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Not Much Cooking at P.F. Chang's China Bistro

The shares fall after a warning but remain expensive given the no-growth outlook.

What can you do
You're in a stew
Hot pot cook it up
I'm never gonna stop...
-- Toto Coelo

Shares of

P.F. Chang's


were shredded like mu shu chicken on Wednesday after the company reported first-quarter earnings.

The earnings themselves were rather benign: 36 cents per share, in line with analysts' estimates. But the company issued a warning for the full year. P.F. Chang's now will earn about $1.31 per share, according to its press release. Wall Street had been looking for $1.40. Roughly 5 to 6 cents of the miss is due to option grants. The rest is due to sales and margin issues, which I forecasted would be a critical issue in my

earnings preview.

Operating and net margins have been decreasing for the past four quarters. While cost of sales actually declined 10 basis points because of falling poultry prices, operating margin fell to 6.7% from 9.2% a year ago. Net margin fell to 4.3% from 5.6%, and this year's total included 90 basis points less provision for income taxes.

In reaction, the stock fell 4% to $44.15 Wednesday on about 6 times its average daily trading volume for the past three months.

On the conference call, management tried to blame cannibalization of territory as one of the main causes for the company's problems. It pointed to six high-volume Pei Wei stores in Phoenix and Dallas that saw cannibalization rates of 15%. Cannibalization occurs when a company puts a new store in the same market as an existing one and the new location pulls sales from the old. The company had expected just 5% cannibalization rates.

Management then tried to persuade investors that it's all good in the hood, there's nothing to see here -- keep moving... oh, and by the way, they


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that the 15% drop off was due to cannibalization, but they can't say for sure.

P.F. Chang's also suffered weaker-than-projected sales in stores in Minneapolis and North Carolina -- two markets where they expect to add more locations this year. The good news is that those particular restaurants have grown according to schedule, but they are still below plan. Investors should be concerned that the new locations in those markets may get off to a slow start as well.


beef with P.F. Chang's (pun intended) has always been related to traffic growth, or the lack thereof.

Pei Wei was supposed to be the big growth driver for the company. But in the first quarter same-store sales fell 2%. For 2006, management projects same store sales growth of just 0.2%. That figure includes an expected 2.5% price increase in June, indicating that traffic at the growth-driving franchise is projected to decrease.

Traffic at the Bistro is also expected to be flat. And that's not taking into account any pressure on the consumer from inflation, interest rates or gas prices. On the conference call Wednesday afternoon, President Robert Vivian acknowledged that he was "anxious regarding the impact of higher gasoline prices" on guests, but that the company had not adjusted its forecasts. In other words, if P.F. Chang's customers begin to feel pinched from any of a host of factors, revenue and earnings expectations will likely be missed.

Keep in mind, P.F. Chang's China Bistro is very popular. I'm not suggesting that tumbleweeds are blowing through the restaurants. But traffic at the Bistro has nowhere to go but down, as most locations are packed at dinner time. It may seem odd to be so negative on such a popular concept, but the stock has always been valued as a growth story. That is simply not the case anymore. The stock trades at roughly 34 times 2006 estimated earnings. Kind of pricey considering that you get no earnings growth in 2006.

There may be a time when P.F. Chang's shares are considered attractive again. But I don't believe that will happen until the stock is below at least $39.

In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86,87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback;

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