P.F.Chang's China Bistro (PFCB)

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Michael Mitchell

Scott Redmond

P.F. Chang's China Bistro (NASDAQ:PFCB) runs two chains of Asian restaurants, P.F. Chang's China Bistro and Pei Wei. As of 2008, PFCB operated 189 China Bistro locations and 159 Pei Wei restaurants.^[1] In 2008, PFCB earned about $1.2 billion in revenue, a 10.5% increase from a year earlier, due to 42 new restaurant openings during the year.^[2]

P.F. Chang's is vulnerable to increases in commodities prices that raise the cost of preparing its food, and the company's operating margin has decreased 2.2% since 2004, dropping to just 4.4% in 2008 because of higher operating expenses.^[3] Revenues are impacted by trends in consumer spending. A weak economy and rising food and gas prices reduce the amount of disposable income consumers can spend dining out, and in 2008 comparable store sales at China Bistro restaurants declined 3.2% while Pei Wei comparable store sales dropped 3.7%.^[4] ]

Business Overview

P.F. Chang's China Bistro operates one of the largest Asian restaurant chains in the United States by revenue and restaurant locations. The company operates two restaurant chains, its namesake P.F. Chang's China Bistro, and Pei Wei, a fast food Asian restaurant chain. The company operates 189 locations of its China Bistro^[1] which account for approximately 77% of the company's revenue.^[5] The company also owns 159 locations^[1] of the Pei Wei chain which earn about 23% of the company's revenue.^[5] Together, the two restaurant franchises earned about $1.2 billion in revenue in 2008, a 10.5% growth from 2007.^[2] In 2009, the company expects its sales to remain flat because of declining consumer spending.^[6] As a result, the company only plans to open between four and six new Bistro locations and two to four Pei Wei restaurants in 2009, significantly less than the 17 and 25 new Bistro and Pei Wei restaurants opened in 2008.^[6]

Business Segments

P.F. Chang's China Bistro (77% of Revenue)

China Bistro's revenue increased about 8.3% during 2008, reaching $919.9 million^[7] which the company attributes mainly to 17 new restaurant openings in 2008.^[7]

• P.F. Chang's China Bistro's 189 restaurants serve Chinese dishes, featuring open kitchens and life-size replicas of terra cotta Chinese warriors.
• China Bistro's are open for both lunch and dinner, accounting for 33% and 67% of the restaurant chain's revenue, respectively, in 2008.^[8]
• The average guest check size was between $20 and $21 in 2008^[8]
• China Bistro's alcoholic beverage sales, which include wine, Asian beer and sake, accounted for 15% of its sales in 2008.^[8]
• China Bistro's comparable store sales decreased 3.2% in 2008, which the company attributes to reductions in guest traffic caused by lower levels of dispensable income in the weakened U.S. economy.^[4]
• The company plans to open between four and six new Bistro restaurants in 2008.^[6]

Pei Wei (23% of Revenue)

Pei Wei's revenue increased almost 18.6% in 2008, reaching approximately $278 million^[7] which was primarily due to the opening of 25 new Pei Wei restaurants during 2008.^[7]

• Pei Wei's 159 restaurants provide casual dine-in and take-out options; take-out sales account for 38% of Pei Wei's revenue^[8]
• Pei Wei restaurants serve both lunch and dinner; lunch sales account for 43% of Pei Wei's revenue and dinner sales account for 57% of its revenue.^[8]
• Customers spent an average of $8.50 to $9.50 per visit during 2008, remaining stable from 2007.^[8]
• Alcoholic beverage sales at Pei Wei locations account for 2% of its revenue.^[8]
• Pei Wei's comparable store sales declined by 3.7% in 2008.^[4]
• The company plans to open only two to four new locations of its Pei Wei chain during 2008.^[7]

Financial Analysis

P.F. Chang's earned $1.2 billion in revenue in 2008, a 10.5% increase from 2007.^[2] PFCB attributes this growth mainly to the additon of 42 new restaurants in 2008, which was partially offset by declines in comparable store sales.^[6] The company attributes reductions in traffic in both its restaurants to decreased amounts of consumer dispensable income caused by the subprime lending crisis in 2007. For example, a 2007 RBC Capital Markets survey indicated that 39% of respondents had reduced their frequency of dining at restaurants.^[9] In 2008, PFCB's operating expenses outpaced its revenue, increasing by 11.1% because of higher cost of sales and marketing expenditures.^[2]

Because of the increase in operating expenses, PFCB's operating income dropped by 1.5% in 2008. Furthermore, the company's cost of sales and labor expenses were the primary contributors to its approximate 14.7% average annual increase in operating expenses since 2004, which have outpaced the company's 13.9% increase in revenue during that period.^[2] Additionally, the company's operating margin has decreased about 2.2% since 2004, reaching 4.4% in 2008 because of its higher operating expenses.^[3]Moving forward, the company expects to only open four to six new China Bistro restaurants and two to four new Pei Wei locations in 2009 because of the weakened consumer environment.^[6]

Trends and Forces

Increased Commodities Prices and Higher Wages Reduce Operating Margin

Since 2005, increases in prices of food and labor have spurred P.F. Chang's steady decline in operating margin. In 2007, wholesale foods reached their highest prices in 27 years.^[10] From 2005 to 2007, P.F. Chang's cost of sales increased an average 13.4% annually, particularly due to increases in fruit and vegetable prices and beef prices.^[2] In 2008, however, PFCB's cost of sales increased 9.6% because of new restaurant openings, but decreased as a percentage of sales from 27.4% in 2007 to 27.2% in 2008.^[2]

Additionally, labor costs, primarily hourly wages and costs of chefs, have increased an average 14.3% since 2004 because of wage increases as well as restaurant expansion.^[3] These costs have been historically variable from each state but as of 2006, 23 states had a minimum wage higher than the $5.15 per hour national minimum.^[11] Furthermore, as part of the Fair Minimum Wage Act of 2007 the national minimum wage will increase over 40% during 2008 and 2009 to $7.25 per hour, which will significantly raise P.F. Chang's labor expenses as the company pays this wage to many of its employees.^[12]

Together, the company's cost of sales and labor expenses were the primary contributors to its approximate 14.7% average annual increase in operating expenses since 2004, which have outpaced the company's 13.9% increase in revenue during that period.^[2] Furthermore, the company's operating margin has decreased about 2.2% since 2004, reaching 4.4% in 2008 because of its higher operating expenses.^[3]

Weakened U.S. Economy Slows Restaurant Traffic and Sales

In 2008, revenues and traffic have declined across the restaurant dining sector as consumers respond to the 2007 Credit Crunch and subprime lending crisis by saving money and eating at home. Although P.F. Chang's total revenue continues to increase, comparable store sales declined 3.2% in 2008 at China Bistro while dropping 3.7% at Pei Wei as consumers began to subsitute for slightly cheaper options like Panda Express.^[4] As a result of slowing sales, PFCB only plans on opening a handful of each of its restaurants in 2009, compared to a total of 42 new restaurants opened in 2008.^[6]

Rising Popularity of Asian Cuisine Spurs Sales

Although the weakened U.S. economy has slowed the growth of the restaurant industry overall, the emerging popularity of Asian cuisine helps P.F. Chang's restaurants maintain positive sales growth. In 2007, Asian restaurants grew 11.6% in revenue, outpacing growth in most other cuisine categories.^[13] The company's 2008 expansions of 17 China Bistro and 25 Pei Wei restaurants, although significantly less than 2007, planned to capitalize on the increasing demand for Asian cuisine primarily through Pei Wei's expansion into new, untapped markets during 2008. Furthermore, the company has added new menu items at its China Bistro chain (an example is Citrus Soy Salmon) and has started to offer more affordable lunch-sized entrees in order to maintain relevance with customers and increase China Bistro's lunch sales.

Competition

The Asian niche of the casual & upscale restaurants industry is primarily comprised of small, locally-owned restaurants with only one or two locations.^[14] P.F. Chang's restaurants also compete with several large national Asian restaurant chains, including Panda Express, Pick Up Stix restaurants of Carlson Restaurants Worldwide, Inc., Benihana (BNHNA) and Kona Grill (KONA).

• Panda Express operates in the fast food restaurants category, serving its most popular Orange Flavored Chicken and other casual Chinese cuisine at 1,168 locations across 34 states.^[15] Panda Express competes most closely with P.F. Chang's Pei Wei restaurants as its food is premade and usually served to customers on-the-go.

• Pick Up Stix operates 125 fast food Chinese restaurants across California, Nevada and Arizona.^[16] Pick Up Stix's made-to-order menu offers many items similar to Pei Wei's menu, with popular items like its House Special Chicken and Beef and Broccoli.^[16] Additionally, Pick Up Stix restaurants present a similar atmosphere with its wok-searing exhibitions in open kitchens.

• Benihana (BNHNA) restaurants are the closest form of direct competition for P.F. Chang's China Bistro. Benihana owns and operates three restaurant chains of Asian cuisine and earned $296.5 million in revenue in 2007.^[17]. First, the company operates 60 of its namesake Benihana teppanyaki-style Japanese restaurants that serve a variety of chicken, steak and seafood prepared at a grill at the center of the customers' table.^[18]. The company also operates 19 restaurants of its RA Sushi chain, which serve sushi and Pacific Rim dishes.^[18] Lastly, Benihana operates 9 locations of its upscale sushi restaurant, Haru.^[18]

• Kona Grill (KONA) operates 21 restaurants across 13 states and earned about $75.81 million in revenue in 2007, up from the approximate $72 million in 2006.^[19] Much of this increase can be attributed to expansion, as Kona Grill opened 3 new locations during 2008.^[19] Kona Grill offers a wide array of American and Pan-Asian dishes with unique twists created by over 40 signature sauces that Kona Grill makes from scratch.^[19]

References

1. ↑ ^{1.0 1.1 1.2} PFCB 2008 10-K, Item 1, pg. 3
2. ↑ ^{2.0 2.1 2.2 2.3 2.4 2.5 2.6 2.7} PFCB 2008 10-K, Item 7, pg. 25
3. ↑ ^{3.0 3.1 3.2 3.3 3.4} PFCB 2008 10-K, Item 6, pg. 17
4. ↑ ^{4.0 4.1 4.2 4.3} MSN.com "P.F. Chang’s Reports Fourth Quarter Earnings" 2/11/2009
5. ↑ ^{5.0 5.1} PFCB 2008 10-K, Item 7, pg. 22
6. ↑ ^{6.0 6.1 6.2 6.3 6.4 6.5 6.6} PFCB 2008 10-K, Item 7, pg. 20
7. ↑ ^{7.0 7.1 7.2 7.3 7.4} PFCB 2008 10-K, Item 7, pg. 26
8. ↑ ^{8.0 8.1 8.2 8.3 8.4 8.5 8.6} PFCB 2008 10-K, Item 1, pg. 4
9. ↑ Nation's Restaurant News 10/1/2007
10. ↑ National Restaurant Association 2008 Restaurant Industry Forecast
11. ↑ Stateline.org 9/22/2006
12. ↑ Cnnmoney.com 7/24/2008
13. ↑ Technomic 2007 Restaurant Industry Report
14. ↑ PFCB 2007 10-K, Item 1, pg. 6
15. ↑ Panda Express Company Profile
16. ↑ ^{16.0 16.1} Up Stix Company Profile
17. ↑ ^{17.0 17.1 17.2 17.3 17.4 17.5 17.6} Benihana Google Finance Profile
18. ↑ ^{18.0 18.1 18.2} Benihana 2008 10-K, Item 1, pg. 1
19. ↑ ^{19.0 19.1 19.2 19.3 19.4 19.5 19.6 19.7} Kona Grill GoogleFinance Page
20. ↑ Kona 2008 10-K, Item 7, pg. 26