California Pizza Kitchen Still A Hold

We expect California Pizza Kitchen (CPKI) to continue suffering declining traffic, deleveraging of its rent expense, and shrinking return on equity throughout 2008. Traffic should stabilize in 2009, but we don’t expect a rebound unless the economy improves substantially and there is little visibility to an improvement in gas prices and real estate values.

Nevertheless, coming off a weak 2008, we think the company can likely reinvigorate earnings primarily through unit growth. We expect it to grow earnings at a mid-teens average rate over the next five years by adding full service restaurants in existing and new markets, increasing comps and restaurant margins through its new prototype restaurant design, further penetrating the fast casual market with the new ASAP concept, repurchasing shares, and building its lucrative Kraft (KFT) frozen pizza licensing business.

In our view, CPKI is likely to meet the lower-end of its 2008 guidance of $0.65-$0.70 EPS and 9%-10% revenue growth, assuming traffic does not deteriorate further, which would happen if the current economic downturn were to worsen. The shares are trading at 17x our 2009 EPS estimate and 19x the consensus EPS estimate, well above, the company’s past growth at a time when there is reduced visibility and above-average estimate risk.

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