California Pizza Kitchen case Essay Example For Students

California Pizza Kitchen case Essay California Pizza Kitchen case essay BY Krysta143 Executive Summary California Pizza Kitchen (CPK) was founded in 1985 by Larry Flax and Rick Rosenfleld with a vision of offering customers designer pizza at reasonable prices. CPKs target market is geared towards affluent customers making $75,000 annually, and over the span of 2 decades the business was able to grow from a single location into 213 locations across 28 states and 6 foreign countries. CPK generates revenue from 3 main sources: company restaurants, franchises, and royalties. CPK stands out from its peers because it offers a compelling menu at low prices, does virtually no arketing, and currently generates profits using zero debt. Despite CPKs positive growth projections, the food industry at the end of 2007 is experiencing increased pressure from higher commodity prices, increasing wages and lower consumer discretionary income. Over the last 2 years we were able to grow sales by 16% while decreasing labor by . 03% in the same period. Despite our strong performance we are currently being pressured by institutional investors to take on additional leverage and re-buy outstanding shares in response to a 10% decrease in our stock price. To etermine if levering the firm would be beneficial I decided to evaluate the benefits of leverage by doing different scenario analysis based on different debt structures 10% 100% leverage. What I found in my analysis was that as we leverage the firm there are many benefits that we are missing out on such as a larger tax shield, increased ROE and disciplined growth effect. On the negative side; there is also the chance that we run into trouble and it may put a squeeze on project spending and in the most unlikely case land us in bankruptcy if we are not careful. It is my ecommendation that we should lever the firm by 30% of debt which should yield us a tax savings to us of roughly $1. 35mm per year and boost our ROE to 11. 05%. Case Analysis California Pizza Kitchen (CPK) is a homemade style pizza company located predominantly in the western region of the United States. It was founded in 1985 by Larry Flax and Rick Rosenfleld with a concept aimed at delivering designer pizza at reasonable prices in family friendly environment. This included an innovative menu that featured items like; Singapore shrimp roll, Shanghai Garlic Noodles, and Chicken Tequila Fettuccine that distinguished it from competitors. Their target market was geared towards affluent consumers making at least $75k annually. Its attractive menu and word-of-mouth marketing concept enabled CPK to expand from a single location to 213 locations across 28 states and 6 foreign countries. CPKs main sources of revenue include: company owned restaurants, franchise, and royalties generated from starting up new franchises. The company also generates royalties through a licensing agreement with Kraft Foods for the manufacture of frozen pizzas that accounts for roughly 5% of annual revenue. Other new sources of revenue include the new brand extension of ASAP stores at various airports. This concept has not been entirely successful and we plan on divesting the remaining 16 new and taking a $770k write down. From a marketing perspective; the company spends minimal amounts on advertising compared to industry standards, as CPK relies heavily on word 0T moutn to attract new customers. I nls allows us to spend only around 1 their overall revenue on advertising. The food industry was divided into two sections; full service and the limited segment. Full service is further divided into asual dining and fine dining while the limited segment is subdivided into fast food and fast casual. CPK is predominantly focused on the limited segment with a sub segment in full service. The CAGR for the limited service segment is projected to grow 5. 5%, while CPKs full service is projected to grow 6. 5%. To hit our 6. 5% growth rate in 2008, we have scheduled between 16 18 new store openings in the coming year. This will require an additional investment of 85 million dollars. A study by the National Association of Restaurants estimates that consumer discretionary spend for ining will increase from 45% to 53% over the next 3 years. Even though spending is on the uptick, the industry is experiencing pressure from rising commodity and labor prices with the new increases in minimum wage instituted by the Bush Administration. Despite the financial pressure, CPK still continues to growth under challenging market conditions. Sales grew by 16% from 2005 to 2006 and royalties increased by 36%. Labor as a percentage of sales decreased from 36. 6% to 36. 3% in the same period. Even with all of these positive metrics CPKs share price saw a decline in the last month by 10% to $22. 0. Agenda Setting EssayAt 35% leverage we assume each additional dollar of debt would force us to pay about 9. 5% per year in interest (Exhibit 3). At this higher interest rate we run the risk of not being able to invest in all of our positive NPV projects, and could even force ourselves into bankruptcy in an extreme situation. We have always remained a stable growth company and I see no need to go above the 30% threshold and subject ourselves to higher rates of interest. If I were to go back the past 3 years we have proven that we can grow comp store sales diligently with zero debt (Exhibit 4). By taking on 30% wortn 0T aeot we snoul a nave enougn extra casn to Duy DacK enougn snares to Doost ROE and still have money left over for our store expansion plans next year. I should also mention that if we benchmark ourselves compared to other restaurant chains, at 30% leverage we would be structured like many of our key competitors such as Darden Restaurants, Brinker International and Red Robin (Exhibit 4). In the past we have outperformed these 3 competitors, but for this to continue it would help to protect our earnings from tax as the market becomes more challenging. Final Recommendation: As the CFO of California Pizza Kitchen I can say with assurance that the decision to lever up the business has less to do with appeasing influential shareholders, and more to do with the tax savings and the disciplining effects of taking on debt. We have already proven to the market that this business has a disciplined approach to rowth, and I see no reason that levering up the company wont have this same sobering effect when we go to pay on our obligations. Based on (exhibit 3) I am safe with taking on an additional 30% of debt which should yield us a tax savings to us of roughly $1. 35mm per year and boost our ROE to 11. 05%. We would turn around and use 100% of the initial proceeds to buy back shares and re-evaluate how to fund the remaining $85mm in capital we need for the remainder of 2007 using secondary financing. If some of our new stores plans are riskier investments perhaps we scale this back in the near term to focus on our existing store footprint. By levering up we are essentially going to pay less income tax to the government in the foreseeable future, allowing us to shield the income that we earn in the difficult period ahead. Already this year our core business has been challenged by higher commodity prices, rising minimum wage, higher energy prices, and eroding consumer discretionary income, but the long term prospects of our business look much better. To make sure that we still maintain flexibility in the interim I will be reviewing our debt structure on a quarterly basis once we make the decision to lever up. This will allow us to control he business and make sure that we avoid a situation where we cant invest in positive NPV projects, or get ourselves into a situation where we are at risk of bankruptcy. From an external standpoint by taking on debt and buying back shares we will be able to boost our ROE to be more competitive with other restaurant chains, and send a positive message to analysts that we have faith in our underlying business. If we are to act on this idea I believe we must act now; access to low interest rates are not going to last much longer and we must lock rates in now before the market deteriorates further.