EAT - Texas Roadhouse Should Continue To Outperform

2023-12-28 11:08:38 ET

Summary

• Texas Roadhouse is well-positioned for growth, with revenue benefiting from traffic growth, value meal offerings, and new unit development.
• Margins may be impacted by elevated beef prices, but price increases, productivity gains, and volume leverage should offset the headwinds.
• The company's valuation is favorable, trading below historical averages, making it a good buy.

Investment Thesis

Texas Roadhouse Inc (TXRH) is well-positioned to continue delivering good growth in the coming year. The company's revenue growth should benefit from healthy traffic growth driven by good traction towards the company's value meal offering, and improving guest experience. Moreover, revenue growth should also see a good contribution from an acceleration of new unit development in 2024. Additionally, the carryover impact of past price increases and potential pricing in the coming year should also support sales growth.

On the margin front, while elevated beef prices are expected to remain a headwind, the company should be able to offset it through price increases, moderation in commodity inflation (except beef), productivity gains, and volume leverage. Furthermore, the company's valuation also looks favorable as it is trading below historical averages. Hence, I continue to have a buy rating on the stock.

Revenue Analysis and Outlook

In my previous article in June, I discussed Texas Roadhouse's good growth prospects benefiting from good demand, increasing guest traffic, price increases, and new restaurant growth. The stock price has also increased by ~15% since then validating my stance. The company reported its third quarter of 2023 in October and similar trends were seen there as well.

In the third quarter of 2023, the company's sales growth momentum continued. Good demand for the company's value meal offerings helped increase traffic count. In addition, average check growth through price increases, and new unit development also helped the company in increasing sales. This resulted in a 12.9% YoY increase in net revenue to $1.12 billion. On a comparable store basis, total company-owned restaurant sales increased by 8.2% YoY, reflecting equal contribution from both the increase in guest traffic and average check growth. The franchise restaurant comparable store sales increased by 7.1% YoY.

Looking forward, I believe the company should be able to continue delivering revenue growth benefiting from good demand for the company's value offerings and improving guest satisfaction, both helping increase restaurant traffic. In addition, price increases, and new unit development should also increase sales growth.

With high inflation over the last couple of years impacting consumers, the company chose to keep menu price increases below inflation to protect its long-term loyal customers even if it meant taking a slight hit on margins. This strategy helped in retaining its loyal customers and also attracted new ones. This approach has allowed the company to capture market share from competitors who adopt a more aggressive strategy of year-round price increases to shield their margins. We can see this in TXRH's reported numbers where it has delivered consistent positive guest traffic growth in the recent quarters while its competitors like Bloomin' Brands (BLMN), and Brinker International (EAT) are experiencing traffic decline in the last few quarters.

On its third quarter earnings call , management commented that in the first four weeks of Q4 2023, average weekly sales per restaurant were over $141,000, driven by 9.2% same-store sales growth, which includes a 3.4% traffic increase. This implies that positive traffic momentum has continued in Q4 2023 as well. Moving forward, the company plans to continue providing attractive value propositions to customers by keeping menu price increases below the level of inflation. This should continue to attract customers and keep supporting guest traffic in Q4 and beyond.

Furthermore, the company is also focused on improving the overall guest experience within its restaurants. Post-pandemic, the company faced staffing challenges due to a tight labor market. This impacted its guest services as restaurants weren't properly staffed resulting in increased waiting times. Since the back half of 2022, the company has been actively engaged to improve staffing conditions at each of its restaurants. Thanks to these efforts, staffing conditions are improving each quarter, resulting in enhanced guest engagement, reduced waiting times, and improved quality of overall service at the restaurants. Moreover, the company has also been investing in technology to provide new services to the guests like a pay-at-the-table system where the customers can pay at their convenience without waiting for a table server to provide the bill, thus improving table turns and reducing waiting time for other customers. I expect these actions should continue to help the company attract guest traffic and support sales growth.

In addition to good guest traffic momentum, I expect the impact of carryover price increases from the second half of 2023, to continue benefiting average check growth and support the comparable sales growth in the coming quarters as well. Moreover, the company anticipates further price increases (although below inflation to keep the value proposition in its menu offerings intact) in the first half of 2024. These incremental pricing should also help sales growth.

Lastly, as I mentioned in my previous article , the company is doing well in expanding its restaurant footprints both domestically and internationally. The company has increased its total restaurant units by 5.4% YoY in Q3 2023 to 722 restaurants globally. This represents a total of 37 net new restaurant openings YoY. For the fourth quarter, the company expects to open another 12 company-owned restaurants.

Furthermore, the company also plans to accelerate unit development in 2024. TRXH is targeting opening ~30 company-owned Texas Roadhouse and Bubba's 33 restaurants and 3 Jaggers restaurants in 2024. The company also expects its franchise partners to open at least nine international and domestic locations in 2024, including 4 for Jaggers. This implies that restaurant opening planned for Q4 2023 and the full year 2024, represents a potential restaurant unit growth of 7.4% by the end of next year as compared to Q3 2023. So, the new restaurant development should also benefit the overall sales growth momentum in the coming year. Hence, I remain optimistic about the company's growth prospects ahead.

Margin Analysis and Outlook

In the third quarter of 2023, the company's margins benefited from price increases, productivity gains, and volume leverage. However, these benefits were more than offset by commodity inflation of 4.2% YoY and wage & labor inflation of 5.6% YoY. In addition, margins also witnessed headwinds from a 70 bps impact of adjustments in general liability insurance reserves as well as a ~30 bps impact from lower gift card breakage adjustment. Overall, this resulted in an 80 bps YoY decline in the restaurant margin to 14.6%.

Looking forward, I believe the company should be able to improve its margins in the coming year. The impact of the adjustment in general liability insurance is one-time in nature. So moving forward, as it does not repeat, it should relieve some margin pressure. In addition, while the company continues to experience elevated beef prices, its overall commodity basket is seeing moderating inflation. In Q1 2023, the company faced an 8.9% YoY commodity inflation which reduced to 6% YoY in Q2 2023 and to 4.2% YoY in Q3 2023. I expect further moderation in overall commodity inflation in Q4 2023 and FY24. For FY2024 management expects the overall commodity basket except beef to stay flat or deflationary. I believe that elevated beef prices should be more than offset by moderation in other commodities, the carryover impact of price increases and further price increases, and volume leverage from good traffic growth.

Furthermore, we should also see productivity benefits from improving labor turnover and overall staffing conditions in the restaurants as discussed in the revenue analysis. Hence, I am optimistic about the company's margin growth prospects in the coming year.

Valuation and Conclusion

Texas Roadhouse is currently trading at a forward FY24 EV/EBITDA ((FWD)) multiple of 17.64x which is lower than its historical 5-year average forward EV/EBITDA ((FWD)) multiple of 18.95x.

I believe the company should continue to outperform given its good growth prospects ahead. Revenue should benefit from good demand for its value offerings, improving customer satisfaction, price increases, and new unit development. Margins should also recover as the cost environment further improves with moderating inflation. So I expect a positive growth trend in the coming year. Considering the company's good growth prospects and the lower-than-historical valuation, I believe the stock continues to be a good buy.

Risks

• If beef prices continue to rise and the cost of other raw material basket doesn't moderate as expected, the company's margins could continue to suffer.
• If the company is not able to achieve its new unit opening plans, it might impact investor sentiments and result in stock price correction.

For further details see: