
28.63%
30.11%
29.77% 46.57%
Cheesecake Factory O'Charley's Looking at the above ratios, it shows the industry is pretty well spread out by
each company having a wide range between ratio correlations. P.F. Chang’s and
O’Charley’s do not account for labor costs as part of their selling and administrative
173 | P a g e
expenses, so their ratio is the lowest of all competitors. Having a low ratio like this is
better for the company, because it shows that P.F. Chang’s is using its operating costs
efficiently to produce more sales. Chipotle has an extremely high operating expense
ratio, which is caused by the large amount of selling and administrative expenses.
Chipotle’s S, G, & A expenses are comprised of every operating costs excluding cost of
goods sold and depreciation and amortization expenses. This raises their expenses up
which cannot be met by sales. This shows Chipotle is not efficiently using their
operating costs to improve sales. Overall, the industry though scattered, each company
has maintained a steady ratio for the past five years.
Operating Profit Margin
Operating profit margin is a measure of overall operating efficiency,
incorporating all of the expenses of ordinary, daily business activities. The formula for
operating profit margin is:
Operating Profit Margin= Operating Profit
Net Sales
A higher operating profit margin shows how the operations of the company
contribute to the revenue of the company. The higher the operating margin ratio, the
better the firm is handling its expenses.
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Operating Profit Margin 2005
2006
2007 2008
2009
P.F. Chang's 6.52%
5.01%
4.92% 4.38%
5.31%
P.F. Chang's Restated 6.52%
5.53%
4.62% 6.17%
7.28%
10.98%
8.12%
7.33% 5.43%
4.60%
O'Charley's 3.14%
4.09%
1.82% ‐11.03%
0.72%
Chipotle 3.33%
6.26%
11.06% 13.32%
23.13%
Industry Average 6.10%
5.80%
5.95% 3.65%
8.21%
Cheesecake Factory P.F. Chang’s operating profit margin ranged anywhere from 4.3 percent to 6.5
percent through the five year period researched. It started by in 2005 as one of the
industry leaders. It progressively declined over the next three years. Even though it
declined over these three years, it stayed right around the industry average. It
increased in 2009 along with the industry as a whole. P.F. Chang’s seems to be
following the norm of the industry with very little significant fluctuations in the ratio.
When restating P.F. Chang’s financials, the income from operations has been affected
by operating leases, therefore the denominator has been adjusted. The operating profit
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margin on P.F. Chang’s restated financials did show minimal changes, in that
percentage points show a small number of increases and decreases throughout the
years. P.F. Chang’s has now developed an operating profit margin to that of the
industry average.
Net Profit Margin
The net profit margin is a very important ratio in terms of valuing a firm because
it shows how profitable a company is compared to the amount of sales they made. The
equation is shown below.
Net Profit Margin = Net Income
Net Sales
A low profit margin indicates high risk of decreasing sales, which can further result in a
loss of income. Therefore, a higher net profit margin is preferred. This can be attributed
to overlooking expenses or a slowdown in the economy. The graph below shows the
net profit margins for P.F. Chang’s and its competitors.
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2005
2006
2007
2008
2009
P.F. Chang's
4.67%
3.55%
2.93%
2.92%
3.63%
P.F. Chang’s Restated
4.67%
2.31%
.83%
2.27%
3.15%
Chipotle
6.01%
5.03%
6.50%
5.87%
8.35%
Cheesecake Factory
7.41%
6.18%
4.89%
3.26%
2.67%
O'Charleys
1.28%
1.91%
0.75%
-14.23%
-0.83%
Industry Average
4.84%
4.17%
3.77%
-0.55%
3.46%
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Overall, the industry as a whole is pretty consistent with the net profit margin
being around 4% to 6%. The downward spike for O’Charley’s in 2008 is because of the
negative $130,000 net income for the year. This also causes the industry average to
spike down. This is not common in the industry and causes the average to be skewed.
P.F. Chang’s is consistent as well staying between 3% and 5% in the five-year span
that we looked at. Therefore, although P.F. Chang’s would like to increase these
numbers, any profit is better than a negative profit. After the restatement of P.F.
Chang’s financials, the company experienced a drop in their net profit margin, slightly
because of the decrease in net income from each period. This caused the numerator to
get smaller and therefore decrease the net profit margin for the firm. P.F. Chang’s is
still near the industry average preventing any concerns for the company.
Return on Assets
Return on assets (ROA) is another lag ratio that is the percentage of assets to
total earnings, and helps reveal which company has high profitability through high asset
return. ROA shows how assets affect profitability and how well the firm is utilizing their
assets. It is calculated by diving the current year’s net income by the previous year’s
total assets. The equation is shown below.
Return on Assets t= Net Income t =
Total Assets t-1
The return on asset ratio allows us to view how much profit is generated for every
dollar of assets invested. A high ratio means that a firm is maximizing the profitability of
its assets to create future income.
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2005
2006
2007
2008
2009
P.F. Chang's
9.86%
7.13%
6.24%
5.62%
6.68%
P.F. Chang’s Restated
9.86%
3.44%
1.33%
3.35%
4.48%
Chipotle
11.44%
10.55%
11.68%
10.83%
15.38%
Cheesecake Factory
11.54%
8.78%
7.11%
4.56%
3.75%
O'Charleys
1.81%
2.75%
1.06%
-20.42%
-1.41%
Industry Average
8.65%
7.30%
6.52%
0.15%
6.10%
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For the most part, the industry is pretty consistent again except for O’Charley’s in
2008 and a little in 2009. The increase in 2008 is telling us that for every dollar of
assets that O’Charley’s has they are ultimately losing income and eventually profits.
They do get closer in 2009 but are still negative. The increase in 2008’s average is
attributed to O’Charley’s, so this can manipulate the average to a certain extent. P.F.
Chang’s does a good job of staying with the rest of the competition and the industry
average. Overall, P.F. Chang’s does an exceptional job of utilizing assets to help create
future net income and profitability. After restating P.F. Chang’s financials, the firms
return on assets decreases, due to the capitalized leases added to the total assets, and
deducted from net income. This resulted in a three-percentage point decrease for the
past five years.
Asset Turnover
Asset Turnover is used to determine how efficiently a company’s assets are being
turned into sales. Asset Turnover is measured by Total Sales divided by the previous
year’s total assets. The ideal scenario is a high asset turnover, because firms want their
assets being used as productively as possible; which in this case would be generating
high revenues.
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Based on the above results, the industry has followed some sort of trend for the
past five years. The industry has averaged a ratio of around 1.6 and has maintained
that for the past years. The ratio is moderately high saying that these companies have
used their assets from the previous years to generate sales. For instance, P.F. Chang’s
had an average ratio of about 2, which means for every dollar of assets there has been
two dollars generated in sales. P.F. Chang’s holds one of the highest asset turnovers of
all the firms, but the amount of assets on the financial statements for the firm,
compared to others, are relatively low. With that said, P.F. Chang’s looks as if they
could use their assets to better generate sales in the future since their asset turnover
ratio is higher than the industry average. After restating P.F. Chang’s financials, their
asset turnover ratio decreased by .4, because of the increase in total assets from
capitalized leases. The company is now slightly underperforming in the industry.
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Return on Equity
Like ROA, return on equity is also a percentage of net sales, and is a lag ratio.
The equation for ROE is shown below.
Return on Equity (ROE) t=
Net Income t
=
Total Owners' Equity t-1
Similar to ROA, ROE is another measure of how efficiently a company is using its
resources and investors to help create profits. ROE can provide vital information for
current and future investors by showing them how well their money is ultimately
producing profits. Generally, a high ROE means that a firm is putting their equity to
work in the most efficient way to create profits. On the other hand, if a firm has a low
ROE, then a company is most likely not using the investors’ money in the most
appropriate way to induce profits. The graph below shows the ROE ratio for P.F.
Chang’s and its competitors.
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For the most part, the industry as a whole is pretty consistent in their numbers
with ROE. The spike in the graph is caused by O’Charleys having a negative 36% return
for the year due to a negative $132,000 net income. Other than this, the industry has
good returns. P.F. Chang’s stays with the industry average, except for the spike. P.F.
Chang’s even has an upward slope in the last three years. With the restated ROE for
P.F. Chang’s, the number drops down in the last four years. This is caused by net
income decreasing due to the capitalization of operating leases. With these numbers,
P.F. Chang’s would fall below the industry average in the beginning and work its way
back up to the industry standard.
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Conclusion
After looking at all of the profitability ratios, P.F. Chang’s is generally average in
comparison with the restaurant industry and has a few areas that it is very strong. As
said before, the profitability ratio analysis is used to examine the efficiency and
profitability of a firm. With gross profit margin and asset turnover, P.F. Chang’s really
excelled these two areas. This is showing that they are using their resources in these
areas to maximize profitability. Overall, P.F. Chang’s is in line with the other companies
in the industry, telling us that P.F. Chang’s could be utilizing more profitability
throughout the entire company, but is not doing a poor job at the same time.
Profitability Ratio Analysis
Ratio
Trend
Performance
Restated
Performance
Gross Profit Margin
Slightly
Increasing
Outperforming
N/A
Operating Profit Margin
Steady
Average
Average
Net Profit Margin
Steady
Slightly
Underperforming
Underperforming
Asset Turnover
Slightly
Decreasing
Outperforming
Underperforming
Return on Assets
Slightly
Decreasing
Average
Underperforming
Return on Equity
Slightly
Increasing
Slightly Outperforming
Increasing
Overall
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Capital Structure Ratio Analysis
The capital structure ratios are used to analyze a firm’s ability to finance their
assets through previous amounts of debt or by increasing shareholders equity. P.F.
Chang’s Bistro financial leverage is partly influenced by its debt financing policy
(Business Analysis and Valuation; Palepu &Healy). This means P.F. Chang’s is
evaluating the firm’s financial leverage through debt and long-term solvency. Three
ratios concerning debt and equity will analyze P.F. Chang’s capital structure. The debt
to equity ratio provides information on how much the firm is financing through debt for
each dollar invested by the company’s stockholders. The times interest earned ratio
shows how difficult or easy a firm can make its interest payments. This ratio calculates
the amount of money earned available for interest payment of that period. The debt
service margin is a similar calculation except it determines the amount of cash
generated by operations for interest of that period.
Debt to Equity Ratio
The debt to equity ratio measures how much money a company should safely be
able to borrow from investors over long periods of time. This ratio is calculated by
comparing the company’s total debt, short term and long term, and dividing it by the
total amount of owner’s equity. The result is the percentage of the company that is
leveraged. To have a debt to equity ratio above 40% to 50%, the company should look
to see if any liquidity problems are occurring. If just starting up a company it might be
difficult to receive a loan or qualify for senior debt and therefore might be more
practical to finance through equity. Taking on debt-financing increases operating risk,
because interest must be paid on debt despite any economic hardships.
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2005
2006
2007
2008 2009
P.F. Chang's 0.62
0.78
1.12
1.08 0.94
O'Charley's 0.97
0.80
0.78
1.47 1.21
Cheesecake Factory 0.43
0.46
1.04
1.52 1.03
Chipotle 0.27
0.27
0.28
0.33 0.37
Industry Average 0.69
0.75
1.04
1.23 1.02
P.F. Chang's Restated 1.15
1.44
2.00
1.75 1.53
The chart above illustrates the relationship between debt and equity, which is an
important factor when considering the amount of credit risk that is exposed to a firm.
As mentioned earlier, the lower the risk a firm has, the greater the borrowing capacity.
Likewise, if the firm has a high debt to equity ratio, the firm will have a higher risk and
possibility of going bankrupt. Compared to other firms in the restaurant industry, P.F.
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Chang’s has a steady debt to equity ratio. This means that its assets are not being
financed through debt. For the years of 2005 through 2006 and 2008 through 2009,
P.F. Chang’s debt to equity ratio was below the industry average. Ratios above the one
signify that the firm is mainly financing its assets through debt. Vice versa, ratios below
one signify that the firm is mainly financing its assets through equity. In 2008, O’
Charley’s and Cheesecake Factory both had a debt to equity ratio that was greater than
one. We can conclude that these two firms were financing their assets through debt,
which can be contributed to the recession. For every $1.00 of equity, there is a $1.47 of
O’ Charley’s and $1.52 of Cheesecake Factory worth of debt/liabilities. It safe to say
that compared to the other restaurants in this industry, P.F. Chang’s is in a good
position with having a higher capacity to borrow and a lower risk in defaulting.
After restating P.F. Chang’s financials, the firm’s debt to equity ratio increased
dramatically. When capitalizing leases there are liabilities that are now recognized on
the balance sheet, this increase in liabilities took away value from owners equity and
ultimately caused the ratio to increase. This now means that for every dollar of equity,
P.F. Chang’s has two dollars worth of debt in 2007. This can pose a high credit risk for
the company seeing that they have close to double the amount of debt to equity.
Banks would definitely consider this if P.F. Chang’s were looking to borrow money.
Times Interest Earned
The times interest earned ratio measures how well a particular company has
interest from debt covered, in terms of ability to pay. This ratio is relevant because a
company’s ability to pay off debt is paramount. Times interest earned is the ratio
resulting from operating income divided by interest expense. If a company has a low
ratio, then they have to expend a lot of energy in paying off the interest on their debt.
This in turn means that not enough income is going towards paying off the principle of
the debt. Banks like to see a times interest earned ratio of 4 to 7 because it shows that
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the company can pay off their interest with relative ease. Below are the results for P.F.
Chang’s and their competitors.
2005
2006
2007
2008
2009 P.F. Chang's 17.978 53.187 21.325 10.939 21.036 Cheesecake Factory 144.157 62.848 10.210 5.895 3.146 O'Charley's 1.979 2.811 1.446 ‐6.862 0.549 Chipotle Mexican Grill 39.233 228.605 365.483 410.725 502.975 Industry Average 40.669 70.132 80.145 84.593 106.103 P.F. Chang's Restated 0.000 3.210 2.260 2.270 2.810 188 | P a g e
From looking at the above chart and graph, the restaurant industry for the most
part has kept a relatively high times interest earned ratio. This is good for the firms,
because it shows their ability to pay off the interest on their debt with ease. Chipotle
Mexican Grill has built a tremendous times interest earned ratio, but this is due to their
low amount of interest expense and large amounts of cash flow from operations. P.F.
Chang’s Bistro started with a high ratio back in 2005 and 2006, but steadily dropped the
last three years. This drop is not significant though, because they still have a ratio of
above 5, which means their ability to pay interest on debt is done in a timely manner.
O’Charley’s on the other hand, has kept a very low times interest earned ratio. In 2008,
O’Charley’s experienced negative cash flows from operations, which gave them a
negative ratio. This might conclude that O’Charley’s has a hard time paying off their
interest on debt or cannot make payments as quick as the other companies can.
Like stated in the intro; bigger is better and P.F. Chang’s has shown no signs of
difficulty paying their interest charges. After restating the income statement due to the
capitalization of operating leases, P.F. Chang’s times interest earned decreased
dramatically. The income from operations did decrease after the restatement, because
the interest expense for the company was increased from the capitalized lease
expenses causing the ratio to decrease. Now that P.F. Chang’s is restated, the
company has a much more precise “times interest earned” ratio, which indicates the
firm can adequately cover their interest charges with income from operations.
Debt Service Margin
The debt service margin of a company determines the company’s ability to pay
off current long-term debt with the cash that is provided by the operating activities of
the firm. We can find this margin by dividing the cash from operations of the current
year, by the amount due for the current portion of the long-term debt of the previous
year. By using the previous value of current long-term debt, we are using the amount
due within the preceding year. This margin tells us how the company uses its cash
189 | P a g e
from operations to pay off the current portion of long-term debt. When analyzing this
number, one must realize that the bigger the margin, the better. The bigger the
margin, the more efficiently the company is spending its cash from operations.
Debt Service Margin 2005 2006 2007 2008 2009 P.F. Chang's 177.026 24.150 25.136 20.161 27.884 P.F. Chang’s Restated 177.026 4.286 5.89 2.91 2.98 Cheesecake Factory N/A N/A N/A N/A N/A O'Charley's 0.51 7.58 6.69 6.32 7.29 0 1817.49 2069.34 2611.93 3178.94 59.18 616.41 700.39 879.47 1071.37 Chipotle Industry Average 190 | P a g e
The debt service margin ratio is very skewed in the restaurant industry. The
Cheesecake factory had no current liabilities that were interest bearing. In addition,
Chipotle had very low current liabilities with interest, so the numbers are skewed with
its high CFFO. Taking these two out, P.F. Chang’s is in better shape than O’Charley’s
with a higher debt service margin ratio. P.F. Chang’s is lower than the industry average,
but this does not mean much with our skewed data. All and all, not much can be told
from our debt service margin ratio because it uses current liabilities that are interest
bearing in nature, which the restaurant industry lacks.
Z-Score
A company’s Z-Score measures how vulnerable the company is to bankruptcy.
In other words, the Z-Score determines a company’s default risk. This can be especially
helpful to lenders and investors. A Z-Score takes into account five different variables of
credit worthiness that allow these lenders and investors to judge whether or not they
should take a risk on a company. To calculate a company’s Z-Score, we must consider
the sum of five variables:
1) 1.2 x working capital/total assets (liquidity)
2) 1.4 x retained earnings/total assets (profitability)
3) 3.3 x EBIT/total assets (ROA)
4) .6 x market value of equity/book value of liabilities (market leverage)
5) Total sales/ total assets (potential of assets)
A Z-Score of over 2.67 means the company is basically not at risk of default. A
score between 1.81 and 2.67 means the company is in a “gray area”. Any score below
a 1.81 is considered to be a company vulnerable to bankruptcy. (Palepu and Healy)
The graph below shows the Z-Score for P.F. Chang’s and its competitors.
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2005
2006
2007
2008
2009
P.F. Chang's
7.80
5.53
3.94
3.45
4.28
Chipotle
N/A
11.51
21.09
9.02
10.61
Cheesecake Factory
9.39
6.13
4.29
2.95
3.84
O'Charleys
2.51
2.95
2.60
1.05
2.15
Industry Average
6.57
6.53
7.98
4.12
5.22
P.F. Chang's Restated
4.30
3.48
2.45
2.50
3.23
In general, P.F. Chang’s and its competitors except for Chipotle follow the industry
trend. This jump to 21.1 in 2007 is largely tied to the market value of equity that the
firms held at this time. It was an outstanding four billion and largely outweighs any
other year for the rest of the industry. However, the following years Z-Score fell back
in line with the industry average. The industry as a whole had been declining in 2005,
2006, 2007, and 2008 but seemed to regain its footing in 2009, with everyone having a
192 | P a g e
positive slope. This 2009 slope is attributed to the jump of retained earnings over
assets and operating income over assets. This shows that firms are being more
responsible with their assets and having ultimately greater profitability with less risk.
P.F. Chang’s is typically around the average except for the jump in 2007, which
shows that the risk potential for P.F. Chang’s is relatively low. Overall, the industry has
a good average with the lowest year being 4.12, a good Z-Score. After restating the
financials, P.F. Chang’s Z-Score went down due to total assets increasing, retained
earnings decreasing, and liabilities increasing. These are all things that can decrease a
firm’s credit worthiness because ability to repay debts is lowered. In turn, this is what
causes the Z-Score to decrease.
Internal Growth Rate
IGR is calculated by multiplying ROA by the earnings retention rate (1-dividend
payout ratio). The retention rate shows the effects of paying dividends to stockholders.
The Equation is shown below.
IGR= ROA * {1‐ (DIVIDEND /NET INCOME)} The internal growth rate (IGR) is the maximum potential at which a firm can
continue to grow using strictly their own earnings without any outside help. The
retained earnings from the previous year would be pumped back into the company for
the current year, and that would be the only incoming capital; equity and debt
agreements are not included because that would skew the IGR. Having a legitimate
internal growth rate is a key component of long-term growth. Early on when the firm
has just started out and is starting to grow at a rapid pace, firms pay little or no
dividends so these funds can be put back into the firm. This tends to be the easiest
way for firms to grow because there is no interest or dividends to be paid. The graph of
internal growth rate for P.F. Chang’s and its competitors is shown below.
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With P.F. Chang’s and its competitors, the IGR graph is identical to the ROA
graph from earlier. This is because none of these companies pays a dividend. This
means that the net income for these firms is not split up between shareholders, and is
funded directly back into the retained earnings of the company. This increases retained
earnings at a higher rate and lets the firm grow at a higher rate. Essentially all of these
firms could fund their own growth by a percentage equal to the ROA without using any
outside financing. P.F. Chang’s does well in this area; it is consistently around the
industry average, except for the spike in 2008 caused by O’Charleys. What the graph is
saying is that with no outside financing, P.F. Chang’s could grow at a rate of close to
7% in 2010. When P.F. Chang’s numbers are restated, it drops considerably in 2006,
2007, and 2008. This is due to an average decrease in net income and increase in total
assets. This number begins to slope toward the industry average in 2009.
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Sustainable Growth Rate
The sustainable growth rate (SGR) is the rate at which a firm can continue to
grow without increasing financial leverage. Increasing the leverage of debt creates
problems because it affects the firm’s structure and total cost of capital. Just like a
good IGR, a good SGR can save the company a lot of money. A company can cut costs
and save money without borrowing money, making payments on the principle of the
loan, and having to issue stock and pay dividends. The higher the SGR, the more the
company can save. The calculation is IGR multiplied by one plus debt divided by equity:
SGR = IGR * [1 + (Debt/Equity)]
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2005
2006
2007
2008 2009
P.F. Chang's 15.39%
11.31%
11.07%
11.92% 13.54%
Cheesecake Factory 13.87%
10.54%
10.39%
9.29% 9.46%
3.59%
5.40%
1.92%
‐36.25% ‐3.46%
Chipotle Mexican Grill 14.36%
13.39%
14.89%
13.91% 20.37%
Restated P.F. Chang's 15.43%
7.37%
3.25%
10.04% 12.34%
Industry Average 11.80%
10.16%
9.57%
‐0.28% 9.98%
O'Charley's From the above data, the industry sustainable growth rate is more or less
averaged around 10 percent. Since none of these restaurants in the industry pay out
dividends, the IGR is equivalent to the return on assets for each firm. P.F. Chang’s has
sustained a steady growth rate of about 12% for the past five years. This shows the
capabilities of P.F. Chang’s future growth without increasing their financial leverage.
When a company has a high SGR, which means they can finance their assets and
business without having to borrow money. This keeps their credit rating up and allows
them to grow in the future without having tons of debt. When we restated the
financials, P.F. Chang’s SGR decreased due to the effects of capitalizing operating
leases. The capitalization of operating leases lead to an increase in total assets and
liabilities and a decrease in net income. Because total assets increased while net income
decreased, the return on assets for the restatements decreased. This decrease in return
on assets caused a decrease in SGR.
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Conclusion
After analyzing all of the capital structure ratios, P.F. Chang’s is strong in a few
areas and average to low in others. The ratios that are relatively solid are debt to
equity, internal growth rate, and sustainable growth rate. All three of these show how
P.F. Chang’s is funding its growth in a very productive and efficient manner. Internal
growth rate and sustainable growth rate are both advantageous because they are
showing at what rate P.F. Chang’s can grow without any additional liabilities. These are
both high for P.F. Chang’s, which is an extremely beneficial quality. The last ratio to
look at is Altman’s Z-Score. As mentioned before, this essentially is a credit score for
businesses. P.F. Chang’s has a very good Z-Score meaning that the firm is not in
financial risk and is credit worthy. Overall, P.F. Chang’s has shown that it likes to
finance through equity over debt, but nevertheless has taken on some debt.
Capital Structure Ratio Analysis
Ratio
Trend
Performance
Restated
Performance
Debt to Equity
Slightly Decreasing
Slightly Outperforming
Underperforming
Times Interest Earned
Slightly Increasing
Underperforming
Underperforming
Debt Service Margin
Steady
Underperforming
N/A
Altman's Z-Score
Slightly Increasing
Slightly Underperforming
Slightly Increasing
Internal Growth Rate
Slightly Increasing
Slightly Outperforming
Slightly Underperforming
Sustainable Growth Rate
Increasing
Outperforming
Slightly Outperforming
Overall
197 | P a g e
Financial Forecasting
It is important to forecast the future financials of a company. Forecasting is
important for several reasons. It lets managers change operations in time to possibly
gain a benefit. It also helps managers prevent losses by making decisions on past
information. “Organizations that can create a high quality and accurate forecasts are
able to see what interventions are required to meet their business performance
targets”. (Ass.Content)
To get a clear picture of the future financials, we forecasted ten years out on the
income statement, balance sheet, and the statement of cash flows. We started with
the income statement, because it is the most important of the financials when
determining the future profitability of the company.
Income Statement
Forecasting the income statement is the most important forecast. The forecasted
income statement sets a basis for the balance sheet and statement of cash flows.
Without the income statement, the other two would be impossible to predict. Since P.F.
Chang’s financials have been restated, there will be an as-stated and restated forecast
of the income statement. Many of the line items in the income statement will remain
the same in both as-stated and restated forecasts, but some will differ after restating.
To accurately forecast the income statement, total sales will be the first item to
forecast, since they are a starting point for the rest of the financials. Sales are the first
line item off the income statement. They will help form forecasts for the remainder
items. Once the total sales have been forecasted, these figures will be used to connect
the income statement to the balance sheet and statement of cash flows. In order to
accurately forecast sales growth, we looked at previous year’s sales trends, quarterly
198 | P a g e
reports, 10-Qs, current economic data, and other industry competitors. This will help
better predict the first forecasted years total sales. Below is the sales growth graph for
P.F. Chang’s and its competitors for the last five years:
2005
2006
2007
2008
2009
P.F. Chang's
14.46%
15.87%
16.54%
9.65%
2.51%
Chipotle
33.96%
31.10%
31.94%
22.67%
14.00%
Cheesecake Factory
21.96%
11.27%
14.92%
6.27%
-0.27%
6.75%
6.38%
-1.19%
-4.77%
-5.40%
19.28%
16.16%
15.55%
8.46%
2.71%
O'Charleys
Industry Average
199 | P a g e
P.F. Chang’s fiscal year ends on December 31st, which allows us to receive the
first quarterly report of 2010. This gives a more precise starting point for the sales
forecast in year 2010. To start, we looked at the fourth quarter sales for 2009 as a
percentage of total revenue in 2009. This amount came out to be roughly 25% of total
revenues in 2009. The next step was to take the first quarter of 2010 and multiply it by
four to come up with 2010 total sales. Since P.F. Chang’s sales have been decreasing
over the past few years, we determined that a growth rate of 1.06% would justify the
sales in 2010. After the current economic downturn, we know sales for P.F. Chang’s
will eventually grow back to its pre-economic level. For 2011, we forecasted the growth
rate to be 3.8%, and in 2012 adjusted the growth rate upward to 5%. In 2013, the
growth rate grew to 7.5%. It then leveled off and stayed constant at a rate of 10%
from 2014-2019.
For the restated income statement, sales are not affected by the restatements
therefore; they will remain the same on the restated income statement. Cost of sales
and total operating costs will not be affected by the restatements, so they will remain
the same for both financials. These line items along with others are determined by a
certain percentage of sales for each period. This is created through a common size
income statement, which takes every material line item and divides them by total
revenues of the current period. This statement shows any trends that have occurred
over the past five years and helps better forecast each individual line item.
The common sized income statement allowed us to forecast the cost of sales,
gross profit, and total operating costs. After taking cost of sales as a percentage of
total sales, the percentages seemed to show a trend of around 27% of sales for the
past five years. We decided this would be a good rate to forecast out with, so we
chose a 27.07% growth rate and forecasted cost of sales out to 2019. This showed
that gross profit after cost of sales would be around 73% of sales. When taking total
restaurant operating costs as a percentage of sales, the past five years showed a
steady rate of about 82%. We figured this would be a good benchmark rate, so we
chose to grow total restaurant operating costs at a rate of 81.61%. The total
200 | P a g e
restaurant operating costs were broken down into labor costs, occupancy costs, and
operating costs. Based on the first quarter of 2010, each operating cost listed above
showed consistency within itself over the past five years, and when added together
came out to around 80% of total sales. Since these costs are very tough to forecast,
we can safely assume they will remain consistent and average out to around 81% of
total sales. As for the other remaining items on the income statement, these items will
be forecasted and discussed in the following section.
As Stated Income Statement
Many of the items on the income statement will have the same effect for both
the as stated and restated income statements. These items were discussed above in
the previous section. The three main items that we will discuss in this section include
total expenses, income from operations, and net income. These items will be different
amounts for the as stated and restated forms of the income statement. By applying the
common size income statement and the previous forecasted line items, these three
items will be easier to predict and forecast. Based on P.F. Chang’s common size income
statement, the total expenses for each year remained fairly constant around an average
of 94% of sales. This looked like a reasonable percentage, so we forecasted total
expenses at 94.7% of sales for the next ten years. Operating income fell into place
once we figured out total sales and total expenses for each year. By subtracting the
two, we got income from operations to be 5.3% of total sales.
The last item to forecast on the income statement is net income. Based on the
common size income statement and the predicted sales growth, the most reasonable
growth rate was figured to be 3.7% indefinitely. Once net income has been forecasted,
the as stated income statement is complete. By researching industry trends and
individual restaurant trends from the past five years including quarterly reports, we
came up with P.F. Chang’s future sales growth. This created a starting ground for the
rest of the income statement, balance sheet, and statement of cash flows. By forming
a common sized income statement, expenses and incomes could better be predicted
201 | P a g e
and measured for the future. The as stated income statement and common size
income statement is presented below and will be used to forecast the as stated balance
sheet and as stated statement of cash flows.
202 | P a g e
As Stated Figures
Income Statement
(In Thousands)
Revenues
2004
As Stated Income Statement
2005
2006
2007
2008
Projections
2009 Average Assume
2010
2011
2012
Forecasted As Stated Income Statement
2013
2014
2015
2016
2017
2018
2019
$ 706,941 $ 809,153 $ 937,606 $ 1,092,722 $ 1,198,124 $ 1,228,179 $ 995,454
$ 1,241,198 $ 1,288,363 $ 1,352,781 $ 1,454,240 $ 1,599,664 $ 1,759,630 $ 1,935,593 $ 2,129,153 $ 2,342,068 $ 2,576,275 $
Cost of sales
$ 200,736 $ 224,634 $ 256,582 $ 299,713 $ 325,630 $ 326,421 $ 272,286
$ 336,052 $ 348,760 $ 366,198 $ 393,663 $ 433,029 $ 476,332 $ 523,965 $ 576,362 $ 633,998 $ 697,398
Gross Profit after Cost of Sales
$ 506,205 $ 584,519 $ 681,024 $ 793,009 $ 872,494 $ 901,758 $ 723,168
$ 905,146 $ 939,603 $ 986,583 $ 1,060,577 $ 1,166,635 $ 1,283,298 $ 1,411,628 $ 1,552,791 $ 1,708,070 $ 1,878,877
Labor
$ 233,325 $ 267,681 $ 310,113 $ 368,059 $ 396,911 $ 401,583 $ 329,612
Operating
$ 99,528 $ 122,742 $ 146,409 $ 173,993 $ 198,967 $ 203,859 $ 157,583
Occupancy
$ 37,693 $ 42,793 $ 52,457 $ 63,111 $ 69,809 $ 70,635 $ 56,083
Total restaurant operating costs
Gross Profit after Total Operating Costs
$ 571,282 $ 657,850 $ 765,561 $ 904,876 $ 991,317 $ 1,002,498
$ 135,659 $ 151,303 $ 172,045 $ 187,846 $ 206,807 $ 225,681
General and administrative
Costs and expenses:
Restaurant operating costs:
$ 815,564
$ 1,036,316 $ 1,051,433 $ 1,104,005 $ 1,186,805 $ 1,305,486 $ 1,436,034 $ 1,579,638 $ 1,737,602 $ 1,911,362 $ 2,102,498
$ 179,890
$ 204,882 $ 234,482 $ 246,206 $ 264,672 $ 291,139 $ 320,253 $ 352,278 $ 387,506 $ 426,256 $ 468,882
$ 34,662 $ 39,181 $ 56,911 $ 66,968 $ 77,488 $ 82,749 $ 59,660
$ 83,744 $ 87,931 $ 94,526 $ 103,978 $ 114,376 $ 125,814 $ 138,395 $ 152,234 $ 167,458
Capitalized Operating Lease Expense
$ ‐
$ ‐
$ ‐
$ ‐
$ ‐
Depreciation of Capitalized Leases
$ ‐
$ ‐
$ ‐
$ ‐
$ ‐
Depreciation and amortization
$ 29,155 $ 36,950 $ 44,863 $ 56,832 $ 68,711 $ 74,429 $ 51,823
Preopening expense
$ 7,995 $ 9,248 $ 12,713 $ 14,983 $ 8,457 $ 3,919 $ 9,553
Partner investment expense
$ 17,671 $ 4,800 $ 4,371 $ (2,012) $ (354) $ (629) $ 3,975
Total Costs and Expenses
$ 660,765 $ 748,029 $ 884,419 $ 1,041,647 $ 1,145,619 $ 1,162,966
$ 46,176 $ 61,124 $ 53,187 $ 51,075 $ 52,505 $ 65,213
Income from operations
$ 6,206 $ 12,884 $ 13,528 $ 14,542 $ 15,997 $ 17,596 $ 19,356 $ 21,292 $ 23,421 $ 25,763
$ 940,574
$ 1,175,414 $ 1,220,080 $ 1,281,084 $ 1,377,165 $ 1,514,882 $ 1,666,370 $ 1,833,007 $ 2,016,308 $ 2,217,938 $ 2,439,732
$ 54,880
$ 65,783 $ 68,283 $ 71,697 $ 77,075 $ 84,782 $ 93,260 $ 102,586 $ 112,845 $ 124,130 $ 136,543
Interest and other income (expense)
Interest Expense from Capitalized Leases
$ ‐
Interest expense
$ 3 $ 10
$ ‐
$ ‐
$ ‐
$ ‐
$ ‐
$ 100 $ 3,362 $ 1,637 $ 1,022
Interest and other income
$ 615 $ 1,851 $ 1,315
$ 1,260
Income before minority interest
$ 46,788 $ 62,965 $ 54,502 $ 50,975 $ 49,143 $ 63,576
$ 54,658
Minority interest
$ (10,078) $ (8,227) $ (8,116) $ (4,169) $ (1,933)
$ (6,505)
Income before provision for income taxes
$ 36,710 $ 54,738 $ 46,386 $ 46,806 $ 47,210 $ 63,576
$ 49,238
Provision for income taxes
$ 10,656 $ 16,942 $ 13,133 $ 11,563 $ 12,193 $ 18,492 $ 13,830
Income from Continuing Operations
$ 26,054 $ 37,796 $ 33,253 $ 35,243 $ 35,017 $ 45,084
Loss from Discontinued Operations, Net of Tax
$ ‐
Net income
$ 26,054 $ 37,796 $ 33,253 $ 32,063 $ 35,017 $ 44,605
$ ‐
$ ‐
$ (3,180)
$ 35,408
$ (479) $ (732)
$ 34,798
$ 45,924 $ 47,669 $ 50,053 $ 53,807 $ 59,188 $ 65,106 $ 71,617 $ 78,779 $ 86,657 $ 95,322
203 | P a g e
Income Statement
(In Thousands)
Sales Growth Percent
2004
23.63%
As Stated Common Size Income Statement
2005
2006
2007
2008
12.63%
13.70%
14.20%
8.80%
Projections
2009 Average Assume
2.45%
10.35%
Forecasted As Stated Common Size Income Statement
2010 2011
2012
2013
2014 2015 2016
2017
2018
2019
1.06% 3.80% 5.00% 7.50% 10.00% 10.00% 10.00% 10.00% 10.00% 10.00%
Revenues
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
27.45%
27.07%
27.07%
100.00%
100.00%
27.07%
27.07%
100.00%
100.00%
100.00%
100.00%
100.00%
27.07%
27.07%
27.07%
100.00%
100.00%
Costs and expenses:
Restaurant operating costs:
Cost of sales
28.40%
27.76%
27.37%
27.43%
27.18%
26.58%
71.60%
72.24%
72.63%
72.57%
72.82%
73.42%
Labor
33.00%
33.08%
33.07%
33.68%
33.13%
32.70%
33.11%
Operating
14.08%
15.17%
15.62%
15.92%
16.61%
16.60%
15.67%
Occupancy
5.33%
5.29%
5.59%
5.78%
5.83%
5.75%
5.59%
80.81%
19.19%
81.30%
18.70%
81.65%
18.35%
82.81%
17.19%
82.74%
17.26%
81.62%
18.38%
Gross Profit after Cost of Sales
Total restaurant operating costs
Gross Profit after total Operating Costs
72.55% 72.90% 72.93%
81.82% 81.61% 81.61%
18.18% 18.20% 16.51%
General and administrative
4.90%
4.84%
6.07%
6.13%
6.47%
6.74%
5.86%
Capitalized Operating Lease Expense
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
Depreciation of Capitalized Leases
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
Depreciation and amortization
4.12%
4.57%
4.78%
5.20%
5.73%
6.06%
5.08%
Preopening expense
1.13%
1.14%
1.36%
1.37%
0.71%
0.32%
1.00%
Partner investment expense
2.50%
0.59%
0.47%
‐0.18%
‐0.03%
‐0.05%
0.55%
93.47%
6.53%
92.45%
7.55%
94.33%
5.67%
95.33%
4.67%
95.62%
4.38%
94.69%
5.31%
Interest and other income (expense)
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
Interest Expense from Capitalized Leases
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
Interest expense
0.00%
0.00%
0.00%
0.01%
0.28%
0.13%
0.07%
Interest and other income
0.09%
0.23%
0.14%
0.00%
0.00%
0.00%
0.08%
Income before minority interest
6.62%
7.78%
5.81%
4.66%
4.10%
5.18%
5.69%
Minority interest
‐1.43%
‐1.02%
‐0.87%
‐0.38%
‐0.16%
0.00%
‐0.64%
Income before provision for income taxes
5.19%
6.76%
4.95%
4.28%
3.94%
5.18%
5.05%
Provision for income taxes
1.51%
2.09%
1.40%
1.06%
1.02%
1.51%
1.43%
Income from Continuing Operations
3.69%
4.67%
3.55%
3.23%
2.92%
3.67%
3.62%
Loss from Discontinued Operations, Net of Tax
0.00%
0.00%
0.00%
‐0.29%
0.00%
‐0.04%
‐0.06%
Net income
3.69%
4.67%
3.55%
2.93%
2.92%
3.63%
3.57%
Total Costs and Expenses
Income from operations
72.90% 72.90%
81.61%
81.61%
18.20% 18.20%
27.07%
27.07%
72.90%
72.90%
81.61%
81.61%
18.20%
18.20%
72.90% 72.90% 72.90%
81.61%
81.61%
81.61%
18.20% 18.20% 18.20%
27.07%
27.07%
72.90%
72.90%
81.61%
81.61%
18.20%
18.20%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
1.00%
0.50%
1.00%
1.00%
1.00%
1.00%
1.00%
1.00%
1.00%
1.00%
1.00%
94.70% 94.70%
5.30% 5.30%
94.70%
5.30%
94.70%
5.30%
94.70% 94.70% 94.70%
5.30% 5.30% 5.30%
94.70%
5.30%
94.70%
5.30%
3.70%
3.70%
3.70%
3.70%
3.70%
3.70%
94.31% 94.70% 94.70%
5.69% 5.30% 5.30%
3.70%
3.70%
3.70%
3.70%
3.70%
204 | P a g e
205 | P a g e
Restated Income Statement
As mentioned above, there are certain line items that will not be affected by
restating the income statement. These items include; total sales, cost of goods sold
and total restaurant operating costs. These forecasted amounts, along with a common
size restated income statement, will help calculate growth rates for the remaining
items. P.F. Chang’s leases all of their restaurants, so capitalizing operating leases was
needed to adjust the income statement financials. By doing this, the following line
items will be of different amounts in the restated forecasts. These items include; total
costs and expenses, depreciation of capitalized leases, income from operations, and net
income.
By using the common size income statement, total costs and expenses showed a
consistent rate around 93% of sales. We then predicted total expenses to be 93.59%
of total sales for the next ten years. This percentage was slightly lower than the as
stated percentage due to small decreases in the previous year’s expenses. Capitalized
operating lease expense is factored into total expenses, so this line item does not need
to be forecasted out. The depreciation of capitalized leases is necessary to forecast
since we adjusted all leases to be recorded on the financials. After taking the
percentages of depreciation of capitalized leases to total sales, there seemed to be a
steady rate between years except for 2008 and 2009. This was caused by the
expiration and renewal of leasing contracts in the last couple of years. After factoring
out the outliers, we forecasted the depreciation of capitalized leases at 1.79% of total
sales.
Income from operations was also affected during the restatement of the income
statement. This growth rate can be calculated by taking the difference between gross
profits and operating income. The rate we used was 6.75% of total sales and grew out
indefinitely. This rate was very consistent with the percentages calculated in the
common size income statement for the past five years. Net income is the last line item
that needs to be forecasted for the restated income statement. With the help of
206 | P a g e
forecasted sales and the common sized income statement, a growth rate for net income
is easier to calculate and forecast. The net income for the restated income statement
will take into effect the total expenses for the restated financials, so this growth rate
will differ from that of the as stated financials. Our net income was averaging around
3% of total sales for the past five years. This is the reason why we chose the growth
rate of 3% for the forecasted net income.
The analysis regarding the restated income statement was found by adjusting
operating leases and adding them back on the books. This resulted in line items
differing from their previous amounts in the as stated financials. The total forecasted
sales and forecasted cost of sales helped to calculate future growth rates for these
specific line items. The restated income statement forecasts will provide more
information, be used to forecast the restated balance sheet, and used to forecast the
restated statement of cash flows.
207 | P a g e
208 | P a g e
Income Statement
(In Thousands)
Revenues
2005
Restated Income Statement
2006
2007
2008
2009 Average
Assume
2010
2011
2012
Forecasted Restated Income Statement
2013
2014
2015
2016
2017
2018
2019
$ 809,153 $ 937,606 $ 1,092,722 $ 1,198,124 $ 1,228,179 $ 1,053,157
$ 1,241,198 $ 1,288,363 $ 1,352,781 $ 1,454,240 $ 1,599,664 $ 1,759,630 $ 1,935,593 $ 2,129,153 $ 2,342,068 $ 2,576,275 $
Cost of sales
$ 224,634 $ 256,582 $ 299,713 $ 325,630 $ 326,421 $ 286,596
$ 336,052 $ 348,760 $ 366,198 $ 393,663 $ 433,029 $ 476,332 $ 523,965 $ 576,362 $ 633,998 $ 697,398
Gross Profit after Cost of Sales
$ 584,519 $ 681,024 $ 793,009 $ 872,494 $ 901,758 $ 766,561
$ 905,146 $ 939,603 $ 986,583 $ 1,060,577 $ 1,166,635 $ 1,283,298 $ 1,411,628 $ 1,552,791 $ 1,708,070 $ 1,878,877
Costs and expenses:
Restaurant operating costs:
Labor
$ 267,681 $ 310,113 $ 368,059 $ 396,911 $ 401,583 $ 348,869
$ 417,900 $ 431,602 $ 453,182 $ 487,170 $ 535,887 $ 589,476 $ 648,424 $ 713,266 $ 784,593 $ 863,052
Operating
$ 122,742 $ 146,409 $ 173,993 $ 198,967 $ 203,859 $ 169,194
$ 211,012 $ 198,923 $ 208,869 $ 224,535 $ 246,988 $ 271,687 $ 298,856 $ 328,741 $ 361,615 $ 397,777
Occupancy
$ 42,793 $ 52,457 $ 63,111 $ 69,809 $ 70,635 $ 59,761
$ 71,352 $ 72,148 $ 75,756 $ 81,437 $ 89,581 $ 98,539 $ 108,393 $ 119,233 $ 131,156 $ 144,271
Total restaurant operating costs
Gross Profit after Total Operating Costs
$ 657,850 $ 765,561 $ 904,876 $ 991,317 $ 1,002,498 $ 864,420
$ 151,303 $ 172,045 $ 187,846 $ 206,807 $ 225,681 $ 188,736
$ 204,882 $ 234,482 $ 246,206 $ 264,672 $ 291,139 $ 320,253 $ 352,278 $ 387,506 $ 426,256 $ 468,882
General and administrative
$ 39,181 $ 56,911 $ 66,968 $ 77,488 $ 82,749 $ 64,659
Capitalized Operating Lease Expense
$ (23,680) $ (17,913) $ (42,242) $ (48,053) $ (32,972)
Depreciation of Capitalized Leases
$ 16,402 $ 18,872 $ 20,863 $ 23,906 $ 20,011
$ 1,036,316 $ 1,051,433 $ 1,104,005 $ 1,186,805 $ 1,305,486 $ 1,436,034 $ 1,579,638 $ 1,737,602 $ 1,911,362 $ 2,102,498
$ 22,217 $ 23,062 $ 24,215 $ 26,031 $ 28,634 $ 31,497 $ 34,647 $ 38,112 $ 41,923 $ 46,115
Depreciation and amortization
$ 36,950 $ 44,863 $ 56,832 $ 68,711 $ 74,429 $ 56,357
Preopening expense
$ 9,248 $ 12,713 $ 14,983 $ 8,457 $ 3,919 $ 9,864
Partner investment expense
$ 4,800 $ 4,371 $ (2,012) $ (354) $ (629) $ 1,235
Total Costs and Expenses
$ 748,029 $ 877,141 $ 1,042,606 $ 1,124,240 $ 1,138,819 $ 986,167
$ 61,124 $ 60,465 $ 50,116 $ 73,884 $ 89,360 $ 66,990
$ 83,781 $ 86,965 $ 91,313 $ 98,161 $ 107,977 $ 118,775 $ 130,653 $ 143,718 $ 158,090 $ 173,899
$ 29,789 $ 30,921 $ 32,467 $ 34,902 $ 38,392 $ 42,231 $ 46,454 $ 51,100 $ 56,210 $ 61,831
Income from operations
$ 6,206 $ 12,884 $ 13,528 $ 14,542 $ 15,997 $ 17,596 $ 19,356 $ 21,292 $ 23,421 $ 25,763
$ 1,161,637 $ 1,205,779 $ 1,266,068 $ 1,361,023 $ 1,497,126 $ 1,646,838 $ 1,811,522 $ 1,992,674 $ 2,191,941 $ 2,411,136
Interest and other income (expense)
Interest Expense from Capitalized Leases
$ ‐
Interest expense
$ 10
$ 18,862 $ 22,080 $ 29,209 $ 30,122 $ 20,055
Interest and other income
$ 1,851 $ 1,315
$ 100 $ 3,362 $ 1,637 $ 1,277
$ 1,583
Income before minority interest
$ 62,965 $ 42,918 $ 27,936 $ 41,313 $ 57,601 $ 46,547
Minority interest
$ (8,227) $ (8,116) $ (4,169) $ (1,933)
Income before provision for income taxes
$ 54,738 $ 34,802 $ 23,767 $ 39,380 $ 57,601 $ 42,058
Provision for income taxes
$ 16,942 $ 13,133 $ 11,563 $ 12,193 $ 18,492 $ 14,465
$ (5,611)
Income from Continuing Operations
$ 37,796 $ 21,669 $ 12,204 $ 27,187 $ 39,109 $ 27,593
Loss from Discontinued Operations, Net of Tax
$ ‐
Net income
$ 37,796 $ 21,669 $ 9,024 $ 27,187 $ 38,630 $ 26,861
$ ‐
$ (3,180) $ ‐
$ (479) $ (732)
$ 37,236 $ 38,651 $ 40,583 $ 43,627 $ 47,990 $ 52,789 $ 58,068 $ 63,875 $ 70,262 $ 77,288
209 | P a g e
Income Statement
(In Thousands)
Sales Growth Percent
Revenues
2005
12.63%
100.00%
Restated Common Size Income Statement
2006
2007
2008
13.70%
14.20%
8.80%
100.00%
100.00%
100.00%
2009 Average
Assume
2.45%
10.35%
100.00%
2010
1.06%
100.00%
2011
3.80%
Forecasted Restated Common Size Income Statement
2012
2013
2014
2015
2016
5.00%
7.50%
10.00%
10.00%
10.00%
2017
10.00%
2018
10.00%
2019
10.00%
Costs and expenses:
Restaurant operating costs:
Cost of sales
27.76%
27.37%
27.43%
27.18%
26.58%
27.26%
27.07%
27.07%
27.07%
27.07%
27.07%
27.07%
27.07%
27.07%
27.07%
27.07%
27.07%
Gross Profit after Cost of Sales
72.24%
72.63%
72.57%
72.82%
73.42%
72.74%
72.00%
72.50%
72.50%
72.50%
72.50%
72.50%
72.50%
72.50%
72.50%
72.50%
72.50%
33.00%
33.50%
33.50%
33.50%
33.50%
33.50%
33.50%
33.50%
33.50%
33.50%
33.50%
17.00%
15.44%
15.44%
15.44%
15.44%
15.44%
15.44%
15.44%
15.44%
Labor
33.08%
33.07%
33.68%
33.13%
32.70%
33.13%
Operating
15.17%
15.62%
15.92%
16.61%
16.60%
15.98%
Occupancy
Total restaurant operating costs
Gross Profit after Total Operating Costs
5.29%
5.59%
81.30%
18.70%
5.78%
81.65%
18.35%
5.83%
82.81%
17.19%
5.75%
82.74%
17.26%
5.65%
81.62%
18.38%
5.60%
81.61%
18.20%
81.61%
18.20%
81.61%
18.20%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
6.50%
1.79%
1.79%
1.79%
1.79%
1.79%
1.79%
1.79%
1.79%
1.79%
1.79%
1.79%
0.50%
1.00%
1.00%
1.00%
1.00%
1.00%
1.00%
1.00%
1.00%
1.00%
93.59%
6.75%
93.59%
6.75%
93.59%
6.75%
93.59%
6.75%
93.59%
6.75%
93.59%
6.75%
93.59%
6.75%
93.59%
6.75%
93.59%
6.75%
93.59%
6.75%
93.59%
6.75%
2.40%
2.40%
2.40%
2.40%
2.40%
2.40%
2.40%
2.40%
2.40%
2.40%
2.40%
4.00%
4.00%
4.00%
4.00%
4.00%
4.00%
4.00%
4.00%
4.00%
4.00%
4.00%
3.01%
3.00%
3.00%
3.00%
3.00%
3.00%
3.00%
3.00%
3.00%
3.00%
3.00%
6.47%
6.74%
6.05%
‐3.91%
‐2.90%
Depreciation of Capitalized Leases
0.00%
1.75%
1.73%
1.74%
1.95%
1.79%
Depreciation and amortization
4.57%
4.78%
5.20%
5.73%
6.06%
5.27%
0.71%
0.32%
‐0.05%
0.98%
0.16%
92.45%
7.55%
93.55%
6.45%
95.41%
4.59%
93.83%
6.17%
92.72%
7.28%
93.59%
6.86%
Interest and other income (expense)
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
Interest Expense from Capitalized Leases
0.00%
2.01%
2.02%
2.44%
2.45%
2.23%
Total Costs and Expenses
Income from operations
Interest expense
Interest and other income
Income before minority interest
Minority interest
Income before provision for income taxes
Provision for income taxes
Income from Continuing Operations
Loss from Discontinued Operations, Net of Tax
Net income
0.00%
0.23%
0.00%
0.14%
0.01%
0.00%
0.28%
0.00%
5.60%
81.61%
18.20%
‐3.53%
‐0.03%
5.60%
81.61%
18.20%
6.13%
1.37%
5.60%
81.61%
18.20%
‐1.64%
‐0.18%
5.60%
81.61%
18.20%
6.07%
1.36%
5.60%
81.61%
18.20%
‐2.53%
0.47%
5.60%
81.61%
18.20%
4.84%
1.14%
5.60%
81.61%
18.20%
0.00%
0.59%
15.44%
5.60%
81.61%
18.20%
Capitalized Operating Lease Expense
Partner investment expense
5.60%
82.02%
17.98%
General and administrative
Preopening expense
5.60%
0.13%
0.00%
0.08%
0.07%
7.78%
4.58%
2.56%
3.45%
4.69%
3.82%
‐1.02%
‐0.87%
‐0.38%
‐0.16%
0.00%
‐0.49%
6.76%
3.71%
2.18%
3.29%
4.69%
4.13%
2.09%
1.40%
1.06%
1.02%
1.51%
1.42%
4.67%
2.31%
1.12%
2.27%
3.18%
2.71%
0.00%
0.00%
‐0.29%
0.00%
‐0.04%
‐0.07%
4.67%
2.31%
0.83%
2.27%
3.15%
2.64%
210 | P a g e
211 | P a g e
Balance Sheet
The balance sheet shows a firm’s financial position at a stated point in time. The
balance sheet is comprised of three main elements: assets, liabilities, and owner’s
equity. December 31st is the end of the fiscal year for P.F. Chang’s, and the balance
sheets are stated as of the end of the year for each year. Due to operating leases, P.F.
Chang’s balance sheet was restated, in order to account for the change in capitalizing
operating leases. As a result, both the as-stated and restated balance sheets will be
forecasted. Both forecasted balance sheets will show growth in the three main areas:
assets, liabilities, and owner’s equity.
Forecasting both balance sheets begins with the sales growth forecasts, which
are found on both the as-stated and restated income statements. In order to forecast
total assets, a ratio is used which best links the income statement to the balance sheet,
which is the asset turnover ratio. This ratio compares the sales of the current year to
the total assets of the previous year, showing how efficiently assets were used to
produce sales. Total assets are then forecasted by taking the next year’s total sales and
dividing by the asset turnover ratio to get total assets for the year being forecasted.
Due to the effects of capitalizing operating leases, total assets are increased, thus a restated balance sheet was created. Because of the increase in total assets, both the asstated and restated balance sheets will be forecasted.
To aid in the forecasting of the balance sheet, both an as-stated and restated
common size balance sheet section was attached to the two balance sheets, specifically
for the asset section. The common size balance sheets show each line item on the asset
side of the balance sheet as a percentage of total assets. Upon analysis of the common
size balance sheet, future predictions were made regarding the stable percentage of
different asset line items.
212 | P a g e
The inventory forecast is based off the inventory turnover ratio. Since the cost of
sales did not change between the as-stated and restated income statement, an
approximation of inventory turnover can be utilized, based off the trend in inventory
turnover from the previous years. Inventory turnover had a high of 66.05 and a low of
60.63, with an average of 63.55. In our approximation, we concluded that inventory
turnover was trending lower, and based our approximation on the inventory turnover of
2009; which was 61.69.
Property, Plant and Equipment is forecasted by using the PPE turnover ratio.
PPE turnover is a lag ratio that takes the current year’s sales and dividing by the total
PPE from the previous year. Examination of P.F. Chang’s PPE turnover from the
previous statements showed a high of 2.88 and a low of 2.30, and a straight average of
2.57. In addition, an estimate was calculated based on the data from the 2010 first
quarter 10-Q, which yielded 2.55. Based on this estimate, along with previous data,
our PPE turnover ratio used in our forecast is 2.35.
Once total assets are forecasted, the common-size balance sheet can be used to
forecast the total non-current assets, since the common-size balance sheet contains
asset line items as a percentage of total assets. The common-size balance sheet can
also be used to forecast capital lease asset rights, found in the restated balance sheet.
Total current assets can be determined once non-current assets are forecasted,
since total current plus total non-current equals total assets. For the as-stated and
restated current asset forecast, total assets were subtracted from non-current assets to
determine total current assets.
Total current liabilities are forecasted using the current ratio, once current assets
are forecasted. Since there is no change in forecasting between the as-stated and
restated balance sheets, total current liabilities can be calculated by dividing current
assets by our approximate current ratio of .6.
213 | P a g e
Forecasted total non-current liabilities can be found by subtracting forecasted
current liabilities from forecasted total liabilities. Since the capitalization of operating
leases leads to an increase in total liabilities, total non-current liabilities on the restated
balance sheet are approximately twice as much as the as-stated balance sheet.
Every balance sheet must follow the fundamental accounting equation: Assets =
Liabilities + Owner’s Equity. Since total assets have now been forecasted, the total
assets must equal the total amount of liabilities and owner’s equity.
When forecasting the balance sheet, there are three choices that can be made:
high errors in both the liabilities and owner’s equity, more accuracy in liabilities than
owner’s equity, or more accuracy in owner’s equity than liabilities. In an equity
valuation, more accuracy should be placed on the owner’s equity section of the balance
sheet. Forecasting total owner’s equity on the as-stated and restated balance sheets
involves forecasting retained earnings. For the forecast of retained earnings, the
previous year’s retained earnings are added to the net income for the current
forecasted year, and dividends paid out for the forecasted year are subtracted.
Dividends for P.F. Chang’s are currently paid out at a fixed rate of 45% of net
income, resulting in a variable dividend payout (Q-4 2009 Conference Call). Typically, a
company’s dividends are paid out at a constant rate. However, P.F. Chang’s utilization
of a fixed dividend payout rate will, in the future, lead to variable dividends. Our
forecast of dividends is based on the 45% fixed rate, and is taken as a percentage of
forecasted net income on both the as-stated and restated balance sheets.
The forecast of total common stockholders’ equity is fairly straightforward. Since
fluctuations in common stock outstanding, treasury stock, and additional paid-in capital
cannot be accurately forecasted, an assumption is made: for the forecasted total
common stockholder’s equity, common stock outstanding, treasury stock, and additional
paid-in capital will be held constant. Therefore, the future forecast for total common
stockholders’ equity is the previous year’s total common stockholders’ equity plus the
214 | P a g e
net income for the current forecasted year minus the current forecasted dividends for
that year.
Since total assets = total liabilities and stockholders’ equity, and total
stockholders’ equity has been calculated, it follows that total liabilities is equal to the
difference between assets and total stockholders’ equity on the as-stated and restated
balance sheets.
As-Stated Balance Sheet
Due to the effects of capitalizing operating leases, P.F. Chang’s Balance Sheet
must be evaluated on an as-stated and restated level. Some of the balance sheet
accounts, such as current assets and current liabilities, are not affected by the
capitalizing of operating leases. However, since some other balance sheet accounts are
affected, it follows that the future forecasts of these accounts must be done on an asstated and restated level.
As stated earlier, the asset turnover ratio is used to forecast the total assets on
both an as-stated and restated level. An analysis of previous year’s asset turnover on
an as-stated basis yielded a high of 2.33 and a low of 1.84. In addition, the most
recent quarter’s 10-Q was also used as a benchmark, and a quarterly asset turnover
ratio of .48 was found. This number, when multiplied by four, leads to an asset
turnover of 1.92. Based on previous year’s data and taking into account trends in the
asset turnover ratio and the most recent 10-Q, we chose an asset turnover ratio of 1.9
to use in our forecast of the as-stated balance sheet.
In order to forecast non-current assets, a percentage based off of total assets is
used. On the as-stated common size balance sheet, non-current assets, as a
percentage of total assets, have a low of 79.9% and a high of 90.16%. Studying the
trend, we found a stable percentage of 84.5% to use in our forecasting.
215 | P a g e
Balance Sheet (In Thousands)
Assets 2005
As Stated Balance Sheet
2006
2007
2008
2009 Ratio
Assume
2010
2011
2012
Forecasted As Stated Balance Sheet
2013
2014
2015
2016
2017
2018
2019
Current assets:
Cash and cash equivalents
$ 31,948 $ 31,589 $ 24,055 $ 40,951 $ 63,499
Short‐term investments
$ 34,150 $ ‐
$ ‐
$ ‐
$ ‐
Restricted short‐term investments
$ 8,260 $ ‐
$ ‐
$ ‐
$ ‐
Inventories
$ 3,461 $ 4,232 $ 4,649 $ 4,930 $ 5,291 Inv Turnover
Prepaid and other current assets
$ 15,957 $ 28,995 $ 32,552 $ 51,643 $ 38,449
Total current assets
$ 93,776 $ 64,816 $ 61,256 $ 97,524 $ 107,239 TA‐NCA
Capitalized Leased Assets Rights
$ ‐
Property and equipment, net
$ 345,864 $ 421,770 $ 520,145 $ 524,004 $ 497,928 PPE Turnover
Deferred income tax assets
$ 1,938
$ ‐
$ ‐
$ ‐
$ ‐
$ ‐
60.00 $ 5,601 $ 5,813 $ 6,103 $ 6,561 $ 7,217 $ 7,939 $ 8,733 $ 9,606 $ 10,567 $ 11,623
$ 105,103 $ 110,358 $ 118,635 $ 130,499 $ 143,549 $ 157,904 $ 173,694 $ 191,063 $ 210,170 $ 231,187
$ ‐
2.35 $ 528,169 $ 548,240 $ 575,652 $ 618,826 $ 680,708 $ 748,779 $ 823,657 $ 906,022 $ 996,625 $ 1,096,287
$ ‐
Goodwill
$ 6,819 $ 6,819 $ 6,819 $ 6,819 $ 6,819
Intangible assets, net
$ ‐
Other assets
$ 18,265 $ 7,996 $ 12,406 $ 14,746 $ 17,923
$ 6,819 $ 6,819 $ 6,819 $ 6,819 $ 6,819 $ 6,819 $ 6,819 $ 6,819 $ 6,819 $ 6,819
$ 12,644 $ 22,004 $ 24,270 $ 22,241
Total Non‐Current Assets
$ 372,886 $ 449,229 $ 561,374 $ 569,839 $ 544,911 Common Size
Total assets
$ 466,662 $ 514,045 $ 622,630 $ 667,363 $ 652,150 ato
84.5%
$ 572,983 $ 601,632 $ 646,754 $ 711,430 $ 782,572 $ 860,830 $ 946,913 $ 1,041,604 $ 1,145,764 $ 1,260,341
1.90 $ 678,086 $ 711,990 $ 765,389 $ 841,928 $ 926,121 $ 1,018,733 $ 1,120,607 $ 1,232,667 $ 1,355,934 $ 1,491,528 2
$ 1.90
LIABILITIES AND COMMON STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
$ 13,850 $ 15,255 $ 17,745 $ 15,203 $ 19,825
Construction payable
$ 6,463 $ 9,075 $ 11,319 $ 4,358 $ 1,600
Accrued expenses
$ 40,864 $ 55,848 $ 59,259 $ 71,162 $ 77,088
Unearned revenue
$ 15,281 $ 18,226 $ 25,346 $ 31,115 $ 35,844
Current portion of long‐term debt
$ 5,110 $ 5,487 $ 6,932 $ 5,753 $ 41,236
Total current liabilities
$ 81,568 $ 103,891 $ 120,601 $ 127,591 $ 175,593 C.R.
Long‐term debt
$ 5,360 $ 13,723 $ 90,828 $ 82,496 $ 1,212
Capitalized Leases Liabilities
$ ‐
Lease obligation
$ 55,991 $ 71,682 $ 93,435 $ 113,178 $ 116,547
Other Liabilities
$ ‐
Minority interests
$ 29,845 $ 33,315 $ 17,169 $ 8,581 $ 4,961
$ ‐
$ ‐
$ ‐
0.60 $ 175,172 $ 183,931 $ 197,726 $ 217,498 $ 239,248 $ 263,173 $ 289,490 $ 318,439 $ 350,283 $ 385,311
$ ‐
$ 1,909 $ 6,710 $ 14,691 $ 18,488
Total Non‐Current Liabilities
$ 91,196 $ 120,629 $ 208,142 $ 218,946 $ 141,208
$ 142,306 $ 141,234 $ 153,309 $ 180,482 $ 210,372 $ 243,250 $ 279,417 $ 319,201 $ 362,962 $ 411,100
Total Liabilities
$ 172,764 $ 224,520 $ 328,743 $ 346,537 $ 316,801
$ 317,479 $ 325,165 $ 351,035 $ 397,980 $ 449,620 $ 506,423 $ 568,907 $ 637,640 $ 713,245 $ 796,412
Common stockholders’ equity:
Common stock, $.001 par value, 40,000,000 shares authorized* (see note)
$ 26 $ 27 $ 27 $ 27 $ 28
Additional paid‐in capital
$ 165,355 $ 174,101 $ 196,385 $ 206,667 $ 217,181
Treasury Stock* (see note)
$ ‐
$ (46,373) $ (96,358) $ (106,372) $ (146,022)
Other Comprehensive Loss
$ ‐
$ ‐
Retained earnings
$ 128,517 $ 161,770 $ 193,833 $ 221,259 $ 264,456
Total common stockholders’ equity
Total liabilities and common stockholders’ equity
$ 293,898 $ 289,525 $ 293,887 $ 320,826 $ 335,349
$ 466,662 $ 514,045 $ 622,630 $ 667,363 $ 652,150
Common Stock Outstanding
26,397,366 25,373,019 24,151,888 24,114,107 22,911,054
Treasury stock ‐
$ ‐
$ (755) $ (294)
$ 289,714 $ 315,933 $ 343,462 $ 373,055 $ 405,609 $ 441,417 $ 480,806 $ 524,135 $ 571,796 $ 624,223
$ 360,607 $ 386,826 $ 414,355 $ 443,948 $ 476,502 $ 512,310 $ 551,699 $ 595,028 $ 642,689 $ 695,116
$ 678,086 $ 711,990 $ 765,389 $ 841,928 $ 926,121 $ 1,018,733 $ 1,120,607 $ 1,232,667 $ 1,355,934 $ 1,491,528
23104
Dividend
1,397,261 3,240,943 3,634,979 5,064,733
45% of NI
45% $ 20,666 $ 21,451 $ 22,524 $ 24,213 $ 26,634 $ 29,298 $ 32,228 $ 35,450 $ 38,995 $ 42,895
216 | P a g e
Balance Sheet (In Thousands)
Assets As Stated Balance Sheet
2006
2007
2005
2008
2009 Average
Assume
Current assets:
Cash and cash equivalents
6.85%
6.15%
3.86%
6.14%
9.74%
Short‐term investments
7.32%
0.00%
0.00%
0.00%
0.00%
1.46%
Restricted short‐term investments
1.77%
0.00%
0.00%
0.00%
0.00%
0.35%
Inventories
0.74%
0.82%
0.75%
0.74%
0.81%
0.77%
Prepaid and other current assets
Total current assets
6.55%
3.42%
5.64%
5.23%
7.74%
5.90%
5.58%
20.10%
12.61%
9.84%
14.61%
16.44%
14.72%
Capitalized Leased Assets Rights
0.00%
0.00%
0.00%
0.00%
0.00%
0.00%
Property and equipment, net
74.11%
82.05%
83.54%
78.52%
76.35%
78.91%
Deferred income tax assets
0.42%
0.00%
0.00%
0.00%
0.00%
0.08%
Goodwill
1.46%
1.33%
1.10%
1.02%
1.05%
1.19%
Intangible assets, net
0.00%
2.46%
3.53%
3.64%
3.41%
2.61%
Other assets
3.91%
1.56%
1.99%
2.21%
2.75%
2.48%
79.90%
100.00%
87.39%
100.00%
90.16%
100.00%
85.39%
100.00%
83.56%
100.00%
85.28%
100.00%
Total Non‐Current Assets
Total assets
84.50%
217 | P a g e
218 | P a g e
Restated Balance Sheet
The restated balance sheet reflects the addition of the capitalization of operating
leases. When the financial statements are adjusted to reflect the capitalization of
operating leases, a number of different accounts are changed. Total assets and total
liabilities increase, as capital lease asset rights and capitalized lease liabilities accounts
are added to the balance sheet. In addition, retained earnings decrease which leads to
a decrease in total stockholders’ equity, when compared to the as-stated balance sheet.
As a result of these changes, some of the forecasting models change as well.
The asset turnover ratio used to forecast the restated balance sheet was
obtained in a similar manner. An examination of previous year’s restatements yielded
an asset turnover ratio high of 1.61 and a low of 1.43. The restated asset turnover
ratios were fairly consistent year-over-year, leading to a straight average of 1.5, which
fit in-line with previous years. As such, our asset turnover ratio used in forecasting total
assets on the restated balance sheet is 1.5. The change from 1.9 to 1.5 is due to the
increase in total assets on the restated financial statements. Since total sales do not
change, and assets increase, it follows that the restated balance sheet would have a
smaller asset turnover ratio.
When forecasting non-current assets, the common size income statement is used
as a guide. The common size income statement for P.F. Chang’s restated balance sheet
shows an increase in the percentage values of non-current assets. This increase is the
direct result of the capitalization of operating leases, as the capitalized leased asset
rights account is considered a non-current asset.
On the as-stated balance sheet and the restated balance sheet, current assets
and liabilities do not change. However, given that total assets increases and
stockholders’ equity decreases, non-current liabilities must increase to cover the
difference. When operating leases are capitalized, a liability account named capitalized
lease liabilities is created. This account covers the change in the liabilities section of the
restated balance sheet.
219 | P a g e
When operating leases are capitalized, a reduction in net income is noted on the
restated income statement. Since net income flows into retained earnings, this
decrease in net income also decreases retained earnings. Since total stockholders’
equity forecasts take into account the prior year’s retained earnings, the current year’s
dividends and current year’s net income, the capitalization of operating leases leads to
a lower stockholders’ equity figure. In addition, due to P.F. Chang’s dividend payout
model, dividends also decreased as compared to the as-stated balance sheet. This
difference is directly attributable to the decrease in net income, since P.F. Chang’s
dividends are based off of 45% of net income.
220 | P a g e
Balance Sheet (In Thousands)
Assets 2005
Restated Balance Sheet
2006
2007
2008
2009 Ratio
Assume
2010
2011
2012
Forecasted Restated Balance Sheet
2013
2014
2015
2016
2017
2018
2019
Current assets:
Cash and cash equivalents
$ 31,948 $ 31,589 $ 24,055 $ 40,951 $ 63,499
Short‐term investments
$ 34,150 $ ‐
$ ‐
$ ‐
$ ‐
Restricted short‐term investments
$ 8,260 $ ‐
$ ‐
$ ‐
$ ‐
Inventories
$ 3,461 $ 4,232 $ 4,649 $ 4,930 $ 5,291 Inv Turnover
Prepaid and other current assets
$ 15,957 $ 28,995 $ 32,552 $ 51,643 $ 38,449
Total current assets
$ 93,776 $ 64,816 $ 61,256 $ 97,524 $ 107,239 TA‐NCA
Capitalized Leased Assets Rights
$ 164,014 $ 164,826 $ 189,762 $ 194,291 $ 181,353 Common Size
Property and equipment, net
$ 345,864 $ 421,770 $ 520,145 $ 524,004 $ 497,928
Deferred income tax assets
$ 1,938
Goodwill
$ 6,819 $ 6,819 $ 6,819 $ 6,819 $ 6,819
Intangible assets, net
Other assets
$ ‐
$ ‐
60.00 $ 5,601 $ 5,813 $ 6,103 $ 6,561 $ 7,217 $ 7,939 $ 8,733 $ 9,606 $ 10,567 $ 11,623
$ 98,775 $ 103,713 $ 111,492 $ 122,641 $ 134,905 $ 148,395 $ 163,235 $ 179,559 $ 197,514 $ 217,266
23.00% $ 197,549 $ 207,426 $ 222,983 $ 245,282 $ 269,810 $ 296,791 $ 326,470 $ 359,117 $ 395,029 $ 434,532
$ ‐
$ 12,644 $ 22,004 $ 24,270 $ 22,241
$ 18,265 $ 7,996 $ 12,406 $ 14,746 $ 17,923
Total Non‐Current Assets
$ 536,900 $ 614,055 $ 751,136 $ 764,130 $ 726,264 Common Size 88.50%
Total assets
$ 630,676 $ 678,871 $ 812,392 $ 861,654 $ 833,503 ATO
$ 760,134 $ 798,141 $ 858,002 $ 943,802 $ 1,038,182 $ 1,142,000 $ 1,256,200 $ 1,381,820 $ 1,520,002 $ 1,672,002
1.50 $ 858,909 $ 901,854 $ 969,493 $ 1,066,443 $ 1,173,087 $ 1,290,396 $ 1,419,435 $ 1,561,379 $ 1,717,517 $ 1,889,268
LIABILITIES AND COMMON STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
$ 13,850 $ 15,255 $ 17,745 $ 15,203 $ 19,825
Construction payable
$ 6,463 $ 9,075 $ 11,319 $ 4,358 $ 1,600
Accrued expenses
$ 40,864 $ 55,848 $ 59,259 $ 71,162 $ 77,088
Unearned revenue
$ 15,281 $ 18,226 $ 25,346 $ 31,115 $ 35,844
Current portion of long‐term debt
$ 5,110 $ 5,487 $ 6,932 $ 5,753 $ 41,236
Total current liabilities
$ 81,568 $ 103,891 $ 120,601 $ 127,591 $ 175,593 C.R.
Long‐term debt
$ 5,360 $ 13,723 $ 90,828 $ 82,496 $ 1,212
Capitalized Leases Liabilities
$ 164,014 $ 176,410 $ 212,801 $ 202,121 $ 187,328
Lease obligation
$ 55,991 $ 71,682 $ 93,435 $ 113,178 $ 116,547
Other Liabilities
Minority interests
0.60 $ 164,624 $ 172,855 $ 185,820 $ 204,402 $ 224,842 $ 247,326 $ 272,058 $ 299,264 $ 329,191 $ 362,110
$ 1,909 $ 6,710 $ 14,691 $ 18,488
$ 29,845 $ 33,315 $ 17,169 $ 8,581 $ 4,961
Total Non‐Current Liabilities
$ 255,210 $ 297,039 $ 420,943 $ 421,067 $ 328,536
Total Liabilities
$ 336,778 $ 400,930 $ 541,544 $ 548,658 $ 504,129 A‐OE
TL‐CL
$ 344,431 $ 357,887 $ 390,241 $ 444,614 $ 504,423 $ 570,214 $ 642,584 $ 722,190 $ 809,757 $ 906,082
$ 509,055 $ 530,742 $ 576,061 $ 649,015 $ 729,265 $ 817,540 $ 914,642 $ 1,021,454 $ 1,138,948 $ 1,268,191
Common stockholders’ equity:
Common stock, $.001 par value, 40,000,000 shares authorized* (see note)
$ 26 $ 27 $ 27 $ 27 $ 28 $ 23
Additional paid‐in capital
$ 165,355 $ 174,101 $ 196,385 $ 206,667 $ 217,181 $ 227,124
Treasury Stock* (see note)
$ (46,373) $ (96,358) $ (106,372) $ (146,022) $ (148,122)
Other Comprehensive Loss
$ (755) $ (294) $ ‐
Retained earnings
$ 128,517 $ 150,186 $ 170,794 $ 213,429 $ 258,481
Total common stockholders’ equity
Total liabilities and common stockholders’ equity
$ 293,898 $ 277,941 $ 270,848 $ 312,996 $ 329,374
$ 630,676 $ 678,871 $ 812,392 $ 861,654 $ 833,503
Common Stock Outstanding
26,397,366 25,373,019 24,151,888 24,114,107 22,911,054
Treasury stock ‐
$ 278,961 $ 300,219 $ 322,540 $ 346,535 $ 372,929 $ 401,963 $ 433,900 $ 469,031 $ 507,675 $ 550,184
$ 349,854 $ 371,112 $ 393,433 $ 417,428 $ 443,822 $ 472,856 $ 504,793 $ 539,924 $ 578,568 $ 621,077
$ 858,909 $ 901,854 $ 969,493 $ 1,066,443 $ 1,173,087 $ 1,290,396 $ 1,419,435 $ 1,561,379 $ 1,717,517 $ 1,889,268
1,397,261 3,240,943 3,634,979 5,064,733
Dividend
45% of NI
45%
ROE
Balance Sheet (In Thousands)
Assets 2005
Restated Balance Sheet
2006
2007
2008
2009 Average
16756.16891 17392.9033 18262.5485
11.31%
Assume
11.05%
10.94%
19632.23964 21595.4636 23755.00996 26130.51096 28743.56205 31617.91826 34779.71009
11.09%
11.50%
11.89%
12.28%
12.65%
13.01%
221
| P a13.36%
ge
Balance Sheet (In Thousands)
Assets 2005
Restated Balance Sheet
2006
2007
2008
2009 Average
Assume
Current assets:
Cash and cash equivalents
5.07%
4.65%
2.96%
4.75%
7.62%
5.01%
Short‐term investments
5.41%
0.00%
0.00%
0.00%
0.00%
1.08%
Restricted short‐term investments
1.31%
0.00%
0.00%
0.00%
0.00%
0.26%
Inventories
0.55%
0.62%
0.57%
0.57%
0.63%
0.59%
Prepaid and other current assets
2.53%
4.27%
4.01%
5.99%
4.61%
4.28%
14.87%
9.55%
7.54%
11.32%
12.87%
11.23%
Capitalized Leased Assets Rights
26.01%
24.28%
23.36%
22.55%
21.76%
23.59%
Property and equipment, net
54.84%
62.13%
64.03%
60.81%
59.74%
60.31%
Deferred income tax assets
0.31%
0.00%
0.00%
0.00%
0.00%
0.06%
Goodwill
1.08%
1.00%
0.84%
0.79%
0.82%
0.91%
Intangible assets, net
0.00%
1.86%
2.71%
2.82%
2.67%
2.01%
Other assets
2.90%
1.18%
1.53%
1.71%
2.15%
1.89%
85.13%
90.45%
92.46%
88.68%
87.13%
88.77%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
Total current assets
Total Non‐Current Assets
Total assets
23.00%
88.50%
222 | P a g e
223 | P a g e
Statement of Cash Flows
The statement of cash flows is the final forecasted financial statement, which
revolves around the cash in and out flows of a firm. The statement of cash flows is
comprised of cash flows from operating activities (CFFO), cash flows from investing
activities (CFFI), and cash flows from financing activities (CFFF). In order to obtain
projected sales, we had to determine the growth rate of sales by using net income as a
percentage of sales. We concluded that net income would remain that same as in the
as-stated income statement. We utilized the same rate in forecasting net income on the
income statement, which is the same rate as the as stated. For the years of 2007 –
2009, the percent of sales of net income was volatile; we then proceeded to review the
average. We took an average of the as stated net income, which was 3.57 % and
utilized 3.7% of projected total sales as our first line item, which is how we calculated
net income
When calculating future cash flows we used three ratios: CFFO/Net Income,
CFFO/Operating Income, and CFFO/Net Sales to determine the use of cash over the
time period. We calculated the three ratios to see if we could find a consistent trend to
use as our growth rate to calculate cash flows from operations. After reviewing the
trends from the three different ratios, we decided on choosing CFFO/net sales because
of its consistency. We determined that 13.25 % would be our benchmark to configure
CFFO. In order to obtain a forecasted cash flow from operations, we multiplied our
projected sales times 13.25% which is our percent of sales (growth rate).
After we forecasted cash flows from operations, we forecasted cash flows from
investing activities. Cash flows from investing activities can be forecasted using two
ratios: CFFI Proxy 1 and CFFI Proxy 2. CFFI Proxy 1 is the change in non-current
assets from the previous year. CFFI Proxy 2 is the change in Property, Plant, and
Equipment from the previous year. To get the ratio, CFFI is divided by each of these
items. Upon analysis of the previous year’s CFFI, change in non-current assets, and
change in PPE, we determined that the ratio that would result in the least amount of
error in forecasts is CFFI/change in PPE. In our determination of the assumed ratio, an
224 | P a g e
analysis of the previous year’s ratios was conducted. Discounting outliers, the ratios of
the previous year’s yielded an average of 1.58. We then projected CFFI out to 2019
using this ratio, and found our data did reflect prior trends in CFFI.
We forecasted cash flows from financing activities by utilizing dividends paid to
stockholders. According to Co-CEO of P.F. Chang’s, Robert Vivian, “Our Company has
reached a point where we believe we will produce free cash flow on a consistent basis.
Beginning in 2010, we are going to augment our share repurchase efforts with a
quarterly variable dividend. We have chosen to fix our dividend payout ratio at 45% of
net income. With a fixed pay out mechanism, our dividend will vary by quarter with our
actual results. Therefore, if our net income increases over the next few years, our
shareholders will automatically participate in that earnings growth. The converse is also
true. If for some reason our earnings decline, the dividend paid to our shareholders will
reflect that lower level of earnings.” In order to forecast dividends we first looked at
P.F. Chang’s first quarter in 2010, which is when they first declared dividends. We
forecasted dividends by taking 45% of net income for the next 10 years, which was
what P.F. Chang’s utilized when they first declared their dividends. We decided to use
the same percentage due its consistency. The following chart displays dividends
forecasted for the next 10 years.
225 | P a g e
Dividend
Per Share
Annual
Dividend
Per Share
Total
Number of
Shares
Annual
Dividends
Paid
$
2010
0.22
$
2011
0.23
$
2012
0.24
$
2013
0.26
$
2014
0.29
$
2015
0.32
$
2016
0.35
$
2017
0.38
$
2018
0.42
$
2019
0.46
$
0.89
$
0.93
$
0.97
$
1.05
$
1.15
$
1.27
$
1.39
$
1.53
$
1.69
$
1.86
23,104
23,104
23,104
23,104
23,104
23,104
23,104
23,104
23,104
23,104
$20,665.94
$21,451.25
$22,523.81
$24,213.10
$26,634.41
$29,297.85
$32,227.63
$35,450.39
$38,995.43
$42,894.98
226 | P a g e
Operating Activities:
Net Income
2004
2005
As Stated Statement of Cash Flows
2006
2007
2008
2009 Average
Assume
2010
$ 26,054 $ 37,796 $ 33,253 $ 36,232 $ 29,359 $ 44,605 $ 34,550
2011
2012
2013
Forecast As Stated Statement of Cash Flows
2014
2015
2016
2017
2018
2019
$ 45,924 $ 47,669 $ 50,053 $ 53,807 $ 59,188 $ 65,106 $ 71,617 $ 78,779 $ 86,657 $ 95,322
Adjustments to reconcile net income to net cash provided by Operating Activities
Depreciation and Amortization
Share‐based Compensation
Non‐Cash Asset Impairment and Lease termination charges in discontinued operations
Deferred income taxes
Partner bonus expense, imputed
Other
Minority Interest
Partner investment expense
Tax (benefit) shortfall from share‐based Compensation, net
$ 29,155 $ 36,950 $ 44,863 $ 57,251 $ 69,661 $ 74,429 $ 52,052
$ ‐
$ ‐
$ 8,941 $ 10,512 $ 9,715 $ 11,552 $ 6,787
$ ‐
$ (195)
$ 1,750
$ ‐
$ 10,078
$ 17,195
$ 7,036
$ ‐
$ 1,817
$ 1,818
$ ‐
$ 8,227
$ 4,800
$ 3,179
$ ‐
$ (6,175)
$ 1,999
$ 294
$ 8,116
$ 4,371
$ (1,937)
$ 3,125
$ 4,767
$ 1,374
$ 167
$ ‐
$ (2,012)
$ (3,981)
$ 9,889
$ 5,381
$ 913
$ 143
$ ‐
$ (354)
$ 491
$ 611
$ (4,354)
$ 484
$ 63
$ ‐
$ (629)
$ (1,348)
$ 2,271
$ 207
$ 1,390
$ 111
$ 4,404
$ 3,895
$ 573
$ (40)
$ (3,561)
$ (1,110)
$ 5,646
$ 4,380
$ 2,608
$ 10,509
$ ‐
$ (510)
$ (6,186)
$ (1,042)
$ (163)
$ 8,566
$ 2,822
$ 10,453
$ ‐
$ (771)
$ (2,257)
$ (2,464)
$ 1,405
$ 14,984
$ 2,945
$ 15,837
$ ‐
$ (417)
$ (786)
$ (3,937)
$ 2,490
$ 3,411
$ 7,120
$ 21,911
$ 693
$ (281)
$ (18,406)
$ (434)
$ (2,542)
$ 9,524
$ 5,769
$ 19,914
$ 1,011
$ (361)
$ 17,640
$ (1,398)
$ 4,622
$ 4,015
$ 4,729
$ 4,382
$ 1,377
$ (397)
$ (2,259)
$ (1,731)
$ 1,910
$ 7,480
$ 4,332
$ 13,834
$ 514
Changes in operating assets and liabilities:
Inventories
Other current assets
Other assets
Accounts payable
Accrued expenses
Unearned revenue
Lease obligations
Other liabilities
Net Cash Provided By Operating Activities
CFFO/Sales
CFFO/Net Income
CFFO/Operating Income
$ 109,505 $ 108,517 $ 123,404 $ 137,920 $ 139,753 $ 160,419 $ 129,920 CFFO/Sales
15.49%
13.41%
13.16%
12.62%
11.66%
13.06%
13.24%
420.30%
287.11%
371.11%
380.66%
476.01%
359.64%
382.47%
237%
178%
232%
270%
266%
246%
238.15%
13.25% $ 164,459 $ 170,708 $ 179,244 $ 192,687 $ 211,955 $ 233,151 $ 256,466 $ 282,113 $ 310,324 $ 341,356
Investing Activities:
Capital expenditures
Capitalized interest
Purchase of Short Term Investments
Purchase of Minority Interests
Sale of Short Term Investments
Net cash used in investing activities
PPE/INV
Change in PPE
CFFI/PPE
$ (84,088) $ (93,792)
$ (58) $ (3,396)
$ (48,180)
$ (595) $ (6,085)
$ ‐
$ 10,770
$ (114,330)
$ (1,003)
$ (12,660)
$ (2,142)
$ 55,070
$ (151,553)
$ (1,791)
$ ‐
$ ‐
$ ‐
$ (87,178)
$ (708)
$ ‐
$ ‐
$ ‐
$ (49,865)
$ (253)
$ ‐
$ ‐
$ ‐
$ (96,801)
$ (1,202)
$ (12,168)
$ (1,470)
$ 10,973
$ (84,741)
0.62
$ (52,471)
1.62
$ (140,683)
0.46
$ (65,223)
2.16
$ (75,065)
1.01
$ (75,906)
0.99
$ (153,344)
0.64
$ (98,375)
1.56
$ (87,886)
0.04
$ (3,859)
22.77
$ (50,118) $ (98,640) Change in PPE
(0.52) 0.56
$ 26,076
(1.92) 4.53 1.58
$ (1,382)
$ ‐
$ ‐
$ (11,161)
$ ‐
$ ‐
$ ‐
$ 1,175
$ ‐
$ (672) $ (5,110) $ (30,475)
$ ‐
$ (46,373) $ (49,985)
$ (13,032)
$ (10,774) $ (10,080) $ (6,365)
$ (135) $ (146) $ (158)
$ ‐
$ 12,000 $ 96,000
$ ‐
$ ‐
$ (254)
$ 1,320 $ 1,205 $ 387
$ ‐
$ 1,937 $ 3,981
$ (12,512)
$ (10,014)
$ (9,763)
$ (3,323)
$ (171)
$ ‐
$ ‐
$ 245
$ (491)
$ (45,850)
$ (39,650)
$ (4,710)
$ (1,749)
$ (185)
$ ‐
$ ‐
$ 50
$ 1,348
1.58 $ (47,779) $ (53,566) $ (84,366) $ (120,925) $ (133,017) $ (146,319) $ (160,951) $ (177,046) $ (194,751) $ (214,226)
Financing Activities:
Repayments of long‐term debt
Purchases of treasury stock
Purchases of noncontrolling interests
Distributions to noncontrolling interest partners
Payments of capital lease obligation
Borrowings on credit facility
Debt issuance costs
Contributions from noncontrolling interest partners
Tax benefit (shortfall) from share‐based compensation, net
Proceeds from stock options exercised and employee stock purchases
Sale/(Purchase) of Subsidiary Common Stock
$ (16,000)
$ (24,337)
$ (6,876)
$ (7,242)
$ (133)
$ 18,000
$ (42)
$ 730
$ 1,129
$ 7,459 $ 7,996 $ 5,214 $ 7,791 $ 1,058 $ 2,993 $ 5,419
$ 76 $ ‐
$ (7,345) $ ‐
$ ‐
$ ‐
$ (1,212)
Net cash provided by (used in) financing activities
$ (3,833) $ (2,295) $ (48,698) $ 7,890 $ (34,971) $ (87,753) $ (28,277) Dividend Forecast
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at the beginning of the period
$ 20,931 $ (34,461) $ (359) $ (7,534) $ 16,896 $ 22,548 $ 3,004
$ 45,478 $ 66,409 $ 31,948 $ 31,589 $ 24,055 $ 40,951 $ 40,072
Cash and cash equivalents at the end of the period
$ 66,409 $ 31,948 $ 31,589 $ 24,055 $ 40,951 $ 63,499 $ 43,075
45% of NI
$ (20,666) $ (21,451) $ (22,524) $ (24,213) $ (26,634) $ (29,298) $ (32,228) $ (35,450) $ (38,995) $ (42,895)
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest
Cash paid for income taxes, net of refunds
$ 104 $ 429 $ 915 $ 1,907 $ 5,442 $ 3,478 $ 2,046
$ 11,144 $ 15,116 $ 12,616 $ 4,615 $ 9,842 $ 11,782 $ 10,853
Supplemental Disclosure of Non‐Cash Items:
Purchases of noncontrolling interests
$ 355 $ 3,756 $ 1,851 $ 11,732 $ 2,693 $ ‐
$ 3,398
227 | P a g e
Net Income
2004
23.79%
2005
34.83%
2006
26.95%
2007
26.27%
2008
21.01%
2009 Average
27.81%
26.59%
26.62%
0.00%
34.05%
0.00%
36.35%
7.25%
41.51%
7.62%
49.85%
6.95%
46.40%
7.20%
40.06%
5.22%
0.00%
‐0.18%
1.60%
0.00%
9.20%
15.70%
0.00%
1.67%
1.68%
0.00%
7.58%
4.42%
0.00%
‐5.00%
1.62%
0.24%
6.58%
3.54%
2.27%
3.46%
1.00%
0.12%
0.00%
‐1.46%
7.08%
3.85%
0.65%
0.10%
0.00%
‐0.25%
0.38%
‐2.71%
0.30%
0.04%
0.00%
‐0.39%
1.75%
0.16%
1.07%
0.09%
3.39%
3.00%
6.43%
2.93%
‐1.57%
‐2.89%
0.35%
‐0.84%
0.44%
‐0.04%
‐3.25%
‐1.01%
5.16%
4.00%
2.38%
9.60%
0.00%
0.00%
100.00%
‐0.47%
‐5.70%
‐0.96%
‐0.15%
7.89%
2.60%
9.63%
0.00%
0.00%
100.00%
‐0.62%
‐1.83%
‐2.00%
1.14%
12.14%
2.39%
12.83%
0.00%
0.00%
100.00%
‐0.30%
‐0.57%
‐2.85%
1.81%
2.47%
5.16%
15.89%
0.50%
0.00%
100.00%
‐0.20%
‐13.17%
‐0.31%
‐1.82%
6.81%
4.13%
14.25%
0.72%
0.00%
100.00%
‐0.23%
11.00%
‐0.87%
2.88%
2.50%
2.95%
2.73%
0.86%
0.00%
100.00%
‐0.31%
‐1.74%
‐1.33%
1.47%
5.76%
3.33%
10.65%
0.40%
0.00%
100.00%
99.23%
0.07%
0.00%
0.70%
0.00%
66.67%
2.41%
34.25%
4.33%
‐7.66%
152.31%
1.34%
16.87%
2.85%
‐73.36%
98.83%
1.17%
0.00%
0.00%
0.00%
99.19%
0.81%
0.00%
0.00%
0.00%
99.50%
0.50%
0.00%
0.00%
0.00%
98.14%
1.22%
12.34%
1.49%
‐11.12%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
Adjustments to reconcile net income to net cash provided by Operating Activities
Depreciation and Amortization
Share‐based Compensation
Non‐Cash Asset Impairment and Lease termination charges in discontinued operations
Deferred income taxes
Partner bonus expense, imputed
Other
Minority Interest
Partner investment expense
Tax (benefit) shortfall from share‐based Compensation, net
Changes in operating assets and liabilities:
Inventories
Other current assets
Other assets
Accounts payable
Accrued expenses
Unearned revenue
Lease obligations
Other liabilities
Net Cash Provided By Operating Activities
Investing Activities:
Capital expenditures
Capitalized interest
Purchase of Short Term Investments
Purchase of Minority Interests
Sale of Short Term Investments
Net cash used in investing activities
228 | P a g e
Estimating Cost of Capital
A firm’s cost of capital is, “the opportunity cost of an investment; that is, the rate
of return that a company would otherwise be able to earn at the same risk level as the
investment that has been selected” (www.investorwords.com). The weighted average
cost of debt and cost of equity make up cost of capital. The weighted average is
calculated using the firm’s capital structure or percentage of assets that are financed by
debt and percentage of assets that are financed by equity. We will estimate the cost of
capital for P.F. Chang’s using their10-K and the future forecast that were estimated
earlier.
Cost of Equity
Estimating the cost of equity is typically difficult for managers to construct due to
the different measurements of beta and riskless rate of return. The cost of equity is
commonly known as the “annual rate of return that an investor expects to earn when
investing in shares of a company.”(valuepro.net) Shareholders that invest in a high risk
asset, call for a higher rate of return. The measured cost of equity used for P.F.
Chang’s was derived from the Capital Asset Pricing Model also known as (CAPM). The
equation is completed by multiplying the firm’s beta by the market risk premium, and
then added to the risk free rate of return. This will measure the expected return an
investor will receive as the asset increases in risk. The CAPM formula is written as:
Cost of Equity (Ke) = Risk Free Rate (Rf) + Beta (β) (Market Risk Premium (mrp))
The risk free rate of return was found using the U.S. Treasury bill rate since
government bonds are risk free assets. This was found in the St. Louis Federal Reserve
economic database. The most difficult part of the equation is to determine the beta
used for the CAPM equation. Beta is “a measure of the volatility or systematic risk, of a
security or a portfolio in comparison to the market as a whole.”(dictionary.com) A
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firm’s security having a beta of 1 specifies that the security will move in comparison to
the market. Having a beta of less than one means the opposite, in that the security will
be more unstable than that of the market. To find the most appropriate beta for P.F.
Chang’s, a regression analysis was performed using returns of a 3 month, 1 year, 2
year, 5 year, and 10 year basis to find the five points on the yield curve. “These
analysis can predict the outcome of a given key business indicator based on the
interactions of other related business drivers”. (VBM) The returns were taken from the
St. Louis Federal Reserve economic database. The regression with the highest adjusted
R² was used to determine the beta for P.F. Chang’s. The risk free rate is the rate used
for the U.S. Treasury bill, and the market risk premium is calculated by subtracting the
risk free rate from the return on the market found in the S&P 500 index as well.
Charted below are the five regression analysis measured within a 72 month, 60 month,
48 month, 36 month, and a 24 month period for the purpose of testing the stability of
beta over time. The five separate regressions will provide information on how beta
changes over time and if so by how much. This can present the total systematic risk
compared to the entire market risk for a 24 – 72 month long regression.
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3 Month Regression
Months Beta Adj R2 B low B up Ke Ke low Ke Up 72 0.86404 0.12140 0.33992 1.38815 9.46826 7.49947 14.83706
60 0.88344 0.13165 0.32268 1.44419 9.60407 7.37878 15.22935
48 0.89184 0.14112 0.28399 1.49969 9.66288 7.10794 15.61783
36 0.94368 0.20229 0.33341 1.55396 10.02578 7.45386 15.99770
24 1.11276 0.39263 0.53344 1.69208 11.20930 8.85405 16.96455
The three month regression analysis shows that the highest adjusted R² came in
the 24 month observation and provided a beta of 1.112. This states that beta can
explain around 39% of the total risk for the security therefore not explaining close to
61% of the risk for the security.
1 Year Regression
Months Beta Adj R2 B low B up Ke Ke low Ke Up 72 0.86310 0.12135 0.33945 1.38676 9.46173 7.49612 14.82734
60 0.88252 0.13163 0.32231 1.44274 9.59767 7.37614 15.21921
48 0.89078 0.14106 0.28353 1.49803 9.65547 7.10473 15.60620
36 0.94304 0.20228 0.33317 1.55291 10.02129
7.45222 15.99035
24 1.11140 0.39250 0.53264 1.69017 11.19982
8.84848 16.95116
The one year regression analysis shows that beta has moved very little from the
three month regression to one year. The highest adjusted R² is in the 24 month
observation again and provides a beta of 1.111, not far off from the three month
regression beta of 1.112.
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2 Year Regression
Months Beta Adj R2 B low B up Ke Ke low Ke Up 72 0.8622 0.1209
0.3382
1.3862
9.4552
7.4872 14.8231
60 0.8817 0.1313
0.3212
1.4423
9.5921
7.3682 15.2160
48 0.8901 0.1407
0.2825
1.4978
9.6509
7.0976 15.6043
36 0.9437 0.2021
0.3332
1.5543
10.0260
7.4521 15.9999
24 1.1130 0.3930
0.5340
1.6920
11.2112
8.8582 16.9642
The two year regression analysis is still providing nearly the same results as the
last two regressions did. The highest adjusted R² still fell within the 24 month
observation and provided a slightly higher beta of 1.113.
5 Year Regression
Months Beta Adj R2 B low B up Ke Ke low Ke Up 72 0.8573 0.1195
0.3331
1.3815
9.4211
7.4515 14.7907
60 0.8766 0.1297
0.3158
1.4375
9.5564
7.3305 15.1824
48 0.8866 0.1395
0.2786
1.4945
9.6260
7.0703 15.5818
36 0.9429 0.2012
0.3313
1.5545
10.0203
7.4389 16.0016
24 1.1156 0.3940
0.5363
1.6948
11.2290
8.8744 16.9836
The five year regression like all others has shown that beta and adjusted R²
have not made a drastic change over time and still remain around the same percentage
of risk. The highest adjusted R² is still provided in the 24 month observation and
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presents a beta of 1.115. Overall the beta is faintly rising over time in each regression
analysis.
10 Year Regression
Months Beta Adj R2 B low B up Ke Ke low Ke Up 72 0.8519 0.1180
0.3276
1.3762
9.3834
7.4133 14.7535
60 0.8710 0.1280
0.3100
1.4319
9.5167
7.2901 15.1434
48 0.8822 0.1381
0.2741
1.4903
9.5954
7.0387 15.5520
36 0.9406 0.1999
0.3282
1.5530
10.0044
7.4175 15.9913
24 1.1161 0.3939
0.5364
1.6957
11.2324
8.8751 16.9896
When deciding the appropriate beta for calculating the cost of equity, evaluating
the explanatory power of each regression is required. The regression with the highest
adjusted R² should be used to determine the beta for estimating the cost of equity.
The adjusted R² is a “measure that determines the degree to which two variable’s
movements are associated,” in our case, a security of P.F. Chang’s and the
market.(help.sap.com) This determines the percentage of total risk an investor will
acquire, given the systematic risk of the firm (beta). An example of this calculation
would be taking for instance; a 72 month period from a 10 year regression. The beta
for this period would explain about 12% of total risk for the stock. Therefore, 88% of
the risk cannot be explained by the beta of the security. This would not be a good
security to invest in, because this is not the highest adjusted R² found in the
regressions. The beta that formed the highest adjusted R² was calculated using the 24
month observation in the five year regression analysis. This beta of 1.116 explains
about 39.4% of the total risk for a P.F. Chang’s security. Compared to the published
233 | P a g e
beta of .864, our beta has slightly differed. After figuring the beta for the CAPM model
we used a risk free rate of about 3.42% and a market risk premium of about 7%. After
configuring all calculations we estimated the cost of equity to be around 11.232%. The
equation was performed as followed:
Ke: 11.23% = 3.42 + 1.116 (7)
In addition to calculating the estimated cost of equity, a 95% confidence interval
was performed using the regression analysis to present an upper and lower bound of
the estimated cost of equity. This means the firm is 95% confidence their cost of
equity lies between the two calculated bounds. The equations are as followed:
Upper Ke = Rf + upper beta (mrp)
Lower Ke = Rf + lower beta (mrp)
Upper Ke: 17.056% = 3.42 + 1.948 (7)
Lower Ke: 7.174% = 3.42 + .5363 (7)
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Size-Adjusted Cost of Equity
The size-adjusted cost of equity remains the same, using the CAPM model, but
proposes that systematic risk is not the only aspect of the CAPM model controlling rates
of return. This important factor is known as the “size effect”. It is said that smaller
firms in an industry tend to produce higher rates of return than that of larger
corporations. This could mean many different things, but the size of the firm should
come in to effect when calculating the cost of equity. Average stock returns for
different firms in the U.S. were varied by size and put in to a table created from 19262005. (Business Analysis and Valuation, By Palepu & Healy) The table associates less
risk for the larger companies listed in the S&P 500. This rate of return can be found in
the table according to the size deciles based on the market cap of the firm. This rate is
then added to the cost of equity therefore ending with a size-adjusted cost of equity.
The calculation is as followed:
Ke = Rf + β(mrp) + size premium
The table listed for the size adjustments ranges from 1 to 10 with respect to the
size of the firm. With 10 being the largest market cap for a firm, the lower the market
cap the higher the size premium for that particular firm. P.F. Chang’s has a market
Capitalization of $1.04 billion and a beta of 1.116. P.F. Chang’s falls between the 3rd
and 4th decile range leading us to a 1.7% size premium. When adding the size
premium to our cost of equity we end up with an estimated Ke of about 12.932%. The
equation is as followed:
Ke: 12.932% = 3.42 + 1.116 (7) + 1.7
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Alternative Cost of Equity
An alternative to calculating the cost of equity is known as the backdoor method.
This incorporates different measures in the Capital Asset Pricing Model using the current
price of the firm’s stock. This measurement requires the forecasting of stockholders
equity and an average growth rate for the next ten years. The equation for the
backdoor method is to calculate or look up the current price to book ratio of the firm
and subtract 1. By setting this equal to the lagged ratio of ROE minus the cost of
equity divided by the cost of equity minus the growth rate, we can solve for the
backdoor or new cost of equity. The formula is as followed:
(Price/book)-1= (ROE-Ke)/ (Ke-g)
The current price to book ratio found on yahoo finance is approximately 2.99.
This measurement takes into account the size of the market capitalization of P.F.
Chang’s. The next step is to predict the future lagged ratio of ROE for the next ten
years and by doing so we came up with an average of about 14.83% for the next ten
years. The growth rate was derived from the average amount of growth for
stockholders equity for the next ten years. Since we based our growth rate on net
sales for future periods, we came up with an average growth rate of about -.3% for the
next ten years. By setting up the equation we came up with an estimated cost of
equity of: 4.76%.
ROE 14.83% Price/Book Growth Rate 2.99
‐.3%
Cost of Equity 4.76% 236 | P a g e
This is a bad measurement considering it does not fall between the upper cost of
equity and the lower cost of equity. 4.76% is also lower than the original calculated
cost of equity, which was about 11%. So overall the backdoor method to calculating
cost of equity is not an acceptable measure we can use.
Cost of Debt
The cost of debt (Kd) is the interest rate a firm like P.F. Chang’s pays its debt
holders. “If the assumed capital structure in future periods is the same as the historical
structure, then the current interest rate on debt will be a good proxy for this.”(Business
Analysis and Valuation, By Palepu & Healy) This is important for investors to calculate;
because if the purposed investor thinks the interest rates will rise in the future it will be
more expensive to acquire the firm’s debt. To receive a measure of the estimated cost
of debt, the weighted-average of interest rates of total liabilities are calculated then
added together. To calculate the weighted-average, each line of liabilities must be
divided in to the total amount of liabilities. Then by figuring the required interest rate
for each liability, the weighted-average is multiplied by that rate to come up with the
weighted interest rate. By adding all the weighted interest rates together, we can
compute the cost of debt. Cost of equity is usually higher than that of debt, because
equity holders face a higher risk than that of debt. Debt investors are not exposed to
such high risks and therefore have a less rate of return. This is because, if a firm has
to default on a payment, then the investors of equity will not make a return until all the
liabilities have been fully paid off. Featured below is the calculation for cost of debt:
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Amount Weight Rate Weighted Rate Current Liabilities: Accounts Payable 19,825 6.36% 0.28%
0.018% Short/Current portion LTD 41,236 13.22% 1.02%
0.135% 1,600 0.51% 0.20%
0.001% Accrued Expenses 77,088 24.72% 3.32%
0.821% Unearned Revenue 35,844 11.49% 3.32%
0.382% Construction Payable 175,593 Total Current Liabilities: Long‐Term Liabilities: Long‐Term Debt Lease Obligations Other Long‐Term Liabilities 1,212
0.39% 1.02%
0.004% 116,547
37.37% 13.90%
5.195% 18,488
5.93% 1.02%
0.060% Total Long‐Term Liabilities: 136,247 Total Liabilities: 311,840 Kd 6.615% Adjusted Capitalized Lease Liabilities 187328
Total
499,168
37.53%
13.90%
Kd
adjusted
5.216%
11.832%
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This table provides the information to calculate the cost of debt. The rates used
to multiply the weights of the liabilities were found in P.F. Chang’s 10-K and by using
the Federal Reserve interest rates. By dividing each of the current liabilities by the total
amount of liabilities we came up with the weight of each liability. The rate chosen for
the accounts payable was the rate on non financial commercial paper. The rate chosen
for long term debt was found in P.F. Chang’s 10-K and calculated by the S&P 500 credit
rating. Once we found these weighted rates we added them together to come up with
an accumulated cost of debt to be 6.615%.
Notice how the estimated return for debt is less than the estimated return on
equity. Like stated above, the equity investors of a firm face a higher risk than that of
debt investors, so the return must be greater for having to acquire more risk. Now that
we have found both the cost of equity and cost of debt we can move on to calculate the
Weighted-Average Cost of Capital or WACC.
Weighted-Average Cost of Capital (WACC)
When valuing a firm’s net assets, the cash flows that are available to both debt
and equity holders are discounted at a rate known as the weighted-average cost of
capital. The equation uses both the cost of equity and debt divided by their respective
value of the firm. The book value of liabilities is divided by its value of the firm and
multiplied by the cost of debt before and after taxes. The market value of equity is
then divided by the value of the firm and multiplied by the cost of equity. These two
calculations are then added up to receive the weighted-average cost of capital which is
the discount rate used for investors of equity and debt. The before tax WACC is
calculated like stated above, but the after tax WACC is taken from multiplying the first
half of the equation; (BVL/MVF)(Kd), by one minus the tax rate. Then, by adding the
first part to the second half of the equation, the after tax WACC is arrived at. Below are
the two calculations and data:
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WACCbt = (BVL/MVF)(Kd) + (MVE/MVF)(Ke)
WACCat = (BVL/MVF)(Kd)(1-t) + (MVE/MVF)(Ke)
Weighted-Average Cost of Capital
BVL/MVF WACCbt Kd Tax Rate MVE/MVF
0%
74.1%
25.9% 6.615%
WACCat 25.9% 6.615%
35%
Ke 12.93% 74.1%
WACC 11.3%
12.93% 10.7%
Weighted-Average Cost of Capital (restated)
BVL/MVF WACCbt WACCat Kd Tax Rate MVE/MVF
0%
63.89%
36.11% 11.83%
36.11% 11.83%
35%
Ke 12.93% 63.89%
WACC 12.93% 12.53%
11.04%
We estimated that the before tax cost of capital for P.F. Chang’s is about 11.3%.
This means that the firm relies mostly on its debt to finance its assets and business. If
the estimates WACC before taxes is correct, this signifies that P.F. Chang’s must turn
out 11.3% on its assets to fully compensate and pay off the debt holders, stockholders,
and other risk barring investors. Once we calculated the before tax WACC we then
went on to say that P.F. Chang’s is in the 35% tax bracket so we multiplied the
equation by 1- the tax rate to come up with the after tax WACC. The after tax WACC
went down as it should to 10.7% return on the firm’s assets to compensate all
investors. After figuring the cost of debt using the restatements, we came up with an
11.83% Kd and a before tax WACC of 12.53%. So, yes the restatement did change the
240 | P a g e
return for all investors slightly, but this difference was an increase to the return making
it more profitable and more risky.
Method of Comparables
In order to determine the value of P.F. Chang’s China Bistro, we will be utilizing
the method of comparables. The method of comparables is one of the simplest methods
in assessing the value of a firm. This method is often used by financial analysts and
outsiders due its simplicity and accessibility of data. After completing the method of
comparables, we will have the ability to determine the stock price for P.F. Chang’s.
There are numerous ratios that are used in order to obtain P.F. Chang’s true value; we
will compute these ratios for P.F. Chang’s and its competitors. Each of these ratios
contains a price variable and along with another variable such as earnings, book value,
dividends, free cash flow, growth and EBITDA. Since P.F. Chang’s is the firm to be
valued we will be excluding this firm from the average. The initial step of this process is
to compute the industry average for P.F. Chang’s and its competitors. After computing
the average, we will review the data to see of the there are any outliers which will be
numbers that will not be included in the average. These numbers that we consider to
be outliers are unrealistic or negative numbers that can have a major affect on the
industry average which in result in a misrepresentation of price for P.F. Chang’s.
Although the method of comparables has a few disadvantages, it gives us a simple way
of determining a firm’s stock price in comparison to its competitors in the industry. The
following ratios will be used in the method of comparables:
ƒ
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Trailing Price/Earnings
Forecasted Price/Earnings
Price/Book Value
P.E.G. (Price/Earnings) / (1-Year ahead Earnings Growth Rate)
Price/EBITDA (un-levered measure)
(Enterprise Value)/(EBITDA)
Price/(FCF per share)
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In order to determine if P.F. Chang’s is fairly/over/under-valued, we will utilize
P.F. Chang’s observed stock price as of June 24, 2010, which is $43.48. This stock price
will be used as our benchmark. We will compare the computed prices to the benchmark
and we will use a 10% confidence interval. If P.F. Chang’s computed stock price lies
between $39.13 and $47.83 it will indicate that the firm is fairly valued. For any results
that fall below $39.13, the stock will be overvalued, and for any price over $47.83 will
be undervalued. The following sections are meant to define and interpret the different
ratios used when evaluating P.F. Chang’s compared to that of other firms in its industry.
All of the information for P.F. Chang’s Industry competitors was provided by the 10(k)’s
for each firm and finance.yahoo.com. The ratios used in the method of comparables will
assist us in determining the stock price for P.F. Chang’s.
Trailing Price to Earnings (P/E)
The Trailing Price to Earnings ratio is calculated by taking the firms most recent
price per share and dividing it by the firms previous year’s earnings per share. In order
to find P.F. Chang’s comparable price per share, we first had to gather other
restaurants’ information to determine an industry average P/E ratio. P.F. Chang’s price
to earnings is not calculated within the industry average along with any negative values
and possible large outliers. The industry average P/E ratio is multiplied by P.F. Chang’s
earnings per share (EPS) to compute their adjusted price per share (PPS). By
evaluating P.F. Chang’s comparables PPS to its current share price, the firm can be seen
as undervalued, fairly valued, or overvalued. The results are presented below:
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Trailing P/E Ratio
P/E Industry Forecast
Avg P.F. Chang's Adj. PPS PPS EPS P.F. Chang's 43.48 1.95 22.3 Cheesecake Factory 23.46 0.85 27.64 O'Charley's 6.28 ‐0.89 N/A Chipotle 144.8 4.36 33.26 Darden Restaurants 39.56 2.91 31.59 Brinker Inc. 14.64 1.13 13.11 26.4
51.48 The P/E ratio is the most commonly accepted method of comparables due to
actual past information presented within the ratio. There is one problem with this in
which there are some uncertainties to how well past information can truly value a firm.
Based on the above data, P.F. Chang’s P/E forecast ratio is slightly lower than the other
firms in the industry, but has a current price per share above the others. After the
adjustment, P.F. Chang’s PPS increased above its current PPF of $43.48. Using the
Trailing P/E method of comparables, P.F. Chang’s is considered undervalued and right
at the 20% analysts range.
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Forward Price to Earnings (P/E)
The Forward P/E ratio is very much similar to the Trailing P/E ratio except now
we will use P.F. Chang’s forecasted or future earnings per share (EPS). This will give us
a look at the future value of the firm moving on. To find the firm’s forecasted EPS we
took the forecasted net income for 2019 since that is when the future sales growth
remained constant, and then divided it by the total number of shares outstanding. The
current price per share (PPS) is then divided by the forecasted EPS to calculate the
forward P/E ratio. In order to find P.F. Chang’s comparables PPS we need to find an
industry average P/E and multiply that by P.F. Chang’s forecasted EPS. The variables of
the ratio for each competitor are found on YAHOO! Finance and are not represent true
values. Below are the results, including P.F. Chang’s as stated and restated adjusted
price per share.
P.F. Chang's Adj. P/E Industry Forecast Avg PPS PPS EPS P.F. Chang's (As Stated) 43.48 4.13 10.53 26.4 109.03 P.F. Chang's (Restated) 43.48 3.35 12.98 26.4 88.44 Cheesecake Factory 23.46 0.85 27.64 O'Charley's 6.28 ‐0.89 N/A Chipotle 144.8 4.36 33.26 Darden Restaurants 39.56 2.91 31.59 Brinker Inc. 14.64 1.13 13.11 244 | P a g e
As seen in the chart above, P.F. Chang’s still has the lowest projected P/E ratio
of all firms listed. After multiplying the firms as stated and restated EPS by the industry
average P/E, P.F. Chang’s price per shares are significantly higher than their current
share price. This would indicate that the firm is extremely undervalued. We are using
a 20% analyst’s recommendation range at which if the adjusted PPS is +/- 20% of the
current share price, the firm can be valued as either under or over. There is a
significant change in share price and it exceeds the 20% analyst’s range, so the forward
P/E ratio indicated P.F. Chang’s is undervalued. Unlike the trailing P/E which uses past
information, the forward ratio can be unreliable due to the inaccuracy of forecasting the
financials.
Price to Book (P/B)
The Price to Book ratio compares the firm’s current price per share to its book
value of equity per share. Price to book ratio tends to be more useful for investors
looking for value in a firm rather than growth. The price in the equation represents the
value of the firm’s assets to the investors. A high P/B ratio indicates that the firm is
overvalued and represents a higher premium people are willing to pay. A low P/B ratio
signifies the firm is undervalued and might be considered a good investment.
(investorwords.com) Like the other method of comparables, we will find an industry
price to book average using company information on YAHOO! Finance. The industry
average will be multiplied by P.F. Chang’s book value of equity per share to calculate
the as stated and restated adjusted share price. This method like the others does not
use significant information to accurately price a firm therefore, the ratio can cause
uncertainty. Below are the results for P.F. Chang’s.
245 | P a g e
PPS BPS P/B Forecast P.F. Chang's (As Stated) 43.48 14.64 2.97 3.042 44.53 P.F. Chang's (Restated) 43.48 14.38 3.02 3.042 43.74 Cheesecake Factory 23.46 8.59 2.73 O'Charley's 6.28 9.66 0.65 Chipotle 144.8 22.95 6.31 Darden Restaurants 39.56 12.36 3.2 Brinker Inc. 14.64 6.31 2.32 Industry Avg P.F. Chang's Adj. PPS Based on the above data, we can see that P.F. Chang’s as stated and restated
PPS is fairly consistent with its current share price. This indicates that the firm is
considered fairly valued. Also, P.F. Chang’s as stated and restated price to book ratio is
consistent with the industry average thus, indicating the firm is fairly valued. This
method is different from the other in which it shows P.F. Chang’s to be fairly valued
rather than extremely undervalued, therefore providing uncertain or inaccurate results.
P.E.G Ratio
The price/earnings to future earnings growth rate also known as the P.E.G ratio
accounts for earning per share relative to price and the future growth opportunities of
the firm. To calculate the P.E.G ratio we will use the trailing P/E ratio and divide it by
the annual earnings per share growth rate. Keep in mind this information can be
inaccurate, because of the forecasting involved with the EPS growth rate. A P.E.G ratio
above two is considered high and means the firm is paying a lot for future growth. A
low P.E.G ratio indicates the firm is undervalued and would be considered a good
investment opportunity. The competitors P.E.G ratio average will be multiplied by P.F.
246 | P a g e
Chang’s earning growth rate and then multiply that number by their EPS. This will give
the adjusted price per share for P.F. Chang’s on an as stated and restated basis. The
results are listed below:
P/E P.E.G Earnings Growth Rate P.F. Chang's (As Stated) 22.3 3.1 7.20 1.95 1.275 17.90 P.F. Chang's (Restated) 25.73 3.94 6.53 1.69 1.275 14.07 Cheesecake Factory 27.64 1.25 22.11 0.85 N/A N/A N/A ‐0.89 Chipotle 33.26 1.49 22.32 4.36 Darden Restaurants 31.59 1.21 26.11 2.91 Brinker Inc. 13.11 1.15 11.40 1.13 O'Charley's EPS Industry Avg P.F. Chang's Adj. PPS Based on the above results, P.F. Chang’s P.E.G ratio and adjusted price per share
indicates that the firm is overvalued. The P.E.G ratio is higher than the other industry
competitors and the adjusted PPS is less than the current share price for the company.
Using a +/- 10% analysts range, we concluded that the firm is significantly
undervalued. Since P.F. Chang’s P.E.G ratio is greater than two, we can suspect that
the company is spending a lot of money on future growth plans. This method of
comparables is once again inconsistent with the other ratios in which it shows the to be
overvalued.
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Price to EBITDA
Price to earnings before interest, taxes, depreciation, and amortization (EBITDA)
ratio is a valuation technique using significant financial numbers to value a firm. The
ratio is completed by using the market cap of a firm as its price. To find the market
caps for P.F. Chang’s and its competitors we went on to Yahoo! Finance and looked up
the number of shares outstanding and multiplied it by the price as of June 24, 2009.
We found the numbers for EBITDA for the competitors on Yahoo! Finance as well. To
find P.F. Chang’s EBITDA we went through our as stated income statement and
restated income statement and took net income plus any interest, taxes, depreciation,
and amortization. The price to EBITDA ratios for P.F. Chang’s and its competitors are
shown below.
Price/EBITDA
P/EBITDA
Industry
Average
Adjusted
PPS
Market Cap
EBITDA
P.F. Chang's
$ 892,035
$ 139,163
$ 34.92
P.F. Chang's
Restated
$ 892,035
$ 183,321
$ 46.00
Chipotle
$ 4,550,000
$ 292,477
$ 15.56
Cheesecake Factory
$ 1,410,000
$ 188,369
$ 7.49
O'Charleys
$ 135,830
$ 57,078
$ 2.38
Brinker
$ 1,500,000
$ 368,896
$ 4.07
Darden
$ 5,550,000
$ 950,381
$5.84
$5.80
Once we put together all of the number for the competitors, we can find an
industry average P/EBITDA of $5.80. This does not include P.F. Chang’s, as this is the
248 | P a g e
company we are evaluating. It also does not include Chipotle or O’Charley’ as these two
would be considered outliers in this ratio. We then multiplied P.F. Chang’s as stated and
restated EBITDA by the industry average then divided this number by the total number
of shares outstanding. The as stated adjusted PPS is $39.42, and the restated adjusted
PPS is $46.00. P.F. Chang’s, with respect to EV/EBITDA, is overvalued in the as stated
ratio as it is a change from the observed share price, and fairly valued with the
restated. This number can be a false hope though as it attempts to value a firm without
taking interest and taxes into account.
Enterprise Value to EBITDA
Just as the ratio before we are using EBITDA to calculate our valuation
techniques. This time though we are using enterprise value of the companies instead of
market cap. Again, this ratio can be flawed, as EBITDA does not take into account
interest and taxes. Enterprise value takes into account more aspect of the financials
than the market cap. Enterprise value is comprised of market cap plus book value of
liabilities minus cash and short-term investments. To compute the actual ratio, the
enterprise value is divided by EBITDA. P.F. Chang’s enterprise value was compiled of
numbers found on the last stated 10-k. All of P.F. Chang’s competitor’s enterprise
values and EBITDA’s were found on Yahoo! Finance. The graph of P.F. Chang’s and its
competitors EV/EBITDA ratio is shown below.
249 | P a g e
Enterprise Value/EBITDA
Market Cap
EBITDA
P/EBITDA
Industry
Average
Adjusted
PPS
P.F. Chang's
$ 1,145,337
$ 139,163
$ 40.68
P.F. Chang's Restated
$ 1,145,337
$ 183,321
$ 53.59
Chipotle
$ 4,510,000
$ 292,477
$ 15.42
Cheesecake Factory
$ 1,530,000
$188,369
$ 8.12
O'Charleys
$ 321,740
$ 57,078
$ 5.64
Brinker
$ 1,990,000
$ 368,896
$ 5.39
Darden
$ 7,470,000
$ 950,381
$ 7.86
$ 6.75
Once all ratios are calculated we found an industry average EV/EBITDA of $6.75.
Again, this average is not including P.F. Chang’s. It is also not including Chipotle, which
could be considered an outlier for this ratio. To get adjusted as stated and restated PPS
for P.F. Chang’s we took the EBITDA and multiplied it by the industry average then
divided that number by shares outstanding. This gave us an as stated adjusted PPS of
$40.68, and an adjusted restated PPS of $53.39. P.F. Chang’s, with respect to
EV/EBITDA, is fairly valued in the as stated ratio and undervalued with the restated, as
it is a change from the observed share price. As stated earlier, this ratio can be
unreliable in the aspect of EBITDA, due to interest and taxes not being included.
250 | P a g e
Price to Free Cash Flow
Price/Free Cash Flow = (PPS * (#of shares outstanding)) / (CFFO + CFFI)
The price to free cash flow ratio (P/FCF) measures the market price of a firm in
comparison to its free cash flows. We can determine this ratio by dividing the firm’s
market capital by its free cash flows (FCF). The difference between P.F. Chang’s
operating and investing cash flows have been calculated to use as the firm’s free cash
flows. The equation above illustrates the calculation of price per free cash flow. This
value can be located on the P.F. Chang’s restated and as stated statement of cash
flows. Unlike the balance sheet and income statement, the statement of cash flows is
one of the most difficult financial statements to forecast; therefore we must exclude
any outliers. The following table illustrates the Price to Free Cash Flows ratios for P.F.
Chang’s and its competitors in the restaurant industry.
P/FCF
PPS
P.F. Chang's
$
Chipotle
43.48
FCF
P/FCF
$
0.98
$
144.80
$
4.10
$
35.32
Cheesecake Factory
$
23.46
$
(0.11)
$
(213.27)
O'Charleys
$
6.28
$
0.72
$
8.72
Brinker
$
14.64
$
0.38
$
38.53
Darden
$
39.56
$
0.11
$
359.64
Industry
Average
Adjusted
PPS
$ 36.18
$ 36.92
251 | P a g e
According to the chart above, P.F. Chang’s price to future cash flow ratio is
slightly under the industry average. We aren’t too concerned with it being under the
average because there are only two firms computed in the industry average. The other
firms, Cheesecake Factory, Darden, and O’Charley’s are all outliers. They are considered
outliers because their price to free cash flow ratios differ greatly from the other firms in
the industry and would skew the industry average. Since P.F. Chang’s is below our 10
percent margin of safety, we conclude that P.F. Chang’s stock price is overvalued.
Conclusion
Financial Based Valuations
As Stated
Restated
Trailing P/E
Undervalued
N/A
Forward P/E
Undervalued
Undervalued
N/A
N/A
Fairly Valued
Fairly Valued
Overvalued
Overvalued
Price to EBITDA
Fairly Valued
Undervalued
EV/EBITDA
Undervalued
Undervalued
Price to FCF
Overvalued
N/A
Dividends to Price
Price to Book
P.E.G Ratio
Intrinsic Valuation Models
In comparison to the method of comparables, the intrinsic valuation models are
more accurate in depicting the value of a firm. When we calculated the ratio’s in the
method of comparables, we were able to determine the price for P.F. Chang’s stock. As
mentioned earlier, the method of comparables is a simple way of determining a firm’s
stock value. Although this method is one of the simplest, it is not considered a top
252 | P a g e
choice due to the outliers in the average which can result in a misrepresentation in
price. The intrinsic valuation model is a method that is chosen by many who are
seeking to value a firm. First of all, this method is more reliable due to the fact
assumptions are established from theory while in the method of comparables they are
based on historical data, which allows us to have a more accurate valuation. Secondly,
the intrinsic valuation model accounts for ten years worth of financial information while
the method of comparables only utilizes a single a year of a firm’s performance. Being a
able to base are valuation on a ten years basis will allow us increase accuracy in the
valuation by decreasing volatility which can arise by using a lesser amount of years.
Another important factor would be that the intrinsic valuation model takes into account
the time value of money by using present values in order to obtain a more accurate
valuation.
The intrinsic models that will be utilized in P.F. Chang’s valuation include the
Dividend Discount Model (DDM), Free Cash Flow Model (FCFM), Residual Income Model
(RIM), Abnormal Earnings Growth Model (AEGM), and the Long-Run Residual Income
Model (LRIM). Out of the five models mentioned above, the Residual Income and AEG
model have the highest explanatory power that reports a high adjusted R2. By utilizing
the intrinsic valuation model we will be able to obtain a fair and transparent picture of
P.F. Chang’s.
After we have determined the calculations for the cost of equity and estimated
growth rate for the intrinsic model, we will then perform a sensitivity analysis to display
how our estimated PPS will be affected if there are changes in our growth rates, cost of
equity, net earnings, or weighted average cost of capital before taxes. Sensitivity
analysis is highly important section of the valuation method due the fact that we will be
able to account for forecast errors and also comprehend the effects of the changing
growth rates by completing this analysis.
We will classify the outcomes from our intrinsic valuation as undervalued, fairly
valued, or overvalued; therefore a benchmark must be set for each of the scenarios. In
253 | P a g e
order to construct the benchmark, we will hold our position as a 10% analyst. In
accordance with are observed stock price on June 1st, 2010, $43.48, if P.F. Chang’s
computed stock price lies between $39.13 and $47.83 it will indicate that the firm is
fairly valued. For any results that fall below $39.13, the stock will be overvalued, and
for any price over $47.83 will be undervalued. Overall we will utilize the intrinsic
valuation model as reliable and accurate method to construct a final basis to determine
P.F. Chang’s value.
Discounted Dividends Model
The discounted dividends model is used to determine the value of one share of
stock. This method does not portray an accurate representation of the value of the
company’s stock. One major flaw is responsible for skewing the data derived from the
model. The flaw is that the model only recognizes the affects of dividend streams and
disregards the affects of capital gains. When we ran this model, the major portion of
P.F. Chang’s value was not accounted for, therefore understating the true value of the
stock.
The discounted dividends model uses both the present value of the next ten
years of expected dividends per share and the perpetuity in year ten. P.F. Chang’s hold
their dividends constant to net income. They have stated that 45 percent of net income
every year will be paid out as dividends. This is very unusual for the restaurant
industry, yet we have no other information to base the dividends off of other than the
company’s statements. The most common way that P.F. Chang’s competitors have gone
about dividends, is to hold dividends constant. This model typically only produces 5
percent explanatory power with good information present. P.F. Chang’s lacks the years
of dividends payout information needed, since they just announced their first dividend
payout during the physical year of 2010.
254 | P a g e
Growth Rate
Cost of
Equity
4%
6%
8%
10%
12%
14%
16%
7.17%
$40.12
$95.48
N/A
N/A
N/A
N/A
N/A
8.93%
$25.28
$37.64
$103.16
N/A
N/A
N/A
N/A
10.93%
$17.64
$22.10
$ 32.67
$88.72
N/A
N/A
N/A
12.93%
$13.45
$15.57
$ 19.40
$28.47
$76.54
N/A
N/A
14.93%
$10.83
$11.98
$ 13.80
$17.10
$24.90
$66.25
N/A
16.93%
$ 9.04
$ 9.73
$ 10.72
$12.29
$15.14
$21.86
$57.52
17.10%
$ 8.91
$ 9.57
$ 10.52
$12.01
$14.66
$20.73
$48.87
Overvalued
$39.13 < Fairly
Undervalued
< 39.13
Valued < $47.83
> $47.83
10% Analyst
In order to approximate the different prices for P.F. Chang’s stock we created
the discount dividends model using the cost of equity and a steady growth rate for
future dividends. This allowed us to determine the sensitivity of P.F. Chang’s stock
price in regards to changes in the cost of equity and dividend growth rate. Using a
10% analysts range, P.F. Chang’s stock is valued using plus or minus 10% of their
current stock price. Any price between $39.13 and $47.83 considers the firm to be
fairly valued while any price outside that range determines the stock price to be
overvalued or undervalued. Using a 95% confidence interval, the upper and lower
bound cost of equity (17.1%, 7.17%) are applied to the model. Since P.F. Chang’s just
recently paid out their first dividend last quarter, and assumes dividends will be equal to
45% of net income in the future, we predicted a fairly high growth rate for the model.
When assessing the discount dividends model results, P.F. Chang’s is considered
to be overvalued in most circumstances. Since P.F. Chang’s just paid their first
255 | P a g e
dividends, we cannot run the model on a restated basis. When applying the firms true
adjusted cost of capital at a four to ten percent growth rate, P.F. Chang’s is overvalued.
Since this model, on average, explains about 5% of the firm’s approximated stock price,
the discounted dividends model cannot be expected to present reasonable results.
When we use a high cost of equity and a high growth rate, the firm then becomes fairly
valued or undervalued. For instance, using our upper bound cost of equity, 17.1%, and
a growth rate of 16%, P.F. Chang’s is considered undervalued. This model is
determined to be unsuccessful when valuing P.F. Chang’s stock price due to the models
low explanatory power and the steady dividends the model accounts for.
Discounted Free Cash Flows Model
The second intrinsic valuation model we used in valuing P.F. Chang’s is the
discounted free cash flows model. This model uses both cash flow from operations
(CFFO) and cash flow from investing (CFFI) activities. This model begins by the
assumption that a firm’s free cash flow will be equal to CFFO minus CFFI. This idea
comes from the most basic of accounting ideas: assets equal liabilities plus owner’s
equity. After calculating P.F. Chang’s free cash flows from assets, we then needed to
find the present value of the year-by-year cash flows and the year-by-year present
values of the perpetuity at year eleven, just as was done in the discounted dividends
model. This valuation technique means that that an accurate discount rate is important
in order to bring the present values of the free cash flows and the perpetuity back to
year zero. Being cautious of double taxation, we used our weighted average cost of
capital before taxes (WACCBT) as our discount rate. We choose the WACCBT to stay
away from double taxation due to the CFFO and CFFI both being forecasted with after
tax dollars.
256 | P a g e
The next step is to add together the present values from year one to ten, and
calculate the value of the perpetuity in year eleven by discounting it back to year zero
with our WACCBT and perpetuity growth rate. These two numbers are then summed
together to give our market value of assets (MVA) at the end of 2009. We then plugged
in our book value of liabilities (BVL) and subtracted this from the market value of assets
to give us our market value of equity (MVE).
Once, we have our market value of equity, this number was then divided by the
number of shares P.F. Chang’s had outstanding at December 31 2009to give us our
price per share(PPS) at this time. In the same way as the discounted dividends model,
we then had to get a time consistent price by compounding the PPS for five months to
give us our June 1, 2010 number. We then used this number to compare against our
observed price of $43.48 on June 1, 2010. The way that we compared these numbers is
through a sensitivity analysis using different growth rates for the perpetuity and
different rates for our WACCBT. We chose a range of 2% through 8% for our perpetuity
growth rate and 8.3% through 14.3% for our WACCBT. The sensitivity analysis for P.F.
Chang’s discounted free cash flows model is shown below.
257 | P a g e
Growth Rate
2%
Weighted
Average
Cost of
Capital
3%
4%
5%
8.3%
$
46.02
$
52.44
$
61.85
$
76.97
9.3%
$
41.51
$
46.19
$
52.64
10.3%
$
38.10
$
41.67
11.3%
$
35.44
12.3%
6%
7%
8%
$
105.23
$
176.97
$
726.98
$
62.09
$
77.27
$
105.64
$
177.65
$
46.37
$
52.84
$
62.33
$
77.56
$
106.04
$
38.25
$
41.83
$
46.54
$
53.04
$
62.56
$
77.85
$
33.29
$
35.57
$
38.89
$
41.98
$
46.72
$
53.24
$
62.80
13.3%
$
31.54
$
33.42
$
35.70
$
38.53
$
42.14
$
46.89
$
53.44
14.3%
$
30.08
$
31.66
$
33.54
$
35.83
$
38.67
$
42.29
$
47.06
Overvalued
$39.13 < Fairly
Undervalued
< 39.13
Valued < $47.83
> $47.83
10% Analyst
Based upon the results above, more than half of the valuation model considers
P.F. Chang’s to be fairly valued or undervalued. Analysts like to use the free cash flow
model when a company does not pay dividends or if the dividends paid differ
significantly from the firm’s capacity to pay dividends. Since P.F. Chang’s has only paid
out one dividend, this model would be a good measurement for the firm’s approximate
stock value. When using our lower bound weighted average cost of capital and a high
growth rate, P.F. Chang’s is consistently undervalued. Unfortunately, when we used a
high weighted average cost of capital and a low growth rate, the firm is considered
overvalued. This model does present shortcomings in which small changes within the
258 | P a g e
model create larger changes in the valuation of the firm. This model is perceived to be
very price sensitive. We used the same 10% analysts position, and determined that
P.F. Chang’s, according to the free cash flow model, is a fairly or undervalued firm.
Since P.F. Chang’s does not invest within their company, a restated free cash flow
model will not be necessary to construct.
Residual Income Model
The residual income model has the highest degree of explanatory power out of
all of the intrinsic valuations. The model has been known to reach up to 90 percent
explanatory power. This high explanatory power makes the residual income model very
important to our evaluations. It can sometimes have a 70 percent higher explanatory
power than the other models we used. The reason for this high explanatory power is
that it is less responsive to changes in the growth rate and most of the valuation weight
is in the firm’s current financial picture. This means that the valuation inputs include net
income, dividends, and book value of equity, which are all on the financial statements.
This in turn means that the stock estimation calculated is based on a larger base of
current accurate values than forecasted values. Being able to use current and accurate
values decreases our chances of having errors in our forecasting.
The residual income model is the only valuation model that takes into
consideration the current net worth of the firm that is being valued, which is based on
the firm’s current book value of equity, plus the present value of the value added by the
firm. The value that has been created or destroyed can be determined by taking the
difference between our current year’s net income and the benchmark net income,
which is comprised of the previous year’s book value of equity, multiplied by our cost of
equity. This is also known’s as the firm’s residual income. If the firm’s current net
income is greater than the benchmark, we can then conclude that the firm has created
value and has generated a positive residual income. Vice versa, if the firm’s current net
income is less than the benchmark, we can conclude that value is being destroy within
259 | P a g e
the firm and that the firm not meeting its target benchmark, furthermore its residual
income will be negative.
In order to calculate P.F. Chang’s residual income, we utilized our forecasted net
income and created a benchmark for each year previous year’s book value of equity
and multiplying it our 7.17% cost of equity, which is also known as normal income. We
then computed the difference between the firm’s current net income and its normal
income, which gave us our residual income. After computing the residual income for 10
years, we than had to calculate the present value of the year-by-year residual income
and multiply that amount by its present value factor. We found the total present value
of P.F. Chang’s residual income by adding the sum of their present value of the annual
residual income to the present value of the terminal value perpetuity. We then add the
book value of equity, the total present value of year-by-year residual income, and the
terminal value of the perpetuity to get the market value of equity at the end of 2009.
We then divide that value by number of shares outstanding to get a model price at the
end of 2009. This is not the time consistent price though, which takes into account the
five months that have elapsed in 2010. To get this value, take the model price and
multiply it by one plus cost of equity raised to the number of months gone by divided
by twelve. This will give a time consistent price to compare with the observed price at
that time.
The final procedure in the residual income model is to perform a sensitivity
analysis. In the residual income model, growth rates must be negative due to the idea
that growth rates will converge to the equilibrium, cost of equity, in the long run. The
sensitivity analysis takes into account seven different cost of equities, and five different
negative growth rates and evaluates what prices the different combinations produce.
Since we are using a 10% analysis, any price that is 10% above or below the observed
price will be undervalued and overvalued, respectively.
260 | P a g e
As Stated Residual Income Sensitivity Analysis
Growth Rate
-10%
Ke
-20%
-30%
-40%
-50%
7.17%
$
50.90
$
46.71
$
43.48
$
43.65
$
42.93
8.93%
$
35.32
$
33.26
$
32.26
$
31.67
$
31.27
10.93%
$
25.02
$
24.08
$
23.60
$
23.31
$
23.11
12.93%
$
18.73
$
18.31
$
18.09
$
17.95
$
17.86
14.93%
$
14.62
$
14.46
$
14.37
$
14.31
$
14.27
16.93%
$
11.81
$
11.77
$
11.74
$
11.73
$
11.72
17.10%
$
11.61
$
11.58
$
11.56
$
11.54
$
11.53
Overvalued
< 39.13
$39.13 < Fairly
Undervalued
Valued < $47.83
> $47.83
10% Analyst
With respect to the residual income model, every growth rate and cost of equity
percentage that we chose to use in our sensitivity analysis caused P.F. Chang’s to be
considered overvalued. This can be attributed in part to the small amount of residual
income that is being created by P.F. Chang’s. In turn, this leads to smaller present
values for the year-by-year values of residual income. Having a reasonable cost of
equity, this would prove to lower the time consistent price in relation to the residual
income model. The only way for the residual income sensitivity analysis to be fairly
valued would be an unthinkably low cost of equity, which is very improbable.
261 | P a g e
Due to the affect of capitalizing operating leases on net income and book value
of equity, we ran a sensitivity analysis on a restated basis. These changes in net income
and book value of equity could significantly affect the time consistent prices for any
firm, which is why it is important to run an analysis on a restated basis. Again in this
sensitivity analysis, the growth rates will be negative just as before.
Restated Residual Income Sensitivity Analysis
Growth Rate
-10%
Ke
-20%
-30%
-40%
-50%
7.17%
$
36.25
$
33.57
$
32.33
$
31.62
$
31.15
8.93%
$
29.33
$
27.92
$
27.23
$
26.82
$
26.55
10.93%
$
23.48
$
22.90
$
22.60
$
22.42
$
22.30
12.93%
$
19.11
$
19.00
$
18.94
$
18.90
$
18.87
14.93%
$
15.80
$
15.93
$
16.01
$
16.06
$
16.09
16.93%
$
13.24
$
13.50
$
13.65
$
13.75
$
13.82
17.10%
$
12.94
$
13.21
$
13.37
$
13.47
$
13.55
Overvalued
< 39.13
$39.13 < Fairly
Undervalued
Valued < $47.83
> $47.83
10% Analyst
Similar to the as stated sensitivity analysis, every combination of possible cost of
equities and growth rates had the value of the firm is overvalued, although the prices
had greater deviation from each other in comparison with the as stated. With the
lowest cost of equity and the lowest growth rate it is fairly close to being fairly valued
but to go any lower with either input would be unreasonable.
262 | P a g e
Overall, the time consistent prices for both the as stated and restated are
overvalued in every possible combination. With the explanatory power that the residual
income possesses, being overvalued in every way could greatly affect our analyst
recommendation.
Long Run Residual Income Model
The long run residual income model differs from the previous residual income
model in that it calculates market value of equity in a slightly different manner. The
market value of equity has added factors to the original book value of equity such as
ROE. This model is a little less accurate since it accounts for different variables than
the residual income model. There are three factors that calculate the time consistent
price for the firm and they are; cost of equity, growth rate, and return on equity. The
model itself has a fairly high explanatory power ranging from on average 40% to 60%.
The growth rates used will be equivalent to the residual income model where all growth
rates are negative values. This model is the simplest of all models due to its simplicity
in calculations and measurements. The formula below will present the market value of
equity for the long run residual income model.
MVE = BVE [ 1 + ((ROE- Ke)/(Ke – g)) ]
The long run residual income model is the only intrinsic valuation model that
does not require a full valuation in terms of forecasting each item in the model. This
would describe its simplicity and ease when trying to value a company in a short period
of time. The three factors that the model takes into account for are easily accessible
since they have been calculated in recent models and formulas. On the other hand,
263 | P a g e
since we are factoring in return on equity to the market value of equity equation, we
must use the forecasted as stated and restated balance sheet and income statement.
This makes the valuation model a little less accurate do to the inaccuracy of forecasted
financials. To start off the equation, book value of equity remains constant focusing on
the present value of equity for the firm. The return on equity, in order to be accurate,
needs to be calculated correctly using a lag ratio. This is produced by taking the
current net income or NI t=1 and dividing it by the previous year’s amount of owners
equity.
The cost of equity has been calculated multiple times through regression analysis
and forming the capital assets pricing model. As like the other models, the cost of
equity will contain an upper bound and lower bound value which will be used in the
sensitivity analysis. Also as listed above, the growth rates will remain at negative
percentages starting with a -10% growth rate and ending with a -50% growth rate. All
of these factors must be calculated and presented correctly in order to accurately
construct a sensitivity analysis.
Differing from the other valuation models, the long run residual income model
factors in three variables which mean three separate sensitivity analysis will be needed.
This requires that one factor will be held constant throughout the sensitivity analysis
while the other two will vary accordingly. The three variables consist of; cost of equity
12.93%, return on equity 15% as stated and 12.5% restated, and a growth rate of
-10%. The three sensitivity analysis performed will include the cost of equity and
growth rate with return on equity being held constant, cost of equity and return on
equity with the growth rate being held constant, and the last will include return on
equity and growth rates with the cost of equity being the variable held constant. Once
all three of the variables have been measured and factored into the equation, the
market value of equity will be divided by the total number of shares outstanding to
arrive at the price per share for P.F. Chang’s.
264 | P a g e
As Stated Long Run Residual Income Model
Growth Rate
Ke
7.17%
8.93%
10.93%
12.93%
14.93%
16.93%
17.10%
-10%
$
42.43
$
35.27
$
29.87
$
26.09
$
23.29
$
21.14
$
21.06
Overvalued
< 39.13
-20%
-30%
$ 44.36 $ 46.30
$ 37.26 $ 39.24
$ 31.90 $ 33.92
$ 28.16 $ 30.23
$ 25.40 $ 27.51
$ 23.28 $ 25.43
$ 23.21 $ 25.35
$39.13 < Fairly
Valued < $47.83
-40%
-50%
$ 48.24 $ 50.17
$ 41.22 $ 43.20
$ 35.95 $ 37.98
$ 32.30 $ 34.37
$ 29.62 $ 31.73
$ 27.57 $ 29.72
$ 27.50 $ 29.64
Undervalued
> $47.83
10% Analyst
Return on Equity Held Constant
Return on Equity
Ke
7.17%
8.93%
10.93%
12.93%
14.93%
16.93%
17.10%
11%
$
32.00
$
26.40
$
22.44
$
19.68
$
17.64
$
16.07
$
16.02
Overvalued
< 39.13
13%
15%
$ 37.47 $ 42.94
$ 30.83 $ 35.27
$ 26.16 $ 29.87
$ 22.89 $ 26.09
$ 20.47 $ 23.29
$ 18.61 $ 21.14
$ 18.54 $ 21.06
$39.13 < Fairly
Valued < $47.83
17%
19%
$ 48.41 $ 53.87
$ 39.71 $ 44.15
$ 33.58 $ 37.29
$ 29.29 $ 32.49
$ 26.12 $ 28.94
$ 23.67 $ 26.21
$ 23.59 $ 26.11
Undervalued
> $47.83
10% Analyst
Growth Held Constant
Growth Rate
Return on Equity
9%
11%
13%
15%
17%
19%
21%
-10%
$
16.48
$
19.68
$
22.89
$
26.09
$
29.29
$
32.49
$
35.70
Overvalued
< 39.13
-20%
-30%
$ 18.55 $ 20.62
$ 21.75 $ 23.82
$ 24.96 $ 27.03
$ 28.16 $ 30.23
$ 31.36 $ 33.43
$ 34.56 $ 36.63
$ 37.77 $ 39.84
$39.13 < Fairly
Valued < $47.83
-40%
-50%
$ 22.69 $ 24.76
$ 25.90 $ 27.97
$ 29.10 $ 31.17
$ 32.30 $ 34.37
$ 35.50 $ 37.57
$ 38.71 $ 40.78
$ 41.91 $ 43.98
Undervalued
> $47.83
10% Analyst
Ke Held Constant
265 | P a g e
Based on the above sensitivity analysis, the long run residual income model
shows P.F. Chang’s to be overvalued in most circumstances with a few prices being
fairly or undervalued. Since this model requires three sensitivity analyses, each one
with a variable being held constant, there are different conclusions drawn from each
one. The first sensitivity analysis includes cost of equity and growth rates with the
return on equity being held constant at 15%. When cost of equity is greater than 8%,
regardless of the growth rate, P.F. Chang’s time consistent price is always negative.
The second sensitivity analysis involves the cost of equity and return on equity with the
growth rate being held constant at -10%. This chart is very similar to the first analysis,
but when the cost of equity is at 7.17% and the return on equity is 17% and 19%, P.F.
Chang’s stock price is undervalued. The third sensitivity analysis measures the return
on equity and growth rates with the cost of equity being held constant at 12.93%. This
analysis is consistent with the others in that most of the values calculated are
overvalued.
266 | P a g e
Restated Long Run Residual Income Model
Growth Rate
Ke
7.17%
8.93%
10.93%
12.93%
14.93%
16.93%
17.10%
-10%
$
35.68
$
29.72
$
25.23
$
22.09
$
19.76
$
17.97
$
17.84
Overvalued
< 39.13
-20%
-30%
$ 37.62 $ 39.55
$ 31.71 $ 33.69
$ 27.26 $ 29.29
$ 24.16 $ 26.23
$ 21.87 $ 23.98
$ 20.12 $ 22.26
$ 19.99 $ 22.13
$39.13 < Fairly
Valued < $47.83
-40%
-50%
$ 41.49 $ 43.42
$ 35.67 $ 37.65
$ 31.31 $ 33.34
$ 28.30 $ 30.37
$ 26.09 $ 28.20
$ 24.41 $ 26.55
$ 24.28 $ 26.43
Undervalued
> $47.83
10% Analyst
Return on Equity Held Constant
Return on Equity
Ke
7.17%
8.93%
10.93%
12.93%
14.93%
16.93%
17.10%
8.5%
$
24.88
$
20.85
$
17.80
$
15.68
$
14.11
$
12.91
$
12.82
Overvalued
< 39.13
10.5% 12.5%
$ 30.28 $ 35.68
$ 25.29 $ 29.72
$ 21.52 $ 25.23
$ 18.88 $ 22.09
$ 16.94 $ 19.76
$ 15.44 $ 17.97
$ 15.33 $ 17.84
$39.13 < Fairly
Valued < $47.83
14.5% 16.5%
$ 41.08 $ 46.48
$ 34.16 $ 38.60
$ 28.94 $ 32.65
$ 25.29 $ 28.49
$ 22.59 $ 25.41
$ 20.51 $ 23.04
$ 20.35 $ 22.86
Undervalued
> $47.83
10% Analyst
Growth Held Constant
Growth Rate
Return on
Equity
6.5%
8.5%
10.5%
12.5%
14.5%
16.5%
18.5%
-10%
$
12.48
$
15.68
$
18.88
$
22.09
$
25.29
$
28.49
$
31.69
Overvalued
< 39.13
-20%
-30%
$ 14.55 $ 16.62
$ 17.75 $ 19.82
$ 20.95 $ 23.02
$ 24.16 $ 26.23
$ 27.36 $ 29.43
$ 30.56 $ 32.63
$ 33.76 $ 35.83
$39.13 < Fairly
Valued < $47.83
-40%
-50%
$ 18.69 $ 20.76
$ 21.89 $ 23.96
$ 25.09 $ 27.17
$ 28.30 $ 30.37
$ 31.50 $ 33.57
$ 34.70 $ 36.77
$ 37.90 $ 39.98
Undervalued
> $47.83
10% Analyst
Ke Held Constant
267 | P a g e
After restating the long run residual income model, there are very few if any
changes at all in the sensitivity analysis. The conclusions that are drawn up from the
above results indicate in most all positions that P.F. Chang’s stock price is overvalued.
There are a couple circumstances where the price is undervalued or fairly valued, but
mostly with a high cost of equity or return on equity and a very low growth rate like 50%. For the Long Run Residual Income model, P.F. Chang’s stock price is overvalued
in the as stated form and the restated form of the sensitivity analysis.
Abnormal Earnings Growth Model
Very similar to the residual income model, the abnormal earnings growth model
(AEG) takes into account forecasted net income and dividends paid when valuing a
company. These two have that in common, but there are differences between them.
The way that the AEG model values the price of a company is by looking at a core net
income, the first year’s forecasted net income, and adding a forward earnings
perpetuity, which is brought back to the present value. This perpetuity is then
discounted back using the cost of equity we have derived for the firm. Using this
forecasted net income as a large component of the model suggests that we are taking a
large assumption of our own, which is why we make adjustments to relatively find the
correct price for the company. Similar to the other valuation models, the key
adjustment used in the AEG model is by changing the growth of the firm to take into
account possible increases or decreases in the rate of growth.
To begin the AEG valuation one must first calculate a dividend drip (DRIP) for
each forecasted year being forecasted. This is done by taking the dividends of the
previous year and multiplying by the cost of equity being used. This is essentially saying
that if the shareholders of the company reinvested dividends paid out what the impact
would be on the following year’s income. Once we have our Drip forecasted we then
add the forecasted net income to the number to get our cumulative dividend earnings
numbers. It is important to remember that the year that would normally be thought of
as year one is now being used as year zero, which is the core year for the AEG model.
268 | P a g e
This is taking into account the timing of dividend payments as previous years dividends
are being used in calculations.
The nest step in the process of AEG is to get a normal, or benchmark, earnings
forecasted for ten years. Normal earnings are saying that a company’s net income
should intuitively grow by its cost of equity being used. Anything above or below this
number shows how a company is performing year by year. A growth above normal
earnings would show value added to the firm and inversely a below normal earnings
growth would show destruction of value. Therefore, to get one’s normal earnings,
simply take the net income from the previous year and multiply by cost of equity. Once
cumulative dividend earnings and normal earnings have been forecasted, the difference
between the two will give the abnormal earnings growth year by year. As the residual
income is closely related to the AEG model, the year-by-year change in residual income
should ultimately equal the year-by-year abnormal earnings growth for a company, if
calculations have been done correctly.
Just as in the discounted dividends and residual income models, we then
discounted back our AEG to year zero and got the sum of these to arrive at our total
present value for AEG. After that, we then took the value of our perpetuity in time
eleven and divided it by cost of equity minus the perpetuity growth rate; this number is
then discounted back to year zero using year ten’s present value factor. This gives the
present value of the terminal value of the perpetuity at year zero.
Since we now have all forecasted numbers back to year zero we can get the total
average net income perpetuity at t+1. This is done by adding the core year’s net
income, total present value of AEG, and the present value of the terminal value of the
perpetuity. Once added together, divide by the number of shares outstanding to get a
company’s average earnings per share perpetuity or seed value to the perpetuity. The
seed value is then divided by cost of equity to arrive at an intrinsic price per share. Just
as in the other valuation models, time must be factored in to the price per share and a
269 | P a g e
time consistent price must be calculated by compounding to reflect the price at a given
date.
Once a time consistent price is calculated by using the AEG model, then a
sensitivity analysis should be run. We chose to use a 10% analyzation when doing the
analysis comparing different cost of equity and growth rate percentages. Just as in the
residual income model, the growth rates are negative as we are trying to find what it
takes to reach equilibrium, where growth is equal to cost of equity.
As stated Abnormal Earnings Growth Sensitivity Analysis
Growth Rate
-10%
Ke
-20%
-30%
-40%
-50%
7.17%
$
50.90
$
46.71
$
43.48
$
43.65
$
42.93
8.93%
$
35.32
$
33.26
$
32.26
$
31.67
$
31.27
10.93%
$
25.02
$
24.08
$
23.60
$
23.31
$
23.11
12.93%
$
18.73
$
18.31
$
18.09
$
17.95
$
17.86
14.93%
$
14.62
$
14.46
$
14.37
$
14.31
$
14.27
16.93%
$
11.81
$
11.77
$
11.74
$
11.73
$
11.72
17.10%
$
11.61
$
11.58
$
11.56
$
11.54
$
11.53
Overvalued
< 39.13
$39.13 < Fairly
Undervalued
Valued < $47.83
> $47.83
10% Analyst
270 | P a g e
For the most part, the as stated abnormal earnings growth model considers P.F.
Chang’s an overvalued firm. As was stated earlier, the AEG is closely related to the
residual income model, which could give us a little insight as to why it is so overvalued.
As the cost of equity and growth rate increases, the rate at which the price declines is
continuously getting smaller. This is showing that when using the negative growth
rates, the rates in the long run will end up equaling cost of equity. The only variance we
have with the valuation is when cost of equity is 7.17% the price for P.F. Chang’s is
fairly valued in relation to all growth rates except with a -10% growth rate. This can be
misleading though because having such a low cost of equity though would seem
unreasonable to many investors.
With the change in our forecasted net income and dividends we created a
restated version of the AEG model with the new forecasted financials. The change in
net income and dividends is directly tied to the capitalization of operating leases and
can significantly change the output of the model. Due to these changes, the DRIP,
cumulative dividends earnings, and normal earnings all will be changed. The net income
and dividends are the two main drivers of the model and if these change it will alter the
look for the entire AEG.
271 | P a g e
Restated Abnormal Earnings Growth Sensitivity Analysis
Growth Rate
-10%
7.17%
8.93%
Ke
$
$
41.52
28.77
-20%
$
$
38.03
27.06
-30%
$
$
36.42
26.22
-40%
$
$
-50%
35.49
$
34.88
25.73
$
25.40
10.93%
$
20.35
$
19.57
$
19.17
$
18.93
$
18.76
12.93%
$
15.21
$
14.87
$
14.68
$
14.57
$
14.49
14.93%
$
11.87
$
11.73
$
11.66
$
11.61
$
11.58
9.51
$
9.50
9.36
$
9.35
16.93%
17.10%
$
$
9.58
9.42
Overvalued
< 39.13
$
$
9.54
9.39
$
$
9.52
9.37
$
$
$39.13 < Fairly
Undervalued
Valued < $47.83
> $47.83
10% Analyst
When looking at the restated AEG sensitivity analysis and the restated residual
income sensitivity analysis, they are much more similar in comparison to the as stated
for both. This can mostly be attributed to the change in leverage of a firm when
financials are restated. This again comes from the capitalization of operating leases.
The prices were ultimately lower in the restated analysis, and every mix between cost
of equity and growth rate had the firm overvalued except for a cost of equity of 7.17%
272 | P a g e
and growth rate of -10% being fairly valued. This is opposed to the as stated having
the cost of equity line at 7.17% being fairly valued except a -10% growth rate being
undervalued. This again is very unlikely to happen as a cost of equity of 7.17% is
extremely low. Overall, both the residual income and AEG models, in almost every
circumstance, had P.F. Chang’s as an overvalued firm. The explanatory power that both
of these models have, with both agreeing on the value of P.F. Chang’s, will play a large
role in our analyst recommendations.
273 | P a g e
274 | P a g e
Appendix
Trial Balances (On Next Page)
275 | P a g e
2005 As Stated
Trial Balance: 2005‐2009
Debit
Credit
2005 Adjustments
Debit
Credit
2005 Restated Ending Balance
Debit
Credit
2005 Carryover
Debit
Current assets:
Cash and cash equivalents
31,948
31,948
Short‐term investments
34,150
34,150
Restricted short‐term investments
8,260
8,260
Inventories
3,461
3,461
Prepaid and other current assets
15,957
15,957
Total current assets
Capitalized Leased Assets Rights
164,014
164,014
Property and equipment, net
345,864
Deferred income tax assets
1,938
345,864
1,938
Goodwill
6,819
6,819
Other assets
18,265
18,265
Total assets
LIABILITIES AND COMMON STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
13,850
Construction payable
6,463
13,850
6,463
Accrued expenses
40,864
40,864
Unearned revenue
15,281
15,281
Current portion of long‐term debt
5,110
5,110
Total current liabilities
Long‐term debt
5,360
5,360
Capitalized Leases Liabilities
164,014
164,014
Lease obligation
55,991
55,991
Minority interests
29,845
29,845
Common stockholders’ equity:
Common stock
26
26
Additional paid‐in capital
165,355
165,355
Retained earnings
128,517
128,517
Total common stockholders’ equity
Total liabilities and common stockholders’ equity
Balance Sheet Check Figure
466,662
Revenues
466,662
630,676
809,153
630,676
809,153
Costs and expenses:
Restaurant operating costs:
Cost of sales
224,634
224,634
Labor
267,681
267,681
Operating
122,742
122,742
Occupancy
42,793
42,793
39,181
39,181
36,950
Total restaurant operating costs
General and administrative
Capitalized Operating Lease Expense
Depreciation and amortization
36,950
Preopening expense
9,248
9,248
Partner investment expense
4,800
4,800
Income from operations
Interest and other income (expense)
Interest Expense from Capitalized Leases
Interest expense
10
Interest and other income
10
1,851
1,851
Income before minority interest
Minority interest
8,227
8,227
16,942
16,942
Income before provision for income taxes
Provision for income taxes
Net income
Income Statement Check Figure
1,239,870
Income Summary
37,796
Total Debit and Credit Trial Balance Check
1,277,666
1,277,666
1,403,884
1,441,680
37,796
1,277,666
164,014
164,014
164,014
164,014
Change in Net Income
Retained Earnings Plug Effect
Final Trial Balance Check
1,441,680
1,441,680
276 | P a g e
Credit
2006 As Stated
Trial Balance: 2005‐2009
Debit
Credit
2006 Adjustments
Debit
Credit
2006 Restated Ending Balance
Debit
Credit
2006 Carryover
Debit
Current assets:
Cash and cash equivalents
31,589
31,589
Short‐term investments
‐
‐
Restricted short‐term investments
‐
‐
Inventories
4,232
4,232
Prepaid and other current assets
28,995
28,995
Total current assets
‐
Capitalized Leased Assets Rights
181,228 16,402 164,826
Property and equipment, net
421,770
Deferred income tax assets
‐
421,770
Goodwill
6,819
Intangible assets, net
12,644
6,819
12,644
Other assets
7,996
7,996
Total assets
LIABILITIES AND COMMON STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
15,255
Construction payable
9,075
15,255
9,075
Accrued expenses
55,848
55,848
Unearned revenue
18,226
18,226
Current portion of long‐term debt
5,487
5,487
Total current liabilities
‐
Long‐term debt
13,723
Capitalized Leases Liabilities
13,723
4,818 181,228
176,410
Lease obligation
71,682
71,682
Other Liabilities
1,909
1,909
Minority interests
33,315
33,315
27
27
Common stockholders’ equity:
‐
Common stock
Additional paid‐in capital
Treasury Stock
174,101
174,101
46,373
Retained earnings
46,373
161,770 11,584
150,186
Total common stockholders’ equity
Total liabilities and common stockholders’ equity
Balance Sheet Check Figure
560,418 560,418
725,244 725,244
937,606
937,606
Revenues
Costs and expenses:
Restaurant operating costs:
Cost of sales
256,582
256,582
Labor
310,113
310,113
Operating
146,409
146,409
Occupancy
52,457
52,457
Total restaurant operating costs
General and administrative
‐
56,911
56,911
Capitalized Operating Lease Expense
23,680
Depreciation of Capitalized Leases
16,402
23,680
16,402
Depreciation and amortization
44,863
Preopening expense
12,713
44,863
12,713
Partner investment expense
4,371
4,371
Income from operations
Interest and other income (expense)
Interest Expense from Capitalized Leases
18,862
18,862
Interest expense
Interest and other income
1,315
1,315
Income before minority interest
Minority interest
8,116
8,116
13,133
13,133
Income before provision for income taxes
Provision for income taxes
Net income
Income Statement Check Figure
905,668
Income Summary
33,253
Total Debit and Credit Trial Balance Check
1,499,339 1,499,339 232,894 221,310 1,687,845 1,687,845
Change in Net Income
938,921
940,932 962,601
21,669
11,584
Retained Earnings Plug Effect
Final Trial Balance Check
1,499,339 1,499,339 232,894 232,894
277 | P a g e
2007 As Stated
Trial Balance: 2005‐2009
Debit
2007 Adjustments
Credit
Debit
2007 Restated Ending Balance
Credit
Debit
2007 Carryover
Credit
Debit
Current assets:
Cash and cash equivalents
24055
24055
Short‐term investments
0
0
Restricted short‐term investments
0
0
Inventories
Prepaid and other current assets
4649
4649
32552
32552
Total current assets
0
Capitalized Leased Assets Rights
Property and equipment, net
Deferred income tax assets
208634
18872
520145
189762
520145
0
0
6819
6819
Intangibles, net
22004
22004
Other assets
12406
12406
Goodwill
Total assets
LIABILITIES AND COMMON STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
17745
17745
Construction payable
11319
11319
Accrued expenses
59259
59259
Unearned revenue
25346
25346
6932
6932
90828
90828
Current portion of long‐term debt
Total current liabilities
0
Long‐term debt
Capitalized Leases Liabilities
‐4167
208634
212801
Lease obligation
93435
Other Liabilities
6710
6710
17169
17169
27
27
Minority interests
93435
Common stockholders’ equity:
0
Common stock
Additional paid‐in capital
Treasury Stock
196385
196385
96358
Retained earnings
96358
193833
23039
170794
Total common stockholders’ equity
Total liabilities and common stockholders’ equity
Balance Sheet Check Figure
718988
Revenues
718988
908750
1092722
908750
1092722
Costs and expenses:
Restaurant operating costs:
Cost of sales
299713
299713
Labor
368059
368059
Operating
173993
173993
Occupancy
63111
63111
66968
66968
Total restaurant operating costs
General and administrative
0
Capitalized Operating Lease Expense
17913
Depreciation of Capitalized Leases
18872
Depreciation and amortization
56832
Preopening expense
14983
Partner investment expense
17913
18872
56832
14983
2012
2012
Income from operations
Interest and other income (expense)
Interest Expense from Capitalized Leases
Interest expense
22080
22080
100
100
4169
4169
11563
11563
3180
3180
Interest and other income
Income before minority interest
Minority interest
Income before provision for income taxes
Provision for income taxes
Loss from Discontinued Operations, Net of Tax
Net income
Income Statement Check Figure
Income Summary
Total Debit and Credit Trial Balance Check
1062671
1094734
1103623
32063
1813722
9024
1813722
268458
Change in Net Income
245419
23039
Retained Earnings Plug Effect
Final Trial Balance Check
268458
268458
2021397
1112647
278 | P a g e
2021397
Credit
2008 As Stated
Trial Balance: 2005‐2009
Debit
2008 Adjustments
Credit
Debit
2008 Restated Ending Balance
Credit
Debit
Credit
2008 Carryover
Debit
Current assets:
Cash and cash equivalents
40951
40951
Short‐term investments
0
0
Restricted short‐term investments
0
0
Inventories
Prepaid and other current assets
4930
4930
51643
51643
Total current assets
Capitalized Leased Assets Rights
Property and equipment, net
Deferred income tax assets
215154
20863
524004
194291
524004
0
0
6819
6819
Intangible Assets, net
24270
24270
Other assets
14746
14746
Goodwill
Total assets
LIABILITIES AND COMMON STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
15203
Construction payable
15203
4358
4358
Accrued expenses
71162
71162
Unearned revenue
31115
31115
5753
5753
82496
82496
Current portion of long‐term debt
Total current liabilities
0
Long‐term debt
Capitalized Leases Liabilities
13033
215154
202121
Lease obligation
113178
113178
Other Liabilities
14691
14691
8581
8581
27
27
Minority interests
Common stockholders’ equity:
0
Common stock
Additional paid‐in capital
Treasury Stock
Other Comprehensive Loss
206667
206667
106372
106372
755
Retained earnings
755
221259
7830
213429
Total common stockholders’ equity
Total liabilities and common stockholders’ equity
Balance Sheet Check Figure
774490
Revenues
774490
968781
1198124
968781
1198124
Costs and expenses:
Restaurant operating costs:
Cost of sales
325630
325630
Labor
396911
396911
Operating
198967
198967
Occupancy
69809
69809
77488
77488
Total restaurant operating costs
General and administrative
0
Capitalized Operating Lease Expense
42242
Depreciation of Capitalized Leases
Depreciation and amortization
Preopening expense
20863
68711
68711
8457
Partner investment expense
42242
20863
8457
354
354
Income from operations
Interest and other income (expense)
Interest Expense from Capitalized Leases
Interest expense
Interest and other income
29209
29209
0
0
3362
3362
1933
1933
12193
12193
0
Income before minority interest
Minority interest
Income before provision for income taxes
Provision for income taxes
0
Net income
Income Statement Check Figure
Income Summary
Total Debit and Credit Trial Balance Check
1163461
1198478
286089
278259
35017
1972968
1213533
1240720
27187
1972968
2209501
Change in Net Income
7830
2209501
279 | P a g e
Retained Earnings Plug Effect
Final Trial Balance Check
1972968
1972968
286089
286089
2209501
2209501
Credit
2009 As Stated
Trial Balance: 2005‐2009
Debit
2009 Adjustments
Credit
Debit
2009 Restated Ending Balance
Credit
Debit
Credit
2009 Carryover
Debit
Current assets:
Cash and cash equivalents
63499
63499
Short‐term investments
0
0
Restricted short‐term investments
0
0
5291
5291
38449
38449
Inventories
Prepaid and other current assets
Total current assets
0
Capitalized Leased Assets Rights
Property and equipment, net
Deferred income tax assets
205259
23906
497928
181353
497928
0
0
6819
6819
Intangible Assets, net
22241
22241
Other assets
17923
17923
Goodwill
Total assets
LIABILITIES AND COMMON STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
19825
Construction payable
Accrued expenses
19825
1600
1600
77088
77088
Unearned revenue
35844
35844
Current portion of long‐term debt
41236
41236
1212
1212
Total current liabilities
0
Long‐term debt
Capitalized Leases Liabilities
17931
205259
187328
Lease obligation
116547
116547
Other Liabilities
18488
18488
4961
4961
28
28
Minority interests
Common stockholders’ equity:
0
Common stock
Additional paid‐in capital
Treasury Stock
Other Comprehensive Loss
217181
217181
146022
146022
294
Retained earnings
294
264456
5975
258481
Total common stockholders’ equity
Total liabilities and common stockholders’ equity
Balance Sheet Check Figure
798466
Revenues
798466
979819
1228179
979819
1228179
Costs and expenses:
Restaurant operating costs:
Cost of sales
326421
326421
Labor
401583
401583
Operating
203859
203859
70635
70635
82749
82749
Occupancy
Total restaurant operating costs
General and administrative
0
Capitalized Operating Lease Expense
48053
Depreciation of Capitalized Leases
Depreciation and amortization
Preopening expense
23906
74429
74429
3919
Partner investment expense
48053
23906
3919
629
629
Income from operations
Interest and other income (expense)
Interest Expense from Capitalized Leases
30122
30122
Interest expense
Interest and other income
1637
1637
Income before minority interest
Minority interest
0
Income before provision for income taxes
Provision for income taxes
Loss from Discontinued operations, Net of Tax
18492
18492
479
479
Net income
Income Statement Check Figure
Income Summary
Total Debit and Credit Trial Balance Check
1184203
1228808
1238231
44605
2027274
1276861
38630
2027274
54028
Change in Net Income
48053
5975
280 | P a g e
Retained Earnings Plug Effect
Final Trial Balance Check
54028
54028
2256680
2256680
Credit
Financial Ratios
Current Ratio
P.F. Chang's Cheesecake Factory O'Charley's Chipotle Mexican Grill Industry Average 2005
1.150
1.326
0.775
0.425
0.919
2006
0.624
1.244
0.766
2.912
1.387
2007
0.508
0.835
0.757
2.754
1.213
2008
0.764
1.024
0.666
2.749
1.301
2009 0.611 0.859 0.768 2.912 1.287 2008
0.516
0.505
0.311
2.496
0.957
2009 0.451 0.424 0.535 2.685 1.024 Quick Asset Ratio
P.F. Chang's Cheesecake Factory O'Charley's Chipotle Mexican Grill Industry Average 2005
0.899
0.788
0.164
0.047
0.475
2006
0.443
0.692
0.316
2.590
1.010
2007
0.330
0.241
0.314
2.409
0.823
A/R Turnover
Receivables Turnover P.F. Chang's Cheesecake Factory O'Charley's Chipotle Industry Average 2005 129.294 145.788 77.207 324.726 169.254 2006
75.584
113.010
66.398
169.153
106.036
2007
68.803
133.214
56.348
202.081
115.111
2008 48.181 128.133 40.698 365.624 145.659 2009
77.970
141.122
51.185
318.794
147.268
Days’ Sales Outstanding
Days Sales Outstanding P.F. Chang's Cheesecake Factory O'Chalrey's Chipotle Industry Average 2005
2.823
2.504
4.728
1.124
2.795
2006
4.829
3.230
5.497
2.158
3.928
2007
5.305
2.740
6.478
1.806
4.082
2008 7.576 2.849 8.969 0.998 5.098 281 | P a g e
2009
4.681
2.586
7.131
1.145
3.886
Inventory Turnover
Inventory Turnover P.F. Chang's Chipotle Mexican Grill
Cheesecake Factory
O'Charley's
Industry Average
2005
64.904
2006
60.629
2007
64.468
2008 66.051 77.06
15.84
6.15
40.99
73.61
16.05
9.44
39.93
79.96
15.84
15.46
43.93
90.20
18.02
11.60
46.47
2009
61.694
83.01
17.76
24.24
46.68
Days’ Supply of Inventory
Inventory Turnover
P.F. Chang's
Chipotle Mexican Grill
Cheesecake Factory
O'Charley's
Industry Average
2005
5.624
4.736
23.040
59.385
23.196
2006
6.020
4.959
22.735
38.651
18.091
2007
5.662
4.565
23.048
23.617
14.223
2008
5.526
4.047
20.257
31.458
15.394
2009
5.916
4.397
20.547
15.056
11.479
Cash to Cash Cycle
2005
2006
2007
2008
2009
P.F. Chang's
8.44
10.84
10.97
13.11
10.60
O' Charley's
64.11
44.15
30.10
40.43
22.19
Cheesecake Factory
25.54
25.97
25.79
23.11
23.14
5.86
7.12
6.37
5.05
5.55
25.99
22.02
18.30
20.42
15.37
Chipotle
Industry Average
282 | P a g e
Working Capital Turnover
2005
2006
2007
2008
2009
66.28
-24.00
-18.41
-39.85
-17.97
-25.98
7.03
8.45
9.92
7.77
27.90
33.15
-42.15
366.26
-56.74
-38.22
-38.33
-46.24
-29.21
-51.99
17.05
-5.54
-24.59
76.78
-29.73
P.F. Chang's
Chipotle
Cheesecake Factory
O'Charleys
Industry Average
Profitability Ratios
Gross Profit Margin
P.F. Chang's Cheesecake Factory O'Charley's Chipotle Mexican Grill Industry Average 2005
72.24%
74.00%
69.85%
67.64%
70.93%
2006
73.01%
74.64%
70.19%
68.53%
71.59%
2007
73.14%
74.79%
67.91%
68.08%
70.98%
2008
72.82%
74.05%
70.33%
67.57%
71.19%
2009 73.42% 75.38% 70.81% 69.31% 72.23% Operating Profit Margin
Operating Profit Margin 2005
2006
2007
2008 2009 6.52%
5.01%
4.92%
4.38% 5.31% 10.98%
8.12%
7.33%
5.43% 4.60% O'Charley's 3.14%
4.09%
1.82%
‐11.03% 0.72% Chipotle 3.33%
6.26%
11.06%
13.32% 23.13% Industry Average 6.10%
5.80%
5.95%
3.65% 8.21% P.F. Chang's Restated 6.52%
5.53%
4.62%
6.17% 7.28% P.F. Chang's Cheesecake Factory 283 | P a g e
Net Profit Margin
2005
2006
2007
2008
2009
P.F. Chang's
4.67%
3.55%
2.93%
2.92%
3.63%
Chipotle
6.01%
5.03%
6.50%
5.87%
8.35%
Cheesecake Factory
7.41%
6.18%
4.89%
3.26%
2.67%
O'Charleys
1.28%
1.91%
0.75%
-14.23%
-0.83%
Industry Average
4.84%
4.17%
3.77%
-0.55%
3.46%
2008 1.92 1.40 1.43 1.84 1.47 1.62 2009
1.84 1.40 1.69 1.84 1.43 1.64 Net Profit Margin
Asset Turnover
Asset Turnover P.F. Chang's Cheesecake Factory O'Charley's Chipotle Mexican Grill Restated P.F. Chang's Industry Average 2005
2.11 1.56 1.40 1.90 2.11 1.82 2006
2.00 1.42 1.42 2.09 1.48 1.68 2007
2.11 1.45 1.41 1.80 1.60 1.67 Return on Assets
Return on Assets
P.F. Chang's Bistro
P.F. Chang's Bistro Restated
Chipotle Mexican Grill
Cheesecake Factory
O'Charley's
Industry Average
2005
9.83%
9.86%
11.44%
11.54%
1.81%
8.65%
2006
7.13%
3.44%
10.55%
8.78%
2.75%
7.30%
2007
6.24%
1.33%
11.68%
7.11%
1.06%
6.52%
2008
5.62%
3.35%
10.83%
4.56%
-20.42%
0.15%
2009
6.68%
4.48%
15.38%
3.75%
-1.41%
6.10%
284 | P a g e
Return on Equity
Return on Equity
P.F. Chang's Bistro
P.F. Chang's Restated
Chipotle Mexican Grill
Cheesecake Factory
O'Charley's
Industry Average
2005
15.39%
15.43%
14.36%
16.19%
3.59%
12.38%
2006
11.31%
7.37%
13.39%
12.57%
5.40%
10.67%
2007
11.07%
3.12%
14.89%
10.39%
1.92%
9.57%
2008
11.92%
9.25%
13.91%
9.29%
-36.25%
-0.28%
2009
13.90%
12.04%
20.37%
9.46%
-3.47%
10.07%
Capital Structure Ratios
Debt to Equity
Debt to Equity P.F. Chang's O'Charley's Cheesecake Factory Chipotle Industry Average P.F. Chang's Restated 2005
0.62
0.97
0.43
0.27
0.69
1.15
2006
0.78
0.80
0.46
0.27
0.75
1.44
2007
1.12
0.78
1.04
0.28
1.04
2.00
2008 1.08 1.47 1.52 0.33 1.23 1.75 2009
0.94
1.21
1.03
0.37
1.02
1.53
Times Interest Earned
Times Interest Earned P.F. Chang's Cheesecake Factory O'Charley's Chipotle Mexican Grill Industry Average P.F. Chang's Restated 2005
2006
2007
2008 2009 17.978 53.187 21.325 10.939 21.036 144.157 62.848 10.210 5.895 3.146 1.979 2.811 1.446 ‐6.862 0.549 39.233 228.605 365.483 410.725 502.975 40.669 70.132 80.145 84.593 106.103 0.000 3.210 2.260 2.270 2.810 285 | P a g e
Debt Service Margin
Debt Service Margin P.F. Chang's Cheesecake Factory O'Charley's Chipotle Industry Average 2005 177.026 N/A 0.51 0 59.18 2006 24.150 N/A 7.58 1817.49 616.41 2007 25.136 N/A 6.69 2069.34 700.39 2008 20.161 N/A 6.32 2611.93 879.47 2009 27.884 N/A 7.29 3178.94 1071.37 Altman’s Z-Score
Altman's Z-Score
P.F. Chang's
Chipotle
Cheesecake Factory
O'Charleys
Industry Average
P.F. Chang's Restated
2005
7.80
N/A
9.39
2.51
6.57
4.30
2006
5.53
11.51
6.13
2.95
6.53
3.48
2007
3.94
21.09
4.29
2.60
7.98
2.45
2008
3.45
9.02
2.95
1.05
4.12
2.50
2009
4.28
10.61
3.84
2.15
5.22
3.23
Growth Rate
Internal Growth Rate
IGR
P.F. Chang's
Chipotle
Cheesecake Factory
O'Charleys
Industry Average
P.F. Chang's Restated
2005
9.83%
11.44%
11.54%
1.81%
8.65%
9.86%
2006
7.13%
10.55%
8.78%
2.75%
7.30%
3.44%
2007
6.24%
11.68%
7.11%
1.06%
6.52%
1.33%
2008
5.62%
10.83%
4.56%
-20.42%
0.15%
3.35%
2009
6.68%
15.38%
3.75%
-1.41%
6.10%
4.48%
286 | P a g e
Sustainable Growth Rate
SGR P.F. Chang's Cheesecake Factory O'Charley's Chipotle Mexican Grill Restated P.F. Chang's Industry Average 2005
15.39%
13.87%
3.59%
14.36%
15.43%
11.80%
2006
11.31%
10.54%
5.40%
13.39%
7.37%
10.16%
2007
11.07%
10.39%
1.92%
14.89%
3.25%
9.57%
2008 11.92% 9.29% ‐36.25% 13.91% 10.04% ‐0.28% 2009
13.54%
9.46%
‐3.46%
20.37%
12.34%
9.98%
287 | P a g e
Regressions
3 Month
SUMMARY OUTPUT Regression Statistics Multiple R 0.365757129 R Square 0.133778277 Adjusted R Square 0.121403681 Standard Error 0.099323616 Observations 72 ANOVA Regression Residual Total df mrp rf Significance SS MS F F 1 0.106649693 0.106649693 10.81071876 0.001580507 70 0.690562644 0.009865181 71 0.797212337 Standard Error Lower 95% Upper 95% Lower 95.0% Upper 95.0% ‐
‐
0.006145229 0.01171169 0.524708955 0.601443363 0.017213001 0.029503458 0.017213001 0.029503458
0.864037434 0.262787845 3.287965747 0.001580507 0.33992361 1.388151258 0.33992361 1.388151258
Coefficients Intercept X Variable 1 SUMMARY OUTPUT Regression Statistics t Stat P‐value 288 | P a g e
Multiple R R Square Adjusted R Square Standard Error Observations ANOVA 0.131652602 0.103247147 60 Significance F MS F 0.10601510
4 9.94515663
1 0.106015104
0.0025544 0.01065997
58 0.618278452
3 59 0.724293556 df Regression Residual Total 0.382583787 0.146370354 X Variable 1 Standard Error t Stat P‐value 0.00298527 0.01334722
0.22366229
1
0.82380603
2
0.883438431 0.280137
3.15359424
0.0025544
Coefficients Intercept SUMMARY OUTPUT SS Lower 95% ‐
0.02373209
4
0.32268330
4
Upper 95% Lower 95.0% Upper 95.0% 0.02970263
3
1.44419355
8
‐
0.02373209
4
0.32268330
4
0.02970263
3
1.44419355
8
289 | P a g e
Regression Statistics Multiple R 0.399237159 R Square 0.159390309 Adjusted R Square 0.141116186 Standard Error 0.109271778 Observations 48 ANOVA df Regression Residual Total SS Standard Error Coefficients Intercept 0.010974265 0.015810354
X Variable 1 0.891840392 0.301977414
SUMMARY OUTPUT t Stat P‐value 0.69411887
5
2.95333475
7
Significance F F 8.72218618 0.00493856
6
8
MS 0.10414570
7
1 0.104145707
0.01194032
46 0.54925479
2 47 0.653400497 Lower 95% ‐
0.02085032
6
0.28399139
4
0.49109844
0.00493856
8
Upper 95% Lower 95.0% Upper 95.0% 0.04279885
6
1.49968938
9
‐
0.02085032
6
0.28399139
4
0.04279885
6
1.49968938
9
290 | P a g e
Regression Statistics Multiple R 0.47442387 R Square 0.225078008 Adjusted R Square 0.202286185 Standard Error 0.105738965 Observations 36 ANOVA df Regression Residual Total SS X Variable 1 Standard Error P‐value 0.01808514 0.017817039
1.01504745
3
0.943683088 0.300295742
3.14251238
0.31725238
8
0.00346297
7
Significance F F 9.87538405 0.00346297
9
7
t Stat Coefficients Intercept SUMMARY MS 0.11041398
1 0.110413989
9
0.01118072
34 0.380144774
9 35 0.490558764 Lower 95% ‐
0.01812343
9
0.33340871
8
Upper 95% Lower 95.0% Upper 95.0% 0.05429371
8
1.55395745
9
‐
0.01812343
9
0.33340871
8
0.05429371
8
1.55395745
9
291 | P a g e
OUTPUT Regression Statistics Multiple R 0.647330066 R Square 0.419036214 Adjusted R Square 0.392628769 Standard Error 0.09349767 Observations 24 ANOVA df Regression Residual Total SS Coefficients Standard Error Intercept 0.036830165 0.019226736
X Variable 1 1.112756937 0.279342954
t Stat 1.91557030
5
3.98347951
7
Significance F F 15.8681090 0.00062792
6
3
MS 0.13871606
1 0.138716064
4
0.00874181
22 0.192319916
4 23 0.331035979 P‐value 0.06850752
0.00062792
3
Lower 95% ‐
0.00304364
5
0.53343511
Upper 95% 0.07670397
5
1.69207876
3
Lower 95.0% ‐
0.00304364
5
0.53343511
Upper 95.0% 0.07670397
5
1.69207876
3
292 | P a g e
1 Year
SUMMARY OUTPUT 7 3.42 Regression Statistics 0.36569026
Multiple R 8 0.13372937
R Square 2 0.12135407
Adjusted R Square 7 0.09932641
Standard Error 9 Observations 72 ANOVA Lower 95.0% Upper 95.0% ‐
0.01701392 0.02971263
7
3
0.33944611 1.38676308
7
8
df Regression 1 Residual Total 70 71 Intercept X Variable 1 Significance MS F F 0.10661070 10.8061565
0.106610705
5
8
0.00158388 0.00986573
0.690601632
8 0.797212337 SS Coefficients 0.00634935
3 0.86310460
3 Standard Error 0.011714223
0.262559541
t Stat P‐value Lower 95% Upper 95% 0.54202087
3
3.28727190
6
0.58952542
2
‐
0.017013927 0.00158388
0.339446117 0.02971263
3
1.38676308
8
293 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.382558266 R Square 0.146350827 Adjusted R Square 0.131632738 Standard Error 0.103248328 Observations 60 ANOVA Regression Residual Total df Significance SS MS F F 1 0.106000961 0.106000961 9.943602399 0.002556238 58 0.618292595 0.010660217 59 0.724293556 Intercept X Variable 1 Coefficients Standard Error t Stat 0.003159633 0.013350366 0.23667015
0.88252485 0.279869175 3.153347808
P‐value Lower 95% Upper 95% Lower 95.0% ‐
0.813746579 ‐0.02356403 0.029883293 0.023564027
0.002556238 0.322305833 1.442743866 0.322305833
Upper 95.0% 0.029883
1.442744
294 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.399170542 R Square 0.159337122 Adjusted R Square 0.141061842 Standard Error 0.109275235 Observations 48 ANOVA Regression Residual Total df Significance SS MS F F 1 0.104110954 0.104110954 8.718723975 0.004946437 46 0.549289543 0.011941077 47 0.653400497 Intercept X Variable 1 Coefficients Standard Error t Stat 0.011143148 0.015814951 0.704595842
0.890780987 0.30167858 2.952748546
P‐value Lower 95% Upper 95% Lower 95.0% ‐
0.484614012
‐0.0206907 0.042976993 0.020690696
0.004946437 0.283533512 1.498028463 0.283533512
Upper 95.0% 0.042977
1.498028
295 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.474419641 R Square 0.225073996 Adjusted R Square 0.202282055 Standard Error 0.105739238 Observations 36 ANOVA Regression Residual Total df Significance SS MS F F 1 0.110412021 0.110412021 9.875156893 0.003463307 34 0.380146742 0.011180787 35 0.490558764 Intercept X Variable 1 Coefficients Standard Error t Stat 0.018325121 0.017828483 1.02785641
0.943041287 0.300094962 3.142476236
P‐value Lower 95% Upper 95% Lower 95.0% ‐
0.311274593 ‐0.01790672 0.054556959 0.017906716
0.003463307 0.333174951 1.552907623 0.333174951
Upper 95.0% 0.054557
1.552908
296 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.647235425 R Square 0.418913695 Adjusted R Square 0.392500681 Standard Error 0.093507529 Observations 24 ANOVA Regression Residual Total df Significance SS MS F F 1 0.138675505 0.138675505 15.86012476 0.000629459 22 0.192360474 0.008743658 23 0.331035979 Intercept X Variable 1 Coefficients Standard Error t Stat 0.037186645 0.019239855 1.932792359
1.111403368 0.279073378 3.982477213
P‐value Lower 95% Upper 95% Lower 95.0% ‐
0.066236328 ‐0.00271437 0.077087662 0.002714372
0.000629459 0.532640609 1.690166128 0.532640609
Upper 95.0% 0.077088
1.690166
297 | P a g e
2 Year
SUMMARY OUTPUT Regression Statistics Multiple R 0.36514279 R Square 0.133329257 Adjusted R Square 0.120948246 Standard Error 0.099349355 Observations 72 ANOVA Regression Residual Total Intercept X Variable 1 1 70 71 Coefficients 0.006480075 0.862164759 Significance SS MS F F 0.106292 0.106291729 10.76885087 0.001611737
0.690921 0.009870294 0.797212 df Standard Error t Stat P‐value 0.011719 0.55297635 0.582041332
0.262728 3.281592734 0.001611737
7 3.42 Lower 95% Upper 95% Lower 95.0% Upper 95.0% ‐
‐
0.016891815 0.029851965 0.016891815 0.029851965
0.338171226 1.386158292 0.338171226 1.386158292
298 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.382069442 R Square 0.145977058 Adjusted R Square 0.131252525 Standard Error 0.103270929 Observations 60 ANOVA Regression Residual Total df Significance SS MS F F 1 0.105730243 0.105730243 9.91386643 0.002591672 58 0.618563314 0.010664885 59 0.724293556 Intercept X Variable 1 Coefficients Standard Error 0.003259881 0.01335517
0.881729241 0.280035901
t Stat P‐value Lower 95% Upper 95% ‐
0.244091279 0.808021521 0.023473397 0.029993158
3.148629294 0.002591672 0.321176487 1.442281996
Lower 95.0% Upper 95.0% ‐0.02347
0.321176
0.029993
1.442282
299 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.398719685 R Square 0.158977387 Adjusted R Square 0.140694287 Standard Error 0.109298613 Observations 48 ANOVA Regression Residual Total df Intercept X Variable 1 Significance SS MS F F 1 0.103875904 0.103875904 8.695318866 0.004999982
46 0.549524594 0.011946187 47 0.653400497 Coefficients Standard Error 0.011256401 0.015821291
0.890130662 0.301863779
t Stat P‐value Lower 95% Upper 95% ‐
0.711471702 0.480384567 0.020590206 0.043103007
2.948782607 0.004999982 0.282510399 1.497750925
Lower 95.0% Upper 95.0% ‐0.02059
0.28251
0.043103
1.497751
300 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.474264197 R Square 0.224926528 Adjusted R Square 0.20213025 Standard Error 0.105749299 Observations 36 ANOVA Regression Residual Total df Intercept X Variable 1 Significance SS MS F F 1 0.11033968
0.11033968 9.866809079 0.003475466
34 0.380219084 0.011182914 35 0.490558764 Coefficients Standard Error 0.018547233 0.017841153
0.943715665 0.300436575
t Stat P‐value Lower 95% Upper 95% ‐
1.0395759 0.305873627 0.017710353 0.054804819
3.141147733 0.003475466 0.33315509 1.554276241
Lower 95.0% Upper 95.0% ‐0.01771
0.333155
0.054805
1.554276
301 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.647631317 R Square 0.419426322 Adjusted R Square 0.39303661 Standard Error 0.093466274 Observations 24 ANOVA Regression Residual Total df Intercept X Variable 1 Significance SS MS F F 1 0.138845203 0.138845203
15.893554 0.000623057
22 0.192190776 0.008735944 23 0.331035979 Coefficients Standard Error 0.037597282 0.019244396
1.113032032 0.27918826
t Stat P‐value Lower 95% Upper 95% ‐
1.953674258 0.063571634 0.002313153 0.077507717
3.986672046 0.000623057 0.534031021 1.692033043
Lower 95.0% Upper 95.0% ‐0.00231
0.534031
0.077508
1.692033
302 | P a g e
5 Year
SUMMARY OUTPUT Regression Statistics Multiple R 0.363210611 R Square 0.131921948 Adjusted R Square 0.119520833 Standard Error 0.099429985 Observations 72 ANOVA Regression Residual Total df 1 70 71 Intercept X Variable 1 7 3.42 Significance SS MS F F 0.10517 0.105169804 10.6379102 0.001713614 0.692043 0.009886322 0.797212 Coefficients 0.006868847 0.857295733 Standard Error t Stat P‐value 0.011734 0.585392925 0.560166051
0.262847 3.261580935 0.001713614
Lower 95% Upper 95% Lower 95.0% ‐
‐
0.016533355 0.030271049 0.016533355
0.333064559 1.381526908 0.333064559
Upper 95.0% 0.030271
1.381527
303 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.380008 R Square 0.144406 Adjusted R Square 0.129654 Standard Error 0.103366 Observations 60 ANOVA Regression Residual Total df Significance SS MS F F 1 0.104592321 0.104592321 9.789160103 0.002745972 58 0.619701236 0.010684504 59 0.724293556 Intercept X Variable 1 Standard t Stat Coefficients Error 0.003637 0.013375345 0.271932855
0.876631 0.280184646 3.12876335
P‐value Lower 95% Upper 95% 0.78663932 ‐0.02313647 0.030410858
0.002745972 0.315780952 1.437481952
Lower 95.0% ‐0.02314
0.315781
Upper 95.0% 0.030411
1.437482
304 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.397193 R Square 0.157762 Adjusted R Square 0.139453 Standard Error 0.109378 Observations 48 ANOVA Regression Residual Total df Significance SS MS F F 1 0.103081846 0.103081846 8.616398716 0.005185104 46 0.550318651 0.011963449 47 0.653400497 Intercept X Variable 1 Standard t Stat Coefficients Error 0.011732 0.015846205 0.740371564
0.886578 0.30203284 2.935370286
P‐value Lower 95% Upper 95% 0.462836973 ‐0.02016468 0.043628835
0.005185104 0.278617659 1.494538786
Lower 95.0% ‐0.02016
0.278618
Upper 95.0% 0.043629
1.494539
305 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.473308 R Square 0.224021 Adjusted R Square 0.201198 Standard Error 0.105811 Observations 36 ANOVA Regression Residual Total df Significance SS MS F F 1 0.10989543 0.10989543 9.815614723 0.003551038 34 0.380663334 0.01119598 35 0.490558764 Intercept X Variable 1 Standard t Stat Coefficients Error 0.019262 0.017889332 1.076715236
0.942899 0.300958213 3.132988146
P‐value Lower 95% Upper 95% 0.289188331 ‐0.01709378 0.055617212
0.003551038 0.331277841 1.554519186
Lower 95.0% ‐0.01709
0.331278
Upper 95.0% 0.055617
1.554519
306 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.648341 R Square 0.420346 Adjusted R Square 0.393998 Standard Error 0.093392 Observations 24 ANOVA Regression Residual Total df Significance SS MS F F 1 0.139149486 0.139149486 15.95364335 0.000611729 22 0.191886494 0.008722113 23 0.331035979 Intercept X Variable 1 Standard t Stat Coefficients Error 0.038708 0.019267123 2.008994516
1.115576 0.279298988 3.994201215
P‐value Lower 95% Upper 95% 0.056964846 ‐0.00125002 0.078665112
0.000611729 0.536345711 1.694807005
Lower 95.0% ‐0.00125
0.536346
Upper 95.0% 0.078665
1.694807
307 | P a g e
10 Year
SUMMARY OUTPUT Regression Statistics Multiple R 0.361187051 R Square 0.130456086 Adjusted R Square 0.11803403 Standard Error 0.0995139 Observations 72 ANOVA Regression Residual Total Intercept X Variable 1 1 70 71 Coefficients 0.007258368 0.851909538 Significance SS MS F F 0.104001 0.104001 10.5019722 0.001826485 0.693211 0.009903 0.797212 df Standard Error t Stat P‐value 0.011751 0.617697 0.538779805
0.26288 3.240675 0.001826485
7 3.42 Lower 95% Upper 95% Lower 95.0% ‐
‐
0.016177668 0.030694403 0.016177668
0.32761131 1.376207766 0.32761131
Upper 95.0% 0.030694
1.376208
308 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.377848 R Square 0.142769 Adjusted R Square 0.127989 Standard Error 0.103465 Observations 60 ANOVA Regression Residual Total Significance SS MS F F 0.103407 0.103406864 9.659730486 0.002916325 0.620887 0.010704943 0.724294 df 1 58 59 Intercept X Variable 1 Coefficients 0.004026 0.870963 Standard t Stat Error 0.013398 0.300510072
0.280232 3.108010696
P‐value Lower 95% Upper 95% 0.764862665 ‐0.02279212 0.030844353
0.002916325 0.310018302 1.431907208
Lower 95.0% ‐0.02279
0.310018
Upper 95.0% 0.030844
1.431907
309 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.395462 R Square 0.15639 Adjusted R Square 0.13805 Standard Error 0.109467 Observations 48 ANOVA Regression Residual Total Significance SS MS F F 0.102185 0.102185199 8.527555688 0.005402219 0.551215 0.011982941 0.6534 df 1 46 47 Intercept X Variable 1 Coefficients 0.012208 0.882193 Standard t Stat Error 0.015875 0.769003081
0.3021 2.920197885
P‐value Lower 95% Upper 95% 0.4458221 ‐0.01974622 0.044161369
0.005402219 0.274096366 1.49028936
Lower 95.0% ‐0.01975
0.274096
Upper 95.0% 0.044161
1.490289
310 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.471944 R Square 0.222731 Adjusted R Square 0.19987 Standard Error 0.105899 Observations 36 ANOVA Regression Residual Total Significance SS MS F F 0.109263 0.109262695 9.742905688 0.00366141 0.381296 0.01121459 0.490559 df 1 34 35 Intercept X Variable 1 Coefficients 0.019931 0.940627 Standard t Stat Error 0.017943 1.110783521
0.301352 3.121362793
P‐value Lower 95% Upper 95% 0.274455411 ‐0.01653378 0.056395368
0.00366141 0.328207455 1.553047397
Lower 95.0% ‐0.01653
0.328207
Upper 95.0% 0.056395
1.553047
311 | P a g e
SUMMARY OUTPUT Regression Statistics Multiple R 0.648254 R Square 0.420233 Adjusted R Square 0.39388 Standard Error 0.093401 Observations 24 ANOVA Regression Residual Total df 1 22 23 Intercept X Variable 1 Coefficients 0.039692 1.116053 Significance SS MS F F 0.139112 0.139112379 15.94630543 0.0006131 0.191924
0.0087238 0.331036 Standard t Stat Error 0.019306 2.055904674
0.279483 3.993282539
P‐value Lower 95% Upper 95% 0.05184836 ‐0.0003469 0.079730812
0.0006131 0.53644142 1.695664005
Lower 95.0% ‐0.00035
0.536441
Upper 95.0% 0.079731
1.695664
312 | P a g e
Method of Comparables
Trailing P/E
P.F. Chang's Cheesecake Factory O'Charley's Chipotle Darden Restaurants Brinker Inc. PPS 43.48 23.46 6.28 144.8 39.56 14.64 EPS 1.95 0.85 ‐0.89 4.36 2.91 1.13 P/E Forecast
22.3 27.64 N/A 33.26 31.59 13.11 Industry Avg 26.4
P.F. Chang's Adj. PPS 51.48 Forward P/E
P.F. Chang's (As Stated) P.F. Chang's (Restated) Cheesecake Factory O'Charley's Chipotle Darden Restaurants Brinker Inc. PPS EPS 43.48 43.48 23.46 6.28 144.8 39.56 14.64 4.13 3.35 0.85 ‐0.89 4.36 2.91 1.13 P.F. Chang's Adj. P/E Industry PPS Forecast Avg 10.53 12.98 27.64 N/A 33.26 31.59 13.11 26.4 26.4 109.03 88.44 313 | P a g e
Price/Book
P.F. Chang's (As Stated) P.F. Chang's (Restated) Cheesecake Factory O'Charley's Chipotle Darden Restaurants Brinker Inc. PPS 43.48 43.48 23.46 6.28 144.8 39.56 14.64 BPS 14.64 14.38 8.59 9.66 22.95 12.36 6.31 P/B Forecast 2.97 3.02 2.73 0.65 6.31 3.2 2.32 Industry Avg 3.042 3.042 P.F. Chang's Adj. PPS 44.53 43.74 P.E.G. Ratio
P.F. Chang's (As Stated) P.F. Chang's (Restated) Cheesecake Factory O'Charley's Chipotle Darden Restaurants Brinker Inc. P/E 22.3 25.73 27.64 N/A 33.26 31.59 13.11 P.E.G 3.1 3.94 1.25 N/A 1.49 1.21 1.15 Earnings Growth Rate 7.20 6.53 22.11 N/A 22.32 26.11 11.40 EPS 1.95 1.69 0.85 ‐0.89 4.36 2.91 1.13 Industry Avg 1.275 1.275 P.F. Chang's Adj. PPS 17.90 14.07 Price/EBITDA
P.F. Chang's
P.F. Chang's
Restated
Chipotle
Cheesecake Factory
O'Charleys
Brinker
Darden
Market Cap
$
892,035
$
892,035
$
4,550,000
$
1,410,000
$
135,830
$
1,500,000
$
5,550,000
EBITDA
$
139,163
$
183,321
$
292,477
$
188,369
$
57,078
$
368,896
$
950,381
P/EBITDA
Industry
Average
Adjusted
PPS
$ 34.92
$ 46.00
$
15.56
$
7.49
$
2.38
$
4.07
$
5.84
$
5.80
314 | P a g e
EV/EBITDA
P.F. Chang's
P.F. Chang's
Restated
Chipotle
Cheesecake Factory
O'Charleys
Brinker
Darden
Market Cap
$
1,145,337
$
1,145,337
$
4,510,000
$
1,530,000
$
321,740
$
1,990,000
$
7,470,000
EBITDA
$
139,163
$
183,321
$
292,477
$
188,369
$
57,078
$
368,896
$
950,381
P/EBITDA
Industry
Average
Adjusted
PPS
$ 40.68
$ 53.59
$
15.42
$
8.12
$
5.64
$
5.39
$
7.86
$
6.75
Price/FCF
PPS
P.F. Chang's
Chipotle
Cheesecake Factory
O'Charleys
Brinker
Darden
$
43.48
$
144.80
$
23.46
$
6.28
$
14.64
$
39.56
FCF
$
0.98
$
4.10
$
(0.11)
$
0.72
$
0.38
$
0.11
P/FCF
Industry
Average
Adjusted
PPS
$ 36.18
$
35.32
$
(213.27)
$
8.72
$
38.53
$
359.64
$
36.92
315 | P a g e
Intrinsic Valuation Models (See Next Page)
316 | P a g e
Discounted Dividends Approach
Relevant Valuation Item
DPS (Dividends Per Share)
PV Factor
PV Annual Dividend
PV of Year by year dividends
TV Perpetuity
Model Price (6/1/2010)
Time consistent price
Observed Share Price (6/1/2010)
Initial Cost of Equity (You Derive)
Perpetuity Growth Rate (g)
0
2009
WACC(AT) 10.70%
1
2
2010
2011
$
$
Kd
3
2012
4
2013
6.62%
5
2014
Ke
6
2015
7
2016
10
63.48
up
low
47.83
39.13
Growth Rate
10%
65.48%
9
2018
0.89 $ 0.93 $ 0.97 $ 1.05 $ 1.15 $ 1.27 $ 1.39 $
1.53 $ 1.69 $ 1.86
0.8855 0.7841 0.6943
0.6148 0.5444 0.4821
0.4269
0.3780
0.3347
0.2964
0.79 $ 0.73 $ 0.67 $ 0.65 $ 0.63 $ 0.61 $ 0.59 $
0.58 $ 0.57
5.812317332
21.25
27.06
28.47
$43.48
12.93%
12.93%
8
2017
Cost
of
Equity
7.17%
8.93%
10.93%
12.93%
14.93%
16.93%
17.10%
4%
6%
$ 40.12 $ 95.48
$ 25.28 $ 37.64
$ 17.64 $ 22.10
$ 13.45 $ 15.57
$ 10.83 $ 11.98
$ 9.04 $ 9.73
$ 8.91 $ 9.57
Overvalued
< 39.13
8%
10%
12%
N/A
N/A
N/A
$ 103.16
N/A
N/A
$ 32.67 $ 88.72
N/A
$ 19.40 $ 28.47 $ 76.54
$ 13.80 $ 17.10 $ 24.90
$ 10.72 $ 12.29 $ 15.14
$ 10.52 $ 12.01 $ 14.66
$39.13 < Fairly
Valued < $47.83
14%
16%
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
$ 66.25
N/A
$ 21.86 $ 57.52
$ 20.73 $ 48.87
Undervalued
> $47.83
10% Analyst
317 | P a g e
Discounted Free Cash Flow
WACC(BT)
0
2009
11.3%
1
2010
Kd
2
2011
3
2012
Cash Flow From Operations
Cash Flow From Investing Activities
$
$
160,419 $ 164,459 $ 170,708 $
(50,118) $ (47,779) $ (53,566) $
FCF Firm's Assets
PV Factor (WACC or Ke?)
PV YBY Free Cash Flows
$
110,301 $ 116,680 $ 117,142 $
0.8985
0.8073
$ 104,834 $ 94,563 $
Total PV YBY FCF
FCF Perp
Market Value of Assets (12/31/2009)
Book Value Debt & Preferred Stock
Market Value of Equity
Divide by Shares to Get PPS at 12/31/2009
Time Consistent Price (6/1/10)
Oberved Share Price (6/1/2010)
$
$
$
$
$
$
$
584,311
760,942
1,345,253
316,801 $ 317,479 $ 325,165 $
1,028,452 $ 104,834
44.51
46.54
$43.48
WACC(BT)
Perpetuity Growth Rate (g)
6.62%
4
2013
Ke
5
2014
12.93%
7
2016
6
2015
8
2017
WACC(AT)
9
2018
10.7%
10
2019
179,244 $ 192,687 $ 211,955 $ 233,151 $ 256,466 $ 282,113 $ 310,324 $
(84,366) $ (120,925) $ (133,017) $ (146,319) $ (160,951) $ (177,046) $ (194,751) $
94,877 $
0.7253
68,814 $
71,762 $
0.6517
46,764 $
78,938 $
0.5855
46,218 $
86,832 $
0.5261
45,678 $
95,515 $ 105,067 $ 115,573 $
0.4726
0.4247
0.3815
45,145 $ 44,617 $ 44,096 $
11
2020
341,356 $ 375,492
(214,226) $ (235,648)
127,131 $ 139,844
0.3428
43,581
$ 2,219,746.03
351,035 $ 397,980 $ 449,620 $ 506,423 $ 568,907 $ 637,640 $ 713,245 $
796,412
11.3%
5%
Growth Rate
Observed Share Price
Initial WACC
Perpetuity Growth Rate (g)
$43.48
11.3%
5%
Weighted
Average
Cost of
Capital
8.3%
9.3%
10.3%
11.3%
12.3%
13.3%
14.3%
$
$
$
$
$
$
$
2%
3%
46.02 $ 52.44
41.51 $ 46.19
38.10 $ 41.67
35.44 $ 38.25
33.29 $ 35.57
31.54 $ 33.42
30.08 $ 31.66
Overvalued
< 39.13
$
$
$
$
$
$
$
4%
5%
6%
61.85 $
76.97 $ 105.23 $
62.09 $ 77.27 $
52.64 $
46.37 $
52.84 $ 62.33 $
41.83 $
46.54 $ 53.04 $
38.89 $
41.98 $ 46.72 $
35.70 $
38.53 $ 42.14 $
33.54 $
35.83 $ 38.67 $
$39.13 < Fairly
Valued < $47.83
7%
176.97 $
105.64 $
77.56 $
62.56 $
53.24 $
46.89 $
42.29 $
Undervalued
> $47.83
10% Analyst
318 | P a g e
8%
726.98
177.65
106.04
77.85
62.80
53.44
47.06
As Stated Residual Income
All Items in Millions of Dollars
Annual Change in Res. Income
Net Income (Millions)
Total Dividends (Millions)
Book Value Equity (Millions)
ROE
WACC(BT)
0
1
2009
2010
$ 44,605.00 $ 45,924.31
$
$ 20,665.94
$ 335,349.00 $ 360,607.37
13.69%
Annual Normal Income (Benchmark)
Annual Residual Income
PV Factor
YBY PV RI
$ (1,520.78)
2
2011
$ 47,669.44
$ 21,451.25
$ 386,825.56
13.22%
Kd
$ (1,006.54)
3
2012
$ 50,052.91
$ 22,523.81
$ 414,354.67
12.94%
6.62%
194.46
4
2013
$ 53,806.88
$ 24,213.10
$ 443,948.45
12.99%
$
$ 1,554.21
5
2014
$ 59,187.57
$ 26,634.41
$ 476,501.61
13.33%
Ke
$ 1,709.63
6
2015
$ 65,106.32
$ 29,297.85
$ 512,310.09
13.66%
12.93%
$ 1,880.60
7
2016
$ 71,616.96
$ 32,227.63
$ 551,699.41
13.98%
$ 2,068.66
8
2017
$ 78,778.65
$ 35,450.39
$ 595,027.67
14.28%
WACC(AT)
$ 2,275.52
9
2018
$ 86,656.52
$ 38,995.43
$ 642,688.76
14.56%
10.7%
$ 2,503.07
10
2019
$ 95,322.17
$ 42,894.98
$ 695,115.95
14.83%
$ 2,753.38
11
2020
$ 104,854.39
$ 47,184.00
$ 752,786.00
15.08%
$ 43,360.63 $ 46,626.53 $ 50,016.55 $ 53,576.06 $ 57,402.53 $ 61,611.66 $ 66,241.69 $ 71,334.73 $ 76,937.08 $ 83,099.66 $ 89,878.49
$ 2,563.69 $ 1,042.91 $
36.37 $
230.82 $ 1,785.03 $ 3,494.67 $ 5,375.26 $ 7,443.92 $ 9,719.44 $ 12,222.51 $ 14,975.89
0.886
0.784
0.694
0.615
0.544
0.482
0.427
0.378
0.335
0.296
$ 2,270.16 $
817.76 $
25.25 $
141.92 $
971.85 $ 1,684.80 $ 2,294.74 $ 2,814.02 $ 3,253.55 $ 3,622.99
Book Value Equity (Millions)
Total PV of YBY RI
Terminal Value Perpetuity
MVE 12/31/10
$ 335,349.00
$ 17,897.04
$ 19,359.56
$ 372,605.60
Divide by Shares
$ 23,104.00
Model Price on 12/31/10
Time Consistent Price
$
$
90.0%
4.8%
5.2%
100.0%
$
$43.48
Initial Cost of Equity-(Ke)
12.93%
-10%
65,311
Growth Rate
16.13
23.00
Observed Share Price (6/1/2010)
Perpetuity Growth Rate (g)
11.3%
Ke
7.17% $
-10%
25.13 $
-20%
24.09 $
-30%
23.62 $
-40%
23.34 $
-50%
23.17
8.93% $
24.21 $
23.49 $
23.14 $
22.93 $
22.80
10.93% $
23.52 $
23.02 $
22.76 $
22.60 $
22.49
12.93% $
23.00 $
22.64 $
22.45 $
22.33 $
22.24
14.93% $
22.61 $
22.34 $
22.20 $
22.10 $
22.04
16.93% $
22.30 $
22.10 $
21.99 $
21.92 $
21.87
17.10% $
22.05 $
21.91 $
21.82 $
21.76 $
21.72
Overvalued
$39.13 < Fairly
Undervalued
< 39.13
Valued < $47.83
> $47.83
10% Analyst
319 | P a g e
Restated Residual Income
All Items in Millions of Dollars
Annual Change in Res. Income
Net Income (Millions)
Total Dividends (Millions)
Book Value Equity (Millions)
ROE
WACC(BT)
0
1
2009
2010
$ 38,630.00 $ 37,235.93
$
- $ 16,756.17
$ 329,374.00 $ 349,853.76
11.31%
Annual Normal Income (Benchmark)
Annual Residual Income
PV Factor
YBY PV RI
$ (1,233.07)
2
2011
$ 38,650.90
$ 17,392.90
$ 371,111.75
11.05%
Kd
$ (816.11)
3
2012
$ 40,583.44
$ 18,262.55
$ 393,432.65
10.94%
6.62%
157.67
4
2013
$ 43,627.20
$ 19,632.24
$ 417,427.61
11.09%
$
$ 1,260.17
5
2014
$ 47,989.92
$ 21,595.46
$ 443,822.06
11.50%
Ke
$ 1,386.19
6
2015
$ 52,788.91
$ 23,755.01
$ 472,855.96
11.89%
12.93%
$ 1,524.81
7
2016
$ 58,067.80
$ 26,130.51
$ 504,793.25
12.28%
$ 1,677.29
8
2017
$ 63,874.58
$ 28,743.56
$ 539,924.28
12.65%
WACC(AT)
$ 1,845.02
9
2018
$ 70,262.04
$ 31,617.92
$ 578,568.40
13.01%
10.7%
$ 2,029.52
10
2019
$ 77,288.24
$ 34,779.71
$ 621,076.93
13.36%
$ 2,232.47
11
2020
$ 85,017.07
$ 47,184.00
$ 706,094.00
13.69%
$ 42,588.06 $ 45,236.09 $ 47,984.75 $ 50,870.84 $ 53,973.39 $ 57,386.19 $ 61,140.28 $ 65,269.77 $ 69,812.21 $ 74,808.89 $ 80,305.25
$ (5,352.13) $ (6,585.20) $ (7,401.31) $ (7,243.64) $ (5,983.47) $ (4,597.28) $ (3,072.47) $ (1,395.19) $ 449.83 $ 2,479.35 $ 4,711.82
0.886
0.784
0.694
0.615
0.544
0.482
0.427
0.378
0.335
0.296
$ (4,739.33) $ (5,163.57) $ (5,139.02) $ (4,453.69) $ (3,257.67) $ (2,216.38) $ (1,311.66) $ (527.42) $ 150.58 $ 734.93
Book Value Equity (Millions)
Total PV of YBY RI
Terminal Value Perpetuity
MVE 12/31/10
$ 329,374
$ (25,923.24)
$ 6,091.04
$ 309,541.80
Divide by Shares
$ 23,104.00
Model Price on 12/31/10
Time Consistent Price
$
$
106.4%
-8.4%
2.0%
100.0%
$
$43.48
Initial Cost of Equity-(Ke)
12.93%
-10%
20,549
Growth Rate
13.40
19.11
Observed Share Price (6/1/2010)
Perpetuity Growth Rate (g)
11.3%
Ke
7.17% $
-10%
36.25 $
-20%
33.57 $
-30%
32.33 $
-40%
31.62 $
-50%
31.15
8.93% $
29.33 $
27.92 $
27.23 $
26.82 $
26.55
10.93% $
23.48 $
22.90 $
22.60 $
22.42 $
22.30
12.93% $
19.11 $
19.00 $
18.94 $
18.90 $
18.87
14.93% $
15.80 $
15.93 $
16.01 $
16.06 $
16.09
16.93% $
13.24 $
13.50 $
13.65 $
13.75 $
13.82
17.10% $
12.94 $
13.21 $
13.37 $
13.47 $
13.55
Overvalued
$39.13 < Fairly
Undervalued
< 39.13
Valued < $47.83
> $47.83
10% Analyst
320 | P a g e
706094.00
Long Run Residual Income
BVE
ROE
Ke
g
MVE
Divide by Shares
Model Price
Time Consistent Price
$ 335,349
Growth Rate
15%
12.93%
-10%
$ 422,571
23,104
$ 18.29
$ 26.09
Ke
7.17%
8.93%
10.93%
12.93%
14.93%
16.93%
17.10%
Estimated Price per Share (end of 2009)
Observed Share Price
-10%
$
42.43
$
35.27
$
29.87
$
26.09
$
23.29
$
21.14
$
21.06
Overvalued
< 39.13
-20%
-30%
$ 44.36 $ 46.30
$ 37.26 $ 39.24
$ 31.90 $ 33.92
$ 28.16 $ 30.23
$ 25.40 $ 27.51
$ 23.28 $ 25.43
$ 23.21 $ 25.35
$39.13 < Fairly
Valued < $47.83
-40%
-50%
$ 48.24 $ 50.17
$ 41.22 $ 43.20
$ 35.95 $ 37.98
$ 32.30 $ 34.37
$ 29.62 $ 31.73
$ 27.57 $ 29.72
$ 27.50 $ 29.64
Undervalued
> $47.83
10% Analyst
Return on Equity Held Constant
$43.48
Return on Equity
Ke
7.17%
8.93%
10.93%
12.93%
14.93%
16.93%
17.10%
11%
$
32.00
$
26.40
$
22.44
$
19.68
$
17.64
$
16.07
$
16.02
Overvalued
< 39.13
13%
15%
$ 37.47 $ 42.94
$ 30.83 $ 35.27
$ 26.16 $ 29.87
$ 22.89 $ 26.09
$ 20.47 $ 23.29
$ 18.61 $ 21.14
$ 18.54 $ 21.06
$39.13 < Fairly
Valued < $47.83
17%
19%
$ 48.41 $ 53.87
$ 39.71 $ 44.15
$ 33.58 $ 37.29
$ 29.29 $ 32.49
$ 26.12 $ 28.94
$ 23.67 $ 26.21
$ 23.59 $ 26.11
Undervalued
> $47.83
10% Analyst
Growth Held Constant
Growth Rate
Return on Equity
9%
11%
13%
15%
17%
19%
21%
-10%
$
16.48
$
19.68
$
22.89
$
26.09
$
29.29
$
32.49
$
35.70
Overvalued
< 39.13
-20%
-30%
$ 18.55 $ 20.62
$ 21.75 $ 23.82
$ 24.96 $ 27.03
$ 28.16 $ 30.23
$ 31.36 $ 33.43
$ 34.56 $ 36.63
$ 37.77 $ 39.84
$39.13 < Fairly
Valued < $47.83
-40%
-50%
$ 22.69 $ 24.76
$ 25.90 $ 27.97
$ 29.10 $ 31.17
$ 32.30 $ 34.37
$ 35.50 $ 37.57
$ 38.71 $ 40.78
$ 41.91 $ 43.98
Undervalued
> $47.83
10% Analyst
Ke Held Constant
321 | P a g e
AEG Valuation
Net Income (Millions)
Total Dividends (Millions)
Dividends Reinvested at 12.93% (Drip)
Cum-Dividend Earnings
Normal Earnings
Abnormal Earning Growth (AEG)
PV Factor
PV of AEG
Residual Income Check Figure
Core Net Income
Total PV of AEG
Continuing (Terminal) Value
PV of Terminal Value
Total PV of AEG
Total Average Net Income Perp (t+1)
Divide by shares to Get Average EPS Perp
Capitalization Rate (perpetuity)
Intrinsic Value Per Share (12/31/2009)
Time Consistent Implied Price 11/1/1988
Observed Price (6/1/2010)
Initial Cost of Equity-(Ke)
Perpetuity Growth Rate (g)
Actual Price per share
WACC(BT)
11.3%
Kd
0
1
2
2009
2010
2011
2012
$44,605.00 $45,924.31 $ 47,669.44 $ 50,052.91
$
- $20,665.94 $ 21,451.25 $ 22,523.81
$ 2,672.11 $ 2,773.65
$ 50,341.55 $ 52,826.56
$ 51,862.33 $ 53,833.10
$ (1,520.78) $ (1,006.54)
0.8855
0.7841
$ (1,346.66) $ (789.25)
$ (1,520.78) $ (1,006.54)
6.62%
3
2013
$ 53,806.88
$ 24,213.10
$ 2,912.33
$ 56,719.21
$ 56,524.75
$ 194.46
0.6943
$ 135.02
$ 194.46
Ke
4
2014
$ 59,187.57
$ 26,634.41
$ 3,130.75
$ 62,318.32
$ 60,764.11
$ 1,554.21
0.6148
$ 955.59
$ 1,554.21
5
2015
$ 65,106.32
$ 29,297.85
$ 3,443.83
$ 68,550.15
$ 66,840.52
$ 1,709.63
0.5444
$ 930.80
$ 1,709.63
12.93%
6
2016
$ 71,616.96
$ 32,227.63
$ 3,788.21
$ 75,405.17
$ 73,524.57
$ 1,880.60
0.4821
$ 906.65
$ 1,880.60
WACC(AT)
7
2017
$ 78,778.65
$ 35,450.39
$ 4,167.03
$ 82,945.68
$ 80,877.03
$ 2,068.66
0.4269
$ 883.13
$ 2,068.66
8
2018
$ 86,656.52
$ 38,995.43
$ 4,583.74
$ 91,240.25
$ 88,964.73
$ 2,275.52
0.3780
$ 860.21
$ 2,275.52
10.7%
9
2019
$ 95,322.17
$ 42,894.98
$ 5,042.11
$ 100,364.28
$ 97,861.20
$ 2,503.07
0.3347
$ 837.90
$ 2,503.07
10
2020
$104,854.39
$ 47,184.47
$ 5,546.32
$110,400.71
$107,647.32
$ 2,753.38 $ 3,001.19
0.2964
$ 816.16
$ 2,753.38
$45,924.31
$ 3,373.39
$ 13,088.47
$ 3,879.68
Growth Rate
$53,177.38
$
2.30
12.93%
$
$
17.80
18.73
$43.48
12.93%
-10%
Ke
7.17%
8.93%
10.93%
12.93%
14.93%
16.93%
17.10%
-10%
$ 50.90
$ 35.32
$ 25.02
$ 18.73
$ 14.62
$ 11.81
$ 11.61
Overvalued
< 39.13
$
$
$
$
$
$
$
-20%
-30%
46.71 $ 43.48
33.26 $ 32.26
24.08 $ 23.60
18.31 $ 18.09
14.46 $ 14.37
11.77 $ 11.74
11.58 $ 11.56
$39.13 < Fairly
Valued < $47.83
$
$
$
$
$
$
$
-40%
43.65 $
31.67 $
23.31 $
17.95 $
14.31 $
11.73 $
11.54 $
Undervalued
> $47.83
-50%
42.93
31.27
23.11
17.86
14.27
11.72
11.53
10% Analyst
322 | P a g e
AEG Valuation Restated
Net Income (Millions)
Total Dividends (Millions)
Dividends Reinvested at 12.93% (Drip)
Cum-Dividend Earnings
Normal Earnings
Abnormal Earning Growth (AEG)
PV Factor
PV of AEG
Residual Income Check Figure
Core Net Income
Total PV of AEG
Continuing (Terminal) Value
PV of Terminal Value
Total PV of AEG
Total Average Net Income Perp (t+1)
Divide by shares to Get Average EPS Perp
Capitalization Rate (perpetuity)
Intrinsic Value Per Share (12/31/2009)
Time Consistent Implied Price 11/1/1988
Observed Price (6/1/2010)
Initial Cost of Equity-(Ke)
Perpetuity Growth Rate (g)
Actual Price per share
WACC(BT)
11.3%
Kd
0
1
2
2009
2010
2011
2012
$ 38,630.00 $ 37,235.93 $ 38,650.90 $ 40,583.44
$
$ 16,756.17 $ 17,392.90 $ 18,262.55
$ 2,166.57 $ 2,248.90
$ 40,817.47 $ 42,832.34
$ 42,050.54 $ 43,648.46
$ (1,233.07) $ (816.11)
0.8855
0.7841
$ (1,091.89) $ (639.93)
$ (1,233.07) $ (816.11)
6.62%
3
2013
$ 43,627.20
$ 19,632.24
$ 2,361.35
$ 45,988.55
$ 45,830.88
$ 157.67
0.6943
$ 109.47
$ 157.67
Ke
4
2014
$ 47,989.92
$ 21,595.46
$ 2,538.45
$ 50,528.37
$ 49,268.20
$ 1,260.17
0.6148
$ 774.80
$ 1,260.17
5
2015
$ 52,788.91
$ 23,755.01
$ 2,792.29
$ 55,581.20
$ 54,195.02
$ 1,386.19
0.5444
$ 754.70
$ 1,386.19
12.93%
6
2016
$ 58,067.80
$ 26,130.51
$ 3,071.52
$ 61,139.32
$ 59,614.52
$ 1,524.81
0.4821
$ 735.12
$ 1,524.81
WACC(AT)
7
2017
$ 63,874.58
$ 28,743.56
$ 3,378.68
$ 67,253.26
$ 65,575.97
$ 1,677.29
0.4269
$ 716.05
$ 1,677.29
8
2018
$ 70,262.04
$ 31,617.92
$ 3,716.54
$ 73,978.58
$ 72,133.57
$ 1,845.02
0.3780
$ 697.47
$ 1,845.02
$
$
$
$
$
$
$
$
10.7%
9
2019
77,288.24
34,779.71
4,088.20
81,376.44
79,346.92
2,029.52
0.3347
679.37
2,029.52
$
$
$
$
$
$
$
$
10
2020
85,017.07
34,779.71
4,497.02
89,514.09
87,281.61
2,232.47 $ 2,500.37
0.2964
661.75
2,232.47
$ 37,235.93
$ 2,735.18
$ 10,904.35
$ 3,232.26
Growth Rate
$ 43,203.37
$
1.87
12.93%
$
$
14.46
15.21
$43.48
12.93%
-10%
Ke
7.17%
8.93%
10.93%
12.93%
14.93%
16.93%
17.10%
$
$
$
$
$
$
$
-10%
41.52
28.77
20.35
15.21
11.87
9.58
9.42
Overvalued
< 39.13
$
$
$
$
$
$
$
-20%
38.03
27.06
19.57
14.87
11.73
9.54
9.39
$
$
$
$
$
$
$
-30%
36.42
26.22
19.17
14.68
11.66
9.52
9.37
$39.13 < Fairly
Valued < $47.83
$
$
$
$
$
$
$
-40%
35.49
25.73
18.93
14.57
11.61
9.51
9.36
$
$
$
$
$
$
$
Undervalued
> $47.83
10% Analyst
323 | P a g e
-50%
34.88
25.40
18.76
14.49
11.58
9.50
9.35
References:
http://www.cftc.gov/
Business Analysis & Valuation, Palepu & Healy
http://www.restaurant.org/
http://www.hoovers.com/restaurants/
http://www.restaurant.org/pdfs/research/2010Forecast_PFB.pdf
http://www.foodsupplier.com/
http://online.wsj.com/article/SB125176231048474323.html?KEYWORDS=PF+Chang%2
7s
Wall Street Journal: Restaurants Dangle Cheaper Drinks but Risk Watering Down Their
Profits (September 29, 2009)
By DAVID KESMODEL and JULIE JARGON
Wall Street Journal: (october9th, 2009); Crafty Ways Restaurants Cut Costs
By NEIL PARMAR
Wall Street Journal: Diners Like Pagers and Online Reservations, Study Finds (May 4,
2009)
By Raymund Flandez
Wall Street Journal: Report Says FDA Struggles to Keep Food Safe (June 8, 2010)
Associated Press
Wall Street Journal: Surfing the Web to Save on Food (June 15, 2008)
By AMY HOAK
324 | P a g e
Wall Street Journal: Consumer Credit Expands (June 7, 2010)
By JEFF BATER And MEENA THIRUVENGADAM
Wall Street Journal: CSPI’S ‘Xtreme Eating Awards’ May Disgust You – Or Make You
Hungry (May 25, 2010)
By Katherine Hobson
Wall Street Journal: Squeezed Restaurants Shed Jobs: Paychecks and Tips Disappear as
Customers Spend Less and Ingredients Prices Rise (December 10, 2008)
By JANET ADAMY
New York Times: Discounts Force Chains to Eat Their Own Lunch, By William Neuman
(June 24, 2009)
USA Today: Casual Dining Chains Hunger for Change; With Slowing Sales and Aging
Restaurants, Executives Rethink, Retrench and Redesign, By Bruce Horovitz (October
14, 2008)
http://www.beemerreport.com/newssingle.php?id=21
http://www.gallup.com/poll/128084/Fewer-Americans-Cutting-Back-Spending.aspx
http://www.gasbuddy.com/gb_retail_price_chart.aspx?time=24
http://investing.businessweek.com/research/sectorandindustry/sectors/sectordetail.asp?
code=25
http://www.qsrmagazine.com/articles/features/129/recession_segments-1.phtml
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