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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


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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.


Texas Roadhouse is a growing restaurant company which operates three restaurant brands: Texas Roadhouse, Bubba’s 33 and Jaggers predominately in the Casual Dining segment. The first Texas Roadhouse opened in 1963 in Clarksville, Indiana. As of September 2018, they owned and operated 479 restaurants and franchised an additional 70 domestic restaurants and 21 international restaurants. Of the 479 restaurants, Texas Roadhouse operates 453 as Texas Roadhouse, 24 as Bubba’s 33 and 2 as Jaggers. Of the 91 franchised restaurants, the Company has a 5% to 10% ownership interest. The income derived from these minority interests is reported in the line item entitled “Equity income from investments in unconsolidated affiliates.”

Texas Roadhouse is a moderately priced, full-service Casual Dining concept which offers an assortment of specialty seasoned and aged steaks hand-cut daily on the premises and cooked to order over an open grill. In addition to steaks, Texas Roadhouse offers a selection of ribs, seafood, chicken, pork chops, pulled pork and vegetable plates, as well as an assortment of burgers, salads and sandwiches. The majority of their entrées include two made from scratch side items. All guests are treated to unlimited supplies of roasted in-shell peanuts and yeast rolls.

Texas Roadhouse’s mission statement is “Legendary Food; Legendary Service.” Their mascot is an armadillo named Andy. The Company restaurants and most franchisees offer entertainment in the form of line-dancing. The wait-staff and host perform these dances throughout the night. The employees also participate in annual intercompany competitions: bartenders compete in “Real Bar” competition and meat cutters in the “Meat Hero” competition.

The main selling entrée on the menu is the 11 oz. USDA Choice Sirloin.

Bubba’s 33 is a family friendly, sports restaurant concept featuring scratch-made food, ice cold beer and signature drinks. The menu features: burgers, pizza, and wings as well as a wide variety of appetizers, sandwiches and dinner entrées.

Jaggers is a Fast Casual concept that focuses on “fresh.” Fresh as in: ingredients, freshly made buns, fresh never frozen. The menu consists of sandwiches: chicken, burgers, pulled pork and fish. Jaggers also offers 4 types of salads and a broad variety of side items which include: Mac & Cheese, fries, tots, coleslaw, and edamame.


Texas Roadhouse’s growth strategy is designed to position each of their concepts as a local hometown favorite for a broad segment of consumers seeking high quality, affordable meals served with friendly, attractive service.

The operating strategies that underline the growth of their concepts are built on the following key components:

  • Offering high quality, freshly prepared food –  They hand-cut all but one of their assortments of steaks and make all of their sides from scratch.
  • Performance based manager compensation – Texas Roadhouse offers a performance based compensation program to their individual restaurant managers and multi-restaurant operators who are called managing partners and market partners, respectively. Each of these partners earns a base salary plus a performance bonus which represents a percentage of their restaurant’s pre-tax income.
  • Focus on Dinner – In a high percentage of their restaurants, Texas Roadhouse limits the operating hours to dinner only during weekdays with approximately half of the restaurants offering lunch on Friday. By focusing on dinner, Texas Roadhouse’s teams have to prepare and manage only one shift per day during the week.
  • Offering attractive price points – They offer a choice of several price points with the goal of fulfilling each guests’ budget and value expectations.
  • Create a fun and comfortable atmosphere while maintaining high quality service focus – Texas Roadhouse believes that the service, quality and atmosphere they establish is a key component for fostering repeat business. They focus on keeping their table-to-serve ratios low to allow servers to truly focus on guests and serve their needs in a personal and individual manner.


Texas Roadhouse’s long-term strategies, with respect to increasing net income and earnings per share along with creating shareholder value, include the following:

  • Expanding their restaurant base – Texas Roadhouse continually evaluates opportunities to develop restaurants in existing markets and in new domestic and international markets.
  • Maintaining and improving restaurant level performance – Texas Roadhouse plans to maintain or possibly improve restaurant level profitability through a combination of increasing comparable sales and managing operating costs.
  • Leveraging Texas Roadhouse’s infrastructure. Texas Roadhouse continually invests in their infrastructure to support, among other things, their growth. In recent years, some of these investments included information and accounting systems, real estate, human resources, legal, marketing, international and restaurant operations to include the development of the new Fast Casual concept, Jaggers.
  • Returning capital to shareholders – Texas Roadhouse continues to pay dividends and evaluate opportunities to return capital to their shareholders through stock repurchases.


In 2017, total revenues were $2.2 billion; more than 99% of which was derived from sales of Company operated restaurants with the remainder from franchise fees and royalties. This was a 11.6% increase in 2017 compared to 2016 revenues. The following table summarizes certain key drivers and/or attributes of Texas Roadhouse restaurant sales. While we have not updated this table to reflect the first nine months of 2018, these numbers reflect the steady growth and consistently high volume restaurant performance within this excellent operator. The unit growth continues, the AUV’s continue to grow, the operating margins have recently been negatively affected by cost increases. As opposed to almost all other casual dining restaurant chains, traffic increases have been maintained.


The Company does not separately break out the sales from Texas Roadhouse and Bubba’s 33. Therefore, the stated average unit volumes were $4,802,000. Alcoholic beverage sales accounted for 11% of sales in 2017.

The average total investment in a Texas Roadhouse was $5,250,000 with average costs for land of $1,265,000, building $2,170,000, FF&E $1,150,000 and pre-opening costs of $665,000.

Overall investment for a Bubba’s 33 restaurant was $6.1 million.

The current prototype for a Texas Roadhouse consists of a freestanding building with approximately 7,100 to 7,500 square feet of building space constructed on a site of approximately 1.7 to 2.0 acres. Seating of approximately 58 to 68 tables for a total of 270 to 280 guests including 18 bar seats and parking for approximately 160 vehicles.

Bubba’s 33 prototype is adaptable to in-line and end-cap locations. The prototype for Bubba’s 33 remains under development as they continue to open additional restaurants. They expect most future Bubba’s 33’s to range between 7,100 to 7,600 square feet and seating for 270 guests.

Texas Roadhouse’s management is focused on achieving an internal rate of return in the mid to high teens, in excess of its normalized cost of capital of 10-11%. Based on overall operating results for 2017, the average Texas Roadhouse was generating approximately $1 million in store-level earnings before interest, depreciation, amortization and rent, or a little under 20% of the cost to develop a restaurant. Store level margins were down 102 bp to 17.9% for the first nine months of 2018 and management indicated after Q3’18 that 18% is about as low as they like to see it. Menu price increases will presumably be implemented to keep store level margins above 18%.

Bubba’s 33 management is focusing on reducing the investment cost as it develops new locations. Bubba’s 33 has higher margins than a Texas Roadhouse primarily because of lower cost of sales so an internal rate of return in the mid to high teens can be achieved with a higher investment cost and similar sales volume.

The Company’s debt level is relatively low, with 9/30/18 year-end debt approximately 6% of shareholders’ equity.


Texas Roadhouse has been one of the better performing Casual Dining restaurant stocks over the last five years, tripling since the fall of 2012, as EPS has grown steadily from $1.11 in calendar 2013 to $2.19 as the consensus estimate for 2018. The current dividend represents a 1.7% yield.

Repurchases of Securities: The most recent authorization was made 5/22/2014, for $100M. After purchasing 1,675,000 shares in 2014 (some of it under a prior authorization), 321,789 shares were bought in 2015, 114,700 shares in 2016, none in 2017 or the first nine months of 2018, and $69.9M remains. Since commencing their repurchase program in 2008, Texas Roadhouse has repurchased a total of 14,844,851 shares of common stock at a total cost of $216.6M.


The third quarter of ’18 provided continued strong sales but lower operating margins. Comps were up 5.5% at company restaurants and 4.2% at franchised locations. Traffic was up an impressive 4.0%, price providing the balance of the comp gain. Restaurant EBITDA margin was down 157 bp to 16.2% as a result of higher labor costs, including insurance reserves. While diluted EPS was down 7% to $0.40/sh., Income Before Taxes (at 15.1% vs. 28.7%) was down a more meaningful 21.4%. Since nine month store level margin was down a more modest 102 bp and EPS was up 23.5%, the third quarter was clearly a deterioration from previous results. In Q3, three company restaurants opened, one international franchise. For nine months, 17 company stores, including four Bubba’s 33, were opened, plus four international franchised locations.

In terms of guidance for the remainder of 2018, management indicated that October had provided a comp of 4%, which was penalized by a point as it rolled over a post-hurricane lift a year ago. The full year 2018 was expected to result in “positive” comps (We would hope so, with 5.4% for nine months and 4% in October), no material change in previous expectations, basically a continuation of the nine month operational trends, though nothing specific was said about Q4 margins.

Looking to 2019, more of the same, with positive comps, 25-30 company openings including four Bubba’s, commodity cost inflation of 1-2%, wage inflation of mid single digits, and income tax rate of 14-15%.

On the conference call: a menu price increase of about 1.7% was planned for November, to offset the cost increases that affected Q3, and further price increases could be taken during early 2019. Average unit volume was up 4.8% in Q3, about in line with the comp, and the monthly sales trend was very consistent: 4.7%, 5.3% and 6.2% for July, August, and September. Cost of sales decreased 15 bp, other operating costs were down 22 bp. G&A increased 38 bp, but labor killed the income statement with a 194 bp increase to 33.5% of sales. Other line item variations were relatively small compared to the labor “giant in the room”. Cash generation remaining strong with $60M in Q3, spent as capex of $44M and dividends of $18M. The Company clearly doesn’t want to go heavily into debt to buy shares at this point.

In terms of store level margins: management indicated that 18% is a “feel good” number for them, so results below that, as in Q3, encourage them to think about raising prices. Bubba’s 33 continues to generate positive comps, up 6.5% through nine months, with two new prototypes to open in 2019.

Other than the above, the conference call consisted of discussion of quarter to quarter menu price increases in 2019, and the challenges of managing labor costs.

 CONCLUSION: Provided at the beginning of this article.

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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.

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