Texas Roadhouse: Low Risk Rapid Growth Story - Buy On Strong Long-Term Outlook

Dec. 01, 2020 1:35 PM ETTexas Roadhouse, Inc. (TXRH)1 Comment
Poonam A. Arora profile picture
Poonam A. Arora
1.75K Followers

Summary

  • TXRH appears to have zero issues to derail its progress and limit its growth.
  • The firm is committed to rapidly implement strategies to benefit from the popularity of its Texas Roadhouse restaurants.
  • Two new restaurant concepts currently being piloted represent additional long-term growth drivers.
  • We're initiating on TXRH with a Buy Rating and a 1-year Price Target of $129/share.

Investment Conclusion

Texas Roadhouse (NASDAQ:TXRH) is a rare asset because of the lack of issues that could potentially derail its progress or limit its growth. The legendary success of TXRH's Texas Roadhouse restaurants has been driven by a business model that is fair to its stakeholders, particularly its customers and its employees. In regards to customers, TXRH provides them with high quality food at reasonable prices in family oriented restaurants with excellent customer service. With respect to its employees, the company shares profits with contributors that support the growth of its business. Driven by TXRH's focus on customers and employees, Texas Roadhouse over FY2019 experienced its 40th consecutive quarter of same store sales growth. Based on financial performance, outstanding customer reviews, and long wait-lines on most nights at Texas Roadhouse restaurants, it appears that customer demand is significant enough to support hundreds of additional restaurants across the United States. In addition, TXRH is currently developing two new restaurant concepts, Bubba's 33 and Jaggers, which could potentially convert into next growth drivers for the firm. Factoring the significant growth opportunities and low uncertainty associated with revenues and cash flows into our 10-year Discounted Cash Flow model, we arrive at a Buy Rating and 1-year Price Target of $129/share for TXRH. Given their emerging status, our Price Target does not include any contribution from the new concepts, which could therefore be considered upside to the TXRH story.

In the context of COVID-19, although as a dine-in restaurant, the company will have to deal with the lingering impact of the final days of the pandemic, long-term repercussions are unlikely. In addition, it is noteworthy that average same store sales for September were positive.

Investment Thesis

TXRH is a restaurant company composed of three brands: Texas Roadhouse, Bubba's 33, and Jaggers. Among them, Texas Roadhouse, a full-service sit-down restaurant which serves All-American cuisine with a focus on steaks, accounts for almost all of the firm's revenues and profits. At the end of F3Q2020, TXRH had 590 Texas Roadhouse restaurants comprised of 563 restaurants in the U.S. (493 company-operated and 70 franchisee-operated) and 27 restaurants in 10 foreign countries (all franchisee-operated). The firm operated 31 Bubba's 33 and two Jaggers restaurants over the period.

In FY2019, TXRH generated: ~$2.76 billion in revenues (comprised mostly of retail sales) reflecting a growth rate of ~12.2% compared to FY2018, same store sales growth of 4.7% over the prior year, ~$474 million in restaurant margin representing year over year growth of 11.8%, ~$175 million in net income reflecting a growth of ~10.3%, $2.46 in Earnings Per Share (+11.8% compared to FY2018), and ~$374 million in operating cash flows.

The predominant element surrounding the TXRH story is related to the firm's strategy to address and convert the strong customer demand for Texas Roadhouse restaurants into rapid growth in revenues and profits over the long term. Related ancillary factors include elements that almost guarantee the success of new Texas Roadhouse restaurants, and the potential of Bubba's 33 and Jaggers to develop into growth drivers for TXRH.

Texas Roadhouse Restaurants Have Persistently Experienced Considerable GrowthTXRH AUVs IncreasingTXRH Customer Traffic IncreasingSource: TXRH's 2019 Form 10-K; Seamist Capital Presentation, November 2020

Strategies To Convert Customer Demand Into Growth

Considering the growth in Texas Roadhouse restaurant's same store sales, average sales volume per restaurant, guest traffic counts, and per person average check, there appears significant customer appetite for Texas Roadhouse restaurants. Therefore, in our opinion, TXRH should rapidly implement prudent strategies to convert the strong customer demand into growth in revenues and profits. Based on initiatives the company is enforcing, it appears that TXRH is cognizant of the growth opportunity and is committed to the rapid expansion of its flagship brand. Presented below is an analysis of the initiatives being implemented to drive top-line growth at Texas Roadhouse restaurants.

New Store Openings. During FY2019, TXRH opened 19 company operated and 9 international franchisee operated Texas Roadhouse restaurants representing a growth rate of ~4.7%. In addition, year-to-date over FY2020, the company launched 10 Texas Roadhouse restaurants, reflecting a growth rate of ~1.7%. Ahead of the viral outbreak, TXRH had guided to the launch of 23 additional Texas Roadhouse restaurants for FY2020. Given that TXRH has set a domestic footprint target of between 700 and 800 Texas Roadhouse restaurants, the company has significant white space to derive growth from geographic expansion.

Expanding Capacity At Existing Restaurants. Labeled as "bump-outs", TXRH typically expands capacity at popular Texas Roadhouse restaurants through remodeling initiatives to increase customer seating. The strategy is the company's favored path to derive incremental same store sales growth from existing Texas Roadhouse restaurants.

Off-Premise Sales. With a view to promote off-premise dining TXRH introduced expanded to-go and curb-side service in response to pandemic conditions. Over the COVID-19 outbreak, to-go and curb-side orders experienced significant growth and at the end of F3Q2020, despite the resumption of dine-in services at most of its restaurants, accounted for ~23% of Texas Roadhouse's total retail sales. Given its popularity among customers, it appears that off-premise retail sales are likely sustainable (to a significant extent) beyond the pandemic and will continue to drive same store sales growth.

In regards to bottom-line growth, we expect substantial leverage related to significantly higher retail sales to reflect in an increase in earnings growth.

Reasons Why The New Texas Roadhouse Restaurants Will Likely Succeed

We believe the value proposition Texas Roadhouse restaurants provides customers and employees, its menu pricing strategy, and its commodity hedging initiatives, ensure the success of potential new restaurants.

That folks enjoy dining at Texas Roadhouse is evident from the excellent customer satisfaction scores it keeps accruing, the solid reviews it receives on websites such as Yelp, and the long wait-lines witnessed at its restaurants. The excellent value proposition Texas Roadhouse offers customers is comprised of the following:

Reasonably Priced Good Quality Food. Texas Roadhouse is well known for providing large portions of its food at value prices. The restaurants serve all-you-can-eat fresh bread rolls with cinnamon honey butter and peanuts for free, early dinner entrees for $10, a full slab of fall-off-the-bone ribs for ~$20, and kids meals beginning at $3.99. All menu items are prepared from scratch in the respective restaurants, steaks are USDA Choice and hand cut, beer is served in cold mugs, and soft drink refills are free.

Family Oriented Ambience. You can bring the kids to Texas Roadhouse restaurants, you don't have to dress-up, and you can relax. The atmosphere is loud and rowdy with significant number of television sets with volumes turned up, children screaming, and people talking loudly. There are peanut shells on the floor from the all-you-can-eat free peanuts. Overall, an unpretentious place customers can come to unwind without the hassle.

Best-In-Class Customer Service. During 2020, Texas Roadhouse secured 80 points on a scale of 0 to 100 on the American Customer Satisfaction Index. The restaurant chain has been a perpetual high scorer on the index since it started being included in the evaluation.

Texas Roadhouse Has Persistently Achieved High Scores On the American Customer Satisfaction IndexTXRH Ranks Highly On ACSISource: American Customer Satisfaction Index; Seamist Capital Presentation, November 2020

Take-Out And Curb-Side Delivery. Although the restaurant chain began providing carry-out service several years ago, it initiated curb-side delivery in response to pandemic conditions. TXRH recently introduced two-way texting for to-go curb-side guests, with a view to improve the pick-up process and labor efficiency. Overall, over F3Q2020, off-premise retail sales accounted for ~23% of total retail sales, demonstrating strong customer demand for the segment.

Mobile Order And Pay. Texas Roadhouse's mobile application facilitates getting on the restaurant's wait-list and ordering take-out. Given that based on financial results, growth in off-premise orders appears sustainable, the mobile order and pay feature is likely to be favorable for driving additional retail sales, in our judgment.

With respect to TXRH's value proposition to employees, it is noteworthy that the firm pays front-line workers higher than industry average wages, and shares profits with General Managers and Market Partners of Texas Roadhouse restaurants.

Texas Roadhouse staffers on being promoted to General Manager of their respective restaurant typically opt-in on a $25,000 buy-in (with funds loaned by the company and forgiven after 5-years of service) that secures them a base salary as well as 10% of the net income generated by their restaurant. Overall, the total compensation a Texas Roadhouse General Manager receives is significantly higher than that secured by their peers at competitor restaurants, with overall compensation exceeding $100,000. Effects of the incentivizing is clearly evident at Texas Roadhouse restaurants where General Managers frequently visit customer tables to check if the service is satisfactory and to promote specials. Given data that demonstrates that 70% of Texas Roadhouse patrons are repeat customers, it is clear that the ownership mentality of employees plays a significant role in customer retention.

General Managers report to Market Partners that are similarly incentivized but on a larger scale. Market Partners supervise 10 to 15 General Managers and provide guidance on site selection for new restaurants and hiring decisions, and are provided the option to opt-in on a $50,000 to $120,000 buy-in which secures them 7% to 9% of the net income of restaurants under their supervision. Considering FY2019 average unit volumes for Texas Roadhouse restaurants were ~$5.5 million, almost double that of their closest competitor, it is clear that profit sharing with key personnel delivers for Texas Roadhouse.

In regards to utilizing menu prices to drive bottom-line growth, it is noteworthy that Texas Roadhouse's business model is focused on (beyond all else) providing customers good quality food at value prices while maximizing profits. The company deploys a barbell menu pricing strategy wherein it charges below market prices for high volume items and premium pricing for higher-end exclusive items. Overall, the approach reflects in considerable margins as the low margins on core items are offset by large volumes and higher margins on premium products. Additionally, TXRH prices Texas Roadhouse menus by region, pushing slightly higher prices onto more expensive geographies. As a whole, the menu pricing strategy is beneficial in driving increased profitability.

In addition, TXRH utilizes commodity hedging to boost the bottom-line. Given that roughly half of cost-of-goods-sold at Texas Roadhouse are comprised of beef, TXRH enters into fixed contracts through commodity hedging strategies to control prices. Since the firm enters into 24-month contracts, beef prices it pays at the time of contract execution are relatively high, but the transaction is ultimately favorable for earnings, as prices of the commodity increase over time.

Overall, the focus on customers and employees (with additional support from prudent menu pricing and commodity hedging strategies) has brought Texas Roadhouse this far, and the policies will continue to drive success at its future restaurants, in our opinion.

New Concepts Represent Embedded Opportunity For Secular Business Upside

TXRH is developing two new restaurant concepts, Bubba's 33 and Jaggers. Based on management's success with Texas Roadhouse, the strength of the concepts, and customer reviews on their experiences at the two restaurants, we believe the businesses are likely to succeed. Therefore, it is highly probable that the restaurant chains could develop into future drivers of secular growth for TXRH.

Bubba's 33. The concept is a chain of sports bars serving burgers, wings, pizza, and drinks. It claims to be a place for all things American - food, family, sports, and beer. There are many similarities between Texas Roadhouse and Bubba's 33: the food is made from scratch, the restaurants are loud, menu items are priced below the competition, they're open only for dinner with only a few stores providing lunch, significant emphasis is placed on providing excellent customer service, and delivery is not offered. Management has plans for rapid growth of the chain, once customer traffic achieves peak velocity. At the end of F3Q2020, TXRH operated 31 Bubba's 33 restaurants.

Jaggers. In contrast to Texas Roadhouse, Jaggers is a quick service restaurant that serves burgers, chicken sandwiches, salads, milk shakes, and French fries, features drive-throughs, and offers delivery. However, similar to Texas Roadhouse, the focus is on great tasting quality food at below competitor prices with excellent customer service. Jaggers is still in the piloting stage with TXRH evaluating novel operation methods and new menu items, ahead of launching a large number of restaurants. Presently, the firm operates two Jaggers restaurants.

Risks

COVID-19 Conditions Might Persist Beyond 2021. We are modeling COVID-19 conditions easing over the next year. If the pandemic related conditions (particularly lockdowns) persist over a protracted period, our Buy Thesis will be impacted considerably. However, given the efficacy outcomes associated with Covid-19 vaccines, it appears that the world is likely to witness an end to the pandemic sooner rather than later. Therefore, we expect a significant increase in percentage of the population returning to normal routines (including dining-in at restaurants) over 2021.

One-Year Price Target

We utilized Discounted Cash Flow analysis including a perpetual growth based terminal value, to arrive at a 1-year Price Target of $129/share for TXRH. We assume a normalized 10-year revenue growth rate of 10%, (vs. FY2019 revenue growth rate of ~12.2%). In addition, we derive our net income for 10-years using a net profit margin of 6% (vs. net profit margin of ~6.3% in FY2019). Based on our analysis of TXRH's historic financial reports, we model normalized 10-year operating cash flows as 14% of revenues/year and straight line 10-year capital expenditure as 7% of revenue/year. Furthermore, we deploy a perpetual growth rate of 3% and a weighted average cost of capital of 7% to reach our terminal value and present value of free cash flow figures. We utilize the current diluted outstanding share count of 69.9 million to arrive at our 1-year Price Target.

Bottom Line

TXRH's Texas Roadhouse restaurants have already succeeded. Underpinned by strong customer demand, loyal employees, and a profitable business model, the steakhouse is in the enviable position of being able to derive growth at will through geographic expansion. Simply based on Texas Roadhouse, TXRH appears to be a significant asset, positioned for long-term outperformance. Bubba's 33 and Jaggers, given their strong likelihood to convert into secular growth drivers, represent cherries on top of the TXRH cake. Overall, the firm is an investment with one of the best risk/reward profiles in the business.

This article was written by

Poonam A. Arora profile picture
1.75K Followers
Currently, I work as an investment analyst at Seamist Capital. Previously, since 2006, I was on the sell-side, covering healthcare stocks as research analyst . The banks I have worked for include the Stanford Group, Madison Williams, Roth Capital, and WR Hambrecht. I have passed the FINRA exams for Series 7, 63, 86, and 87. My educational background includes a Bachelors Degree in Finance and Investments and a Masters Degree in Finance. Ranked 104 out of 7,519 bloggers and 589 out of 14,344 total experts on TipRanks with 75% success rate and 35.6% average returns.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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