China's Stomach Is Grumbling

Running a fast-growing restaurant chain in China doesn't guarantee you success. Country Style Cooking Restaurant Chain (NAS: CCSC) now trades at a third of last year's highs. Its recipe for disaster has been one part initial exuberant hype, and two parts disappointing financials.

After posting back-to-back quarters of softer-than-expected adjusted profitability, the fast-growing chain specializing in Sichuan-style comfort food came up short for the third time in a row last night. CSC's earnings -- adjusted for a one-time tax levy and stock-based compensation -- clocked in at $0.04 a share, just shy of the $0.06 a share that Wall Street was ordering.

At first glance, you might blame the miss on escalating food prices in these inflationary times. Chinese pork producer Zhongpin (NAS: HOGS) has seen its prices skyrocket over the past year. However, food cost is one of the few line items that actually didn't outpace CSC's top-line growth. Instead, wages, rent, utilities, and SG&A expenses are all gnawing away at margins by growing faster than CSC's revenue.

The silver lining here? Investors already trashed the stock for an even weaker performance three months ago. The hype balloon has long been popped, with the 159-unit chain trading well below last year's IPO at $16.50.

CSC still needs to get its internal costs in order to woo investors. It's certainly got growth to spare. Revenue climbed by a better-than-forecast 39% to hit $36.3 million. Its guidance for the current quarter -- calling for revenue between $43.5 million and $45 million -- also makes it likely that analysts are aiming too low with their current $43.5 million estimate at the moment. CSC also now aims to open between 70 and 80 new locations this year, five more than it was previously projecting. Comps rose by 6.3%, but that's not as impressive as it sounds, given that it's in the ballpark of China's own CPI growth.

Clearly, there's money to be made in China. Conservative investors have been flocking to Yum! Brands (NYS: YUM) as a play on China, given its success with KFC and recent acquisition of the Little Sheep hot-pot chain.

CSC did reveal that it increased prices by 5% to 10% at two-thirds of its restaurants toward the end of the quarter. If hungry patrons keep coming at these new price points, margins and obviously comps should bounce back this current quarter.

I recommended CSC to Rule Breakers newsletter service subscribers, sadly at much higher price points, late last year. Today's entry points are certainly attractive, but it wouldn't hurt if CSC could curb its free-spending ways on this heady growth path. It can feed its patrons while also feeding shareholder appetite for stronger margins. If it wants to revisit last year's highs, that's the only real item on the menu that CSC needs to tackle.

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At the time thisarticle was published The Motley Fool owns shares of Yum! Brands. Motley Fool newsletter services have recommended buying shares of Yum! Brands and Country Style Cooking Restaurant Chain. Motley Fool newsletter services have recommended writing puts in Zhongpin. Try any of our Foolish newsletter services free for 30 days. Longtime Fool contributor Rick Munarriz believes in Chinese growth stocks and owns shares in Country Style Cooking. He is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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