TEXAS ROADHOUSE (TXRH) – “BEST OF BREED” – REPORTS JUNE QUARTER – WHAT CAN WE LEARN ?

SUMMARY OF TEXAS ROADHOUSE REPORT

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

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