Summary
California Pizza Kitchen, a luxury pizza restaurant, was founded in Beverly Hills, California in 1985 by lawyers Larry Flax and Rick Rosenfield. It currently operates 213 locations, with 41% located in California, 6 in international destinations, and the rest spread across 27 other states within the United States.
CPK generates revenue from three sources: sales at its own restaurants, royalties from franchised restaurants, and royalties from its partnership with Kraft Foods. This partnership involves selling frozen pizzas under the California Pizza Kitchen brand in grocery stores. Additionally, CPK operates ASAP, a quick "grab and go" restaurant found mainly in airports and malls. However, the company has halted expansion of ASAP in order to focus on expanding internationally. Given the recent 10% decline in share price, CPK management is considering whe
...ther it is a good time to repurchase shares and potentially use the company's existing line of credit to further strengthen its balance sheet.
The company is considering using debt financing to repurchase shares and fund expansion, which is a departure from their previous approach of avoiding debt since going public. In order to improve their performance, they need to restructure their capital policy and take advantage of leverage. Utilizing debt allows them to buy back stock and sustain steady growth, while also lowering taxes and increasing return on equity. Another strategy to enhance brand recognition and boost performance is to increase advertising expenditure.
Currently, CPK spends only 1% on advertising, while other similar restaurants allocate 3% to 4% of their budget for advertising purposes. Additionally, CPK does not have any debt recorded on their balance sheet. CPK should consider utilizing
debt leverage in an appropriate amount that will enhance their financial capabilities without causing over-leverage, which may negatively impact their financial performance. Striking a careful balance of leverage will contribute to a higher return on equity (ROE) by facilitating growth funding and minimizing the tax burden.
Increasing leverage would lower CPK's Cost of Capital. Relying more on debt would generate a tax shield, boosting profitability compared to their current debt-free approach. It is advised to adopt a 30% capital structure to maximize the tax shield advantage. Additionally, repurchasing stocks could elevate share prices and mitigate the decline in equity market value.
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