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NEW YORK CITY-Lehman Bros. has initiated coverage of the P.F. Chang’s China Bistro chain, rating its stock as “equal” to others in the category, meaning it is expected to perform in line with others in its sector over 12 months. The research report on Chang’s, by Lehman Bros. analyst Jeffrey A. Bernstein, calls P.F. Chang’s “the clear leader in the Asian segment of the restaurant industry,” butsays that “recent sales weakness keeps us cautious.”

The report notes that P.F. Chang’s operates two leading Asian concepts, its high-end P.F. Chang’s China Bistro brand and its fast-casual Pei Wei Asian Diner, with a third concept called Taneko Japanese Tavern in the works. Although calling the chain a “best-in-class operator,” the report says that despite the strong long-term outlook, “traffic trends remain weak and the ongoing slowdown in percentage unit growth at the Bistro puts added pressure on Pei Wei to lead.”

Lehman Bros. foresees 25% unit growth but relatively flat comparable store sales over the next few years, with sales growth of 16% to 18%. In general, it sees a deceleration of growth at the Bistro offset by more aggressive growth at Pei Wei.

The report outlines how the Bistro and Pei Wei chains have grown. It says the Bistro strategy has been based on building restaurants in top tier markets throughout the country in order to generate brand awareness and to capture premium real estate sites ahead of competitors.

“As the Bistro concept continues to mature, management expects to go back to fill-in around the most successful restaurants,” the report explains. It says that many of the most desirable major metropolitan markets have already been tapped, so management has found it increasingly difficult to enter new markets, with 10 of a projected 20 new units opening in existing markets in 2006.

Development of the Pei Wei concept has been based more on capturing individual markets with greater penetration and density, resulting in 77 Pei Wei locations in 13 states at the end of 2005 as compared to 131 Bistros in 34 states. In addition, management has recently begun to consider “blitzing” a market by opening a handful of Pei Wei stores at once, the report notes.

The recent slowdown in traffic at P.F. Chang’s and other chains is a result of “macro-consumer pressures,” according to the report, which says that the slowdown has led to a “more difficult operating environment” for growing restaurant chains. It suggests that the focus on the Asian segment of the market may in some ways limit the chain. “We believe it is too early to consider saturation.”

The full-service Asian dining segment is a $14 billion niche market, representing less than 10% of the total full-service restaurant industry, according to the Lehman Bros. research, which notes that sales in the sector increased 4.5% in 2005 and are expected to continue to grow in the mid-single digits over the next few years.

Approximately just about 12% of Asian chains have grown to any appreciable size, with much of the segment composed of independent restaurants that often struggle when a chain concept enters their particular market, the report points out. These conditions have worked in favor of Chang’s, which has been able to capture market share quickly and enter new markets with high initial volumes.

The success of P.F. Chang’s “has paved the way for the early development of competing Asian chains,” including Mama Fu’s, Paul Lee’s Chinese Kitchen, and the Cheesecake Factory’s soon-to-be-introduced Asian concept, the report notes. Despite the increased competition, P.F. Chang’s management remains optimistic on the segment, explaining that the target customer base has grown large enough to support multiple concepts.

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