Texas Roadhouse: Time To Saddle Up

Jul.23.14 | About: Texas Roadhouse, (TXRH)

Summary

Texas Roadhouse has achieved strong revenue growth while maintaining high margins.

The company's focus on local marketing has helped Texas Roadhouse bring in many customers at a very low cost.

Texas Roadhouse is establishing franchise partners in the Middle East and Taiwan.

Texas Roadhouse (NASDAQ:TXRH) is an American steakhouse chain that strives for a casual, fun environment embracing its Southwestern theme which includes upbeat country music, birthday celebrations, and line dances. It has approximately 350 company restaurants and about 75 franchise restaurants across every state in the continental US. A few of the franchises are in Kuwait, UAE, and Saudi Arabia. Each restaurant seats about 250 people at around 60 tables.

Texas Roadhouse focuses on offering its customers high-quality, affordable steaks which range in price from a $9.99 6 oz sirloin to a $24.99 23 oz porterhouse T-bone. It also offers many other entrees including chicken, fish, and seafood. The vast majority of Texas Roadhouse's revenue comes from dinner sales with most of its stores only open for lunch on weekends.

Texas Roadhouse tries to motivate managers through performance-based incentives. In addition to a base salary, managers are paid a percentage of their restaurant's pre-tax net income as well as with stocks. These performance-based bonuses serve to attract aspiring, motivated individuals who feel they can manage a successful restaurant. The bonuses also encourage managers to want the best for their restaurants and the entire company since the success of both is tied directly to their financial compensation. Multi-store supervisors are compensated through a similar incentive-based combination.

Texas Roadhouse mostly leaves marketing to individual stores and their managers. Restaurant managers are encouraged to focus on local community-based marketing involving local charities and organizations ranging from hosting local radio shows to providing time, money, and food to the Special Olympics. The rest of Texas Roadhouse's marketing is focused around holiday promotion and gift cards and other efforts to attract repeat customers. Texas Roadhouse's choice to avoid national marketing campaigns and let each restaurant manage most of its own marketing allows restaurants to tailor promotions to their potential market and helps differentiate Texas Roadhouse from other large restaurant chains, many of whom rely on national advertising campaigns. Not using national advertising also keeps operating costs low with less than 7% of Texas Roadhouse's revenue being spent on sales, general, and administrative expenses. Comparatively, Del Frisco's Restaurant Group (NASDAQ:DFRG), Ruby Tuesday (NYSE:RT), and Darden Restaurants (NYSE:DRI), which owns Longhorn Steakhouse, Olive Garden and Red Lobster, spend about 10-13% of revenue on sales, general and administrative expenses.

Growth

Texas Roadhouse's management has expressed plans to expand to 700 to 800 restaurants. The pre-opening cost for each Texas Roadhouse location was on average $4.2 million in 2013 and the pre-opening cost is supposed to remain relatively flat in 2014. In 2014, Texas Roadhouse plans to open 25-30 company restaurants and 5 franchise restaurants and continue to grow at this pace for at least the next few years. This will cost Texas Roadhouse $105-$126 million in 2014 and will probably rise about $5 million a year due to increases in opening costs. Six new company restaurants already opened in the first quarter.

In the past, Texas Roadhouse has primarily expanded to small cities and will continue to focus on small and mid-sized cities for future expansion. Since, Texas Roadhouse is not present in most large cities across the US, if its management believes it is a good choice in the future, it has plenty of room to expand in larger markets.

In 2010, Texas Roadhouse expanded its franchise to the Middle East with four current franchise locations in three countries in this area. This was part of an extended franchise agreement to develop 35 franchise restaurants in the Middle East in the next ten years. Texas Roadhouse signed a similar agreement to expand its franchise to Taiwan. Its management has regularly shown interest in further international expansion seeking to mirror the success of many other US based restaurant chains that have become profitable internationally.

Financials

Texas Roadhouse has increased its revenue and earnings every year for the last 10 years with double-digit growth per year for the last three years. Although operating margins have declined for Texas Roadhouse to 8.3% over the last 12 months, slightly below its three-year average of 8.56, it margins have not been effected as much as many of its competitors. Darden Restaurants, Del Frisco's and Ruby Tuesday all reported significantly lower margins for the same period.

At the end of the first quarter of 2014, Texas Roadhouse only had $51 million in long-term debt and no short-term debt, resulting in a debt/equity ratio under 0.1. With almost $100 million in cash and projected net income around $100 million, for the next year, indebtedness is not a concern for Texas Roadhouse.

Risk

Americans' continued focus on healthy eating may drive customers away from steak.

Even a small rise in food prices will cut into Texas Roadhouse's margins or force its restaurants to raise prices.

Texas Roadhouse may struggle to find favorable locations for its new restaurants slowing store growth.

Although Texas Roadhouse did not struggle following the stock market crash in 2008, a future economic downturn could hurt its sales as consumers are forced to turn to quick-service restaurants instead of full-service ones.

Valuation

Texas Roadhouse currently trades at a forward P/E of 17.3 and a P/E of 22.4 compared to an industry average of 29.1. Its earnings are expected to grow 16% annually for the next two years. Compared to competitors, Texas Roadhouse seems undervalued. Many competitors, like Ruby Tuesday, which currently trades at a forward P/E of 75, are struggling to maintain positive earnings. Darden Restaurants has a slightly higher forward P/E but much slower earnings growth.

Texas Roadhouse's strong cash flow from operations allowed it to begin paying a dividend in 2011 and has raised it every year since, currently paying 2.3%. In addition to its dividend, Texas Roadhouse's Board of Directors approved a plan in May, to repurchase up to $100 million of its own common stock. Since 2008, Texas Roadhouse has spent almost $200 million to repurchase about 14 million shares. At the end of the first quarter, Texas Roadhouse was only approved to repurchase $33.7 million worth of its stock. The increase in allowable repurchases shows that Texas Roadhouse is still committed to providing value to shareholders through buybacks. Part of the reason for these buybacks is to avoid dilution caused by Texas Roadhouse's use of shares as compensation for employees.

Conclusion

Texas Roadhouse is forecasted to report earnings on August 4th of $0.33 per share, up 18% from the same quarter last year and seems to be in a good position to meet these earnings and continue to experience earnings growth in the high teens. Texas Roadhouse was voted "#1 Steakhouse" by Restaurant News just over a year ago. It also was the only casual restaurant chain to make it on Glassdoor's Top 50 Best Places to Work list and was named by Forbes as one of America's 100 Most Trustworthy Companies. With all these accolades, it is no surprise Texas Roadhouse has achieved strong same-store sales growth and will likely continue this trend in the future. Its management compensation program provides strong incentives for new managers to create successful stores as the company works to meet its yearly goal of 25-30 new company stores per year. Its focus on smaller cities helps to keep its expenses low, as does its local promotion-based marketing strategy, both of which have helped keep its margins high. Texas Roadhouse is also working to expand to the Middle East and Asia. These two markets will be very profitable if Texas Roadhouse is able to set up franchise partnerships and appeal to consumers in those markets. Through rising dividends, corresponding to a payout ratio around 40%, and a strong share repurchase program, Texas Roadhouse has shown it is committed to returning value to investors and is a strong long-term buy.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.