Texas Roadhouse generally met and even exceeded expectations in the quarter ending 6/25, especially in terms of sales results. Comp sales were up 4.7% at company locations, including 1.7% traffic growth, and up 4.3% at franchised stores, both very similar to Q1.  Restaurant EBITDA margin dollar generation was up 6.5%, from new store contribution. Average Unit Volumes also looked good, up 4.2% at company, and 4.3% at franchised stores. EPS was $0.63 vs $0.62 a year earlier, up 1.6%.

The sobering part of the situation is that 4.7% same store sales was not enough to allow for improvement, or even maintenance of, the restaurant EBITDA % margin, which decreased 53 basis points YTY to 17.6%. To be sure, that was an improvement over the 128 bp decline of Q1. The pressure came almost entirely from the labor line, which increased 90 bp in Q2 to 32.9%, more than offsetting the improvement in Cost of Sales (from unexpectedly low beef prices)  by 40 bp. Operating Income and Income Before Taxes was down slightly for the quarter, and lower taxes allowed for the slight increase in EPS. The quarter was largely a repeat of Q1, except that labor pressure was a little less (118 bp worse YTY in Q1) and Cost of Sales helped in Q2 (worse YTY by 7 bp in Q1).

Without going through all the details of the quarter, it is largely “business as usual”. Of note is their lack of interest in delivery, but to-go is growing 15-20% annually, up to about 7% of sales.

Looking ahead in the formal guidance, there is expected to be commodity cost inflation of 1-2%, and 7-8% in labor dollars per store week, so there is no indication of relief in the labor component, and the Q2 improvement in beef prices is expected to be “transitory”, as Janet Yellin or Jerome Powell would put it.


The bottom line for us is that even for this best of breed operator, generating store level volumes among the highest in the industry, with unit growth at a manageable 5% annually, generating admirable same store sales growth which includes traffic improvement, operating margins have deteriorated. Calendar 2017 showed an 8.3% improvement in Income from Operations, aided by an improvement of 131 bp in the volatile Cost of Goods expense line which offset labor pressure. Calendar 2018 showed EPS growth of 10%, but operating income was virtually flat, and a lower tax rate was the saving grace. Operating margin pressure continues to be the case in 2019, and we see no predictable reason that there should be material improvement in 2020.  We heard one CNBC commentator just last night talk about the attractiveness of restaurant stocks because they are immune from Amazon. True enough, but what is a flat earnings trend, with no change in sight, worth?

Readers can refer to our full writeup of TXRH, dated 1/31/19, by clicking  through on our Home Page at “Publicly and Privately Held Companies”. Not much has changed since January. Our Conclusion at that point, after Q3’18 results were in, went like this:

CONCLUSION – as of 1/30/2019 with TXRH at $61.14

Texas Roadhouse is one of the premier operators in the space. Management is outstanding, their long term record is superb, and we don’t doubt that they will continue to be very profitable, will maintain a strong balance sheet, and show steady unit growth. At the same time, it is clear that even 4% traffic growth and 5.5% comps are not sufficient to overcome costs increases, and the menu increases to come could discourage at least a few customers. At 27-28x trailing 2018 EPS, and 24x the 2019 estimate of $2.55 (which might be a reach), the most recent quarter provided a vivid picture of how difficult it is to increase operating earnings. We therefore suspect that Q3 is a harbinger of mediocre results to come, and there could be a better buying opportunity at some time in the next 6-12 months.

Roger Lipton



Well regarded pure franchising Restaurant Brands, QSR, Best of Breed company operator, Texas Roadhouse, TXRH, mature professionally managed multi-chain company operator/franchisor, Brinker, Int’l.,(EAT) all reported their March quarters within the last 36 hours. What can we learn?

Before we start, because the news is not great and I recently seem to be consistently pessimistic (I would say “realistic”), you should know that I am not “talking my book”. I am neither long nor short two of the three companies discussed, and have a very modest short position in only one of them (which shall go nameless). All three stocks are down since they reported, QSR and EAT more modestly than TXRH, which is down about 10% this morning.

We are not going to provide extensive details, which you can read about elsewhere and which we will discuss in our full writeups to be posted within the next couple of weeks. We will provide just the pertinent highlights as we see them, and our conclusion.

Restaurant Brands (QSR), franchisor of Tim Horton’s, Burger King and Popeye’s, reported EPS down YTY, because of a higher tax rate. Actual Income Before Taxes was up, $302M versus $281M, but it should be noted that Other “Income” this year of $17M was $30M better than Other “Loss” a year ago of $13M. Let’s call it “flat” pretax income, by our simple adjustments. Everybody looks at comps and EBITDA by division here. Tim Horton’s delivered a negative comp of 0.6% in Q1, on top of a negative 0.3% in 2018. Price changes are not discussed relative to any of QSR’s three brands, so we can’t comment on traffic. Adjusted EBITDA at Tim Horton’s was $237M, down from $245M. Burger King had systemwide comps of 2.2% on top of 3.8% in ’18. BK’s Adjusted EBITDA was $222M vs. $214M in ’18. Popeye’s had a comp of 0.6% versus 3.2% in ’18. Adjusted EBITDA was $41M vs. $39M in ’18. The three brands, therefore, had total Adjusted EBITDA of $500M vs $498M a year earlier. Let’s call the results flat, and the bottom line is that, as we have predicted for some time, it will be very difficult to grow the EBITDA and EPS comparisons by more than mid single digits. Combining the “hard” results with the conference call commentary, there is very little happening that will accelerate the cash flow and earnings progress. Readers can refer to our previous commentary regarding QSR, , but, suffice to say: Tim Horton EBITDA growth, which grew from 2015 through 2017 largely by price increases imposed on the distribution chain, is not going to recur, especially in light of the lawsuits by franchisees. Burger King is a steady grower, especially overseas, but the G&A magic has already been imposed on this system so the easy money has been made. Popeye’s is the most rapid growth division, but is too small to move the total needle by much. The dividend of almost 4% supports the stock price, but it has seemed to us for a while that this “mid-single digit” grower is fully priced at 20x trailing EBITDA and 25x forward EPS. It should also be noted that much of the “free cash flow” has been used to buy back partnership interests from their parent, 3G, so this “return to shareholders” has primarily benefited 3G. From 12/31/16 to 12/31/18 the average weighted fully diluted shares outstanding has gone from 470M to 477M to 473M. There is substantial cash flow here, but a great deal of it has been used to buy back exchangeable Partnership interests from 3G. The long term debt was constant at $11.8B in ’18 over ’17 (after $3B was borrowed to buy back Berkshire’s Preferred), and “free cash flow” is not so “free” when debt is over five times trailing EBITDA. The Board of Directors preferred in ’18 to buy back stock from 3G (at 25x expected earnings and 20x trailing EBITDA) rather than reduce the debt. We agree that it seems sensible, from 3G’s standpoint, to lighten up. To be sure, there is a substantial dividend for common shareholders.

Texas Roadhouse (TXRH) is a simpler story. They are truly one of the premier operators in the full service casual dining space, consistently delivering same store sales growth as well as traffic gains. The most recent quarter was no exception, with an admirable comp of 5.2%, including 2.6% traffic. The monthly comps, though decelerating through the quarter were fine, up 7.2%, 4.7%, and 4% in January, Feb., and March. April to date is up 2.9% on top of 8.5% a year earlier. However: Income from Operations was down 6.8%, and diluted EPS was $.70 vs $.76. Restaurant margin (EBITDA) was down 128 bp to 17.9%, and the problem was labor, which cost 118 bp. The discouraging part for investors and analysts is that the Company has predicted ongoing wage pressure, and these guys are not about to disappoint customers by cutting labor.  An additional concern, though a lot smaller, is expected commodity inflation of 1-2% for all of ’19. There’s a lot more that could be detailed here, but the results at TXRH demonstrates what we’ve been saying for a while, that it takes more than even 3-4% comps (and now 5.2%) to leverage the higher costs of operations, labor in particular. We don’t know to what extent the Street will lower expectations for ’19 but at $54.37 at the moment (24.7x ’18 EPS) doesn’t seem like a bargain when it is hard to know when EPS growth will resume. FWIW, $54.37 is 14.5x Bloomberg’s estimate of TTM EBITDA.

Brinker International (EAT) reported Q3 (ending March) with somewhat of a “mixed bag”. The headline indicated that EPS, excluding special items, was up 16.7% to $1.26 vs $1.08. Comp sales for Chili’s was up 2.9% (company) and 2.0% (franchised). Maggiano’s was up 0.4%. Operating Income was 8.4% of Revenues, down 50 bp from 8.9%. Restaurant margin (EBITDA) was 14.3%, down from 16.1% but, excluding the effect of a sale-leaseback transaction, would have been flat YTY. (However, the higher rent is a cash charge vs. depreciation which is non-cash, so the true cash EBITDA margin was truly 180 bp lower). Chili’s results are the main driver of results, and, aside from the sale-leaseback penalty, it was pointed out that: “cost of sales increased due to unfavorable  menu mix, and commodity pricing, partially offset by menu pricing, also partially offset by a decrease in restaurant labor from lower incentive compensation, which in turn was partially offset by higher wages.” So: CGS was up, wages were up, restaurant labor (hours?) was down, and there was less incentive compensation. That doesn’t sound like the industry wide wage increase is abating, and commodity costs are up, which we also heard at Texas Roadhouse. While it is admirable that comps were up again at Chili’s, with traffic up as well, it should be noted that the gain in after tax EPS was entirely due to a lower tax rate and far fewer shares outstanding. Income Before Taxes was $55.5M, down from $58.9M. Adjusted for an Other Gain of $3.5M this year versus a $2.7M loss, the comparison would be $52.0M of Adjusted Pretax Operating Income vs. $61.6M. The number of fully diluted shares was 38.1M vs. 46.0M. From a financial engineering standpoint, EAT chose to do a sale-leaseback transaction, paying higher “rent” vs. non-cash depreciation of the stores in return for retiring a large number of shares. From an operating standpoint, even with flat EBITDA at the store level, we see that same store sales (and traffic) gains of 2 or 3% are not sufficient to overcome higher labor (and other) expenses.

The Bottom Line:

The above capsulized reports show that the operating challenges have not abated, and will not likely relent in the foreseeable future. Restaurant Brands’ results show how ten years of low interest rates have allowed financially astute executives to assemble a portfolio of franchised brands, but mature (Tim Horton’s and Burger King) chains can only be financially engineered to a certain point, especially in a difficult environment. Texas Roadhouse and Brinker results show how operators ranging from a Best of Breed growth company  to relatively mature brands are similarly challenged.

Broader than the Restaurant Industry: There are something like 20M individuals employed in the hospitality industries, including restaurants, retail and lodging and this is a material portion of the entire US workforce. The wage increases that are so evident to us will inevitably start to affect the national averages, and the next step will be price increases. Operators of restaurants and retail stores and lodging will not allow their margins to deteriorate indefinitely. All those surcharges such as baggage fees at airlines, “facility” charges at hotels, and miscellaneous add-ons with car rentals (that add 25-30% to the quote), will increasingly be joined by higher menu prices. It’s not a question of “if”, rather “when”.

Roger Lipton




Readers are encouraged to read our descriptive report for broad background, presented here:


Last evening, after the market close, Texas Roadhouse reported their second quarter results. We consider TXRH among the best operators in the full service restaurant universe, with industry leading sales and traffic comparisons, consistent margins, bullet proof balance sheet, and a long term strategic focus.

The headlines included diluted earnings per share up 16.9%, comp sales up 5.7% at company restaurants and 3.9% at domestic franchise  restaurants. Most impressively, traffic was up 4.1%, almost unheard of these days. Also encouraging: comps in the first month of Q3 have been up 4.7%.  New store development has continued, with 14 company restaurants having opened in the last six months, 27-28 planned for the full year. Their Bubba’s 33 restaurants are also doing better, the twelve restaurants in the comp basis improving sales by 7.5%.

The most obvious issue is that almost the entire net earnings after tax gain was from an effective tax rate of 15.6% versus 27.9%  a year earlier. Restaurant operating margin decreased 77 basis points to 18.2%, primarily due to higher labor costs, very typical of almost every operator. Cost of sales actually declined 24 bp, atypical of most operators these days, due to higher average ticket.  In the wake of this more than acceptable report, the manic depressive money management community and computer driven traders reacted to the $.05 shortfall in estimated earnings  by adjusting the market value of TXRH by a cool $500M in the post 4:00 trades and almost $300M as this is written Tuesday morning.

The conference call should have been comforting since, from our vantage point, nothing has changed for the worse. Comp sales are expected to remain in the same range, commodity costs will rise by a relatively modest 1%, labor costs will continue to be rising by mid single digits, costing something like a point in operating margins, though continued traffic gains can mitigate that impact. New Roadhouse locations are averaging over $105,000 per week, and previous class years are showing overall returns well in excess of the weighted cost of capital. The Bubba’s 33 concept, with 20 locations at 12/31/17 plus 7 planned for ’18, is still being evaluated. New units, costing over $6M each, will be modestly smaller than in the past (just over 7,000 sq.ft.). Average AUVs at Bubba’s have not been disclosed.   While the contribution to corporate revenue from Bubba’s is material, it is still small relative to the much larger base of Roadhouses.

Most importantly, with very modest menu price increases over the last year or so, just over a point, we believe there is pricing power here to offset the inevitable increases in labor costs and the possible rise in volatile commodity costs. The operating culture here, so dependent on the long term retention of store level partners and their commitment to long term strategic values, seems capable of reacting better than most to operating challenges.

In summary: What has gone wrong at Texas Roadhouse? Virtually nothing. Investors can make up their own minds whether the short term reduction in share price is adequate to make this stock attractive at just over 25x ’18 EPS, especially since ’19 gains will not benefit from a further material reduction in the tax rate. The growth in revenues, profits, and cash flow may not be as rapid in the past but it will be more a function of industry wide issues  than management shortfalls.