All Wall Street wants for Christmas is a resolution to the fiscal cliff. The ongoing budget negotiations have dominated market movement over the last few weeks, with stocks swinging based on the sentiment of the latest comments, as we saw with today’s strong performance.
We’ve talked extensively about the fiscal cliff in all three services, so you know that I still expect Congress to reach some sort of deal by the December 31 deadline, even if it’s just a placeholder agreement. Getting an agreement in place is important, but don’t think that a failure to reach one will automatically mean a market crash come January 1. Negotiations will go on, and if nothing else, public pressure on political leaders by that time would likely force some type of compromise. At that point, all the scheduled tax increases and spending cuts would be replaced by a new plan, and businesses would at least have the information they need to move forward.
Of course, there are other year-end factors to be aware of beyond the fiscal cliff, and an important one kicked off today. The Federal Reserve Open Market Committee began its two-day policy meeting, and analysts widely expect the central bank to conclude it tomorrow with an announcement of a new round of Treasury securities purchases to replace “Operation Twist,” which expires at the end of the month.
The announcement of QE4 will likely not be another twist but rather an outright purchase to buy $45 billion of securities. Another form of easing would normally be a market-moving event, but with the move widely anticipated and so much focus on the fiscal cliff, we can expect the reaction to be relatively low key.
Even with so much still up in the air, I continue to anticipate a strong end to the year and a Santa Claus rally should help investors start 2013 off right. (We’ll talk more about next year in a moment). While we wait for the budget issue to be resolved, our strategy in High Octane Trader is to be extremely selective with our trades, locking in gains or cutting losses quickly with the knowledge that things could change fast. In GameChangers and Breakout Stocks Under $10, our best strategy remains investing in companies with clear growth paths and catalysts that don’t depend on a robust economy. That also applies to our Inner Circle stocks, and I have a new company to tell you about that has built a strong foundation for more expansion ahead in the restaurant industry while also offering an attractive dividend.
Stock of the Month: TXRH
Competition in the restaurant industry is intense, which can make it difficult to remain profitable while also standing out to consumers who want a fun night out but don’t have wallets thick enough for high-priced alternatives. But I’ve found a restaurant that offers the best of both worlds, successfully competing against mid-priced, full-service, casual dining restaurants primarily on the basis of quality, price and overall dining experience.
Texas Roundhouse (TXRH) may already be familiar to you – or at least their ribs may be. Starting with its first location in Indiana in 1993, owner Kent Taylor turned his goal of a family-and-wallet-friendly steakhouse into more than 380 locations in 47 states. As you can see, the story here is growth. TXRH has worked to create a “down-home” environment with the synergies and scale of a chain restaurant that has resonated nicely with consumers, and shows no signs of quitting.
Underlying all this growth is an operational strategy built on several key components that help give you a clearer picture of what this company is about and where it’s headed. Let’s take a look at each now:
Focus on dinner: The Roadhouse is famous for its steaks and ribs, but the menu also features several chicken and seafood selections. The bar options are also a cornerstone of the restaurant’s appeal. Beer, margaritas and a host of specialty drinks draw in the crowds and contribute to profitability.
Although the restaurants are open for lunch on the weekends, the dinner-only philosophy during the week streamlines operations and affords managers and employees a better lifestyle. It is actually a very smart strategy since employees can hold full-time jobs in other places and everyone makes more money in terms of tips and check tabs. It is just reality that dinner time means entrees rather than sandwiches and salads, and tables that wouldn’t order alcoholic drinks during daylight hours would most likely indulge during their evening dining experience. However, some restaurants do operate with a traditional lunch and dinner schedule where it makes sense.
Investing in food standards: Management takes the idea of high-quality, freshly-prepared food seriously, and makes sure its kitchen staff does as well. Each of the restaurants employs a butcher and a baker. The butchers hand-cut each and every steak, working in 34-degree coolers and cutting an average of $500,000 of meat a year per store, while the bakers are responsible for making yeast rolls from scratch every day.
Attractive price points: Texas Roadhouse likes to say that they provide “more food for your dollar,” so value is an important mantra for the company. TXRH offers both food and beverages at moderate price points that are often as low, or lower, than those of competitors. The majority of entrees, which include two sides, generally range from $9.49 to $24.99. The average customer check is only $14.89 – you can see why so many people like this place compared to the higher-end steakhouses.
Creating a fun and comfortable atmosphere: A unique dining experience is also part of management’s goal. Each location features a rustic southwestern lodge décor with murals, neon signs, rugs, and jukeboxes. Diners may even catch a line dancer or two (possibly related to how many of the drinks they’ve ordered!).
Performance-based manager compensation: This is a big part of Texas Roundhouse’s consistent quality experience. In order to attract and retain talented, experienced and highly motivated restaurant operators, the company offers performance-based compensation programs to restaurant managers and area managers.
One final cornerstone of TXRH’s operating strategy is international expansion. This is a key element, and management has made it a priority to not only fund new restaurants in the United States, but also to attract franchise operators that want to build and grow this appealing American concept in other parts of the world.
Strong Q3 Speaks to Growth Ahead
What I like about TXRH’s strategy is that it allows for more growth ahead, better equipping the company to defy the cyclical ups and downs of a recovering economy and inflationary food prices.
Texas Roadhouse continues to expand its restaurant base and improve its restaurant profitability through a combination of increased comparable restaurant sales and operating cost management. The company is also leveraging its scalable infrastructure to support growth – having made significant investments in infrastructure, including information systems, real estate, human resources, legal, marketing, and operations.
These efforts are making an impact. TXRH reported double-digit revenue and earnings growth for the third quarter, even in a challenging consumer environment and with continued commodity cost pressures. I believe this success speaks to the distinct qualities Texas Roadhouse offers customers that we just discussed.
Management doesn’t see this momentum slowing, updating its annual guidance to the high end of its previous $0.94-$0.96 range compared to EPS of $0.88 in 2011. Comparable restaurant sales for the first month of its fourth quarter were already up 3% from a year ago.
The company plans to continue its focus on long-term growth potential and brand positioning in 2013. TXRH has a strong balance sheet and cash flow that will allow internal funding for new restaurants, as well as returning excess capital to shareholders through dividends and share repurchases. The stock currently yields 2.24% annually, and just yesterday, the Board of Directors authorized the payment of a special year-end cash dividend of $0.10 per share of common stock payable on December 28 to shareholders of record at the close of business on December 21. This special dividend is in addition to the company’s previously-announced quarterly cash dividend of $0.09 per share also payable on December 28.
The stock has pulled back slightly since its strong earnings report, giving us a nice entry point right in the middle of its 52-week range. Currently trading at $16.30, I see the shares easily doubling to more than $30 in the next five years. With a market cap of only $1.1 billion, there is also room for Texas Roadhouse to be an acquisition target, making TXRH a good buy up to $18.
Portfolio Update
Wall Street certainly has been busy in the month since we last checked in on our Inner Circle stocks. I’ve been keeping a close eye on them, and wanted to share a quick update on each as we wrap up the year.
Itau Unibanco (ITUB) has been tempered by the financial struggles in the global economy, but is still up about 9% since my last update. ITUB is still the largest private bank in Brazil, so any signs of economic improvement will help boost the stock. The Brazilian economy should also strengthen as the country hosts of the upcoming 2014 World Cup and the 2016 Summer Olympics. Continue to buy ITUB under $16.
Vodaphone (VOD) is another good buying opportunity right now, especially with how the business is handling the financial struggles in Europe. Because the company owns such a large portion of Verizon, when VOD sales aren’t doing well, the Verizon sales help make up the difference. This should continue to help VOD cope with the situation in Europe, as will a plan to raise prices for pre-pay customers next month. I also found it interesting that VOD is dipping into philanthropy, partnering with GlaxoSmithKline (GSK) in an effort to vaccinate children in Africa. I’m still confident in VOD and like it as a buy at current prices.
True Religion Apparel (TRLG) has been moving away from its wholesale model to a direct-to-consumer model, which I believe is a far more profitable move since it allows the company to showcase its full line of products. Because of this move, sales from the direct segment have jumped 50% in two years with a 3.3% dividend yield, and current shareholders stand to gain 40% over the current price. This is a strong stock that is a globally popular brand, and has jumped 17% since I recommended it in late August. If you have not bought this stock, I recommend waiting for the next time it pulls back under $24.
Cal-Main Foods (CALM) is moving forward with expansion plans, positioning themselves to grow and strengthen their Texas operations for the holiday season. CALM is the largest producer and distributor of fresh shell eggs in the U.S., so this is a busy time of year for the company. The stock had an outstanding November, with steady momentum carrying over into December. CALM has moved above my suggested limit of $42.50, so I recommend continuing to hold your shares.
Piper Jaffray (PJC) also joined our portfolio in late September and has seen steady growth ever since. The investment bank recently appointed Dr. Charles Duncan to expand the Biotechnology Research Platform. He will focus on small and mid-cap emerging growth biotechnology companies. This company is still providing funds for growing businesses, and in fact, Charles Schwab is expanding its municipal bond business with PJC. Shares are up 8% since my last update, but the stock remains a good buy below $30.
Apache (APA) is our newest stock and has pulled back slightly in the last month, but I believe this is still a quality bargain buy. APA has been undervalued, and should start to show some positive growth on improved earnings, higher natural gas prices and recently-announced positive drilling results in Canada. The company is also seeing strong North American oil production, which will help support shares into next year. Buy APA up to $85.
Keeping Our Focus
The big question on investors’ minds this time of the year is what to buy for 2013. It’s a much more complicated question than usual this year because so many things could change in whatever deal takes shape to resolve the fiscal cliff. But as you know, we’ve been focusing on that for a long time in GameChangers, Breakout Stocks Under $10 and here in your exclusive Inner Circle issues.
In the end, it always comes back to earnings. The outlook for next year at this point is actually better than expected, and even though the global economy may stay sluggish in 2013, there are companies out there finding ways to grow the top and bottom lines. We’re investing in those that give us the highest degree of confidence in their growth.
In general, I expect the market to trend up as we wrap up the year, though there will be back-and-forth action based on the fiscal cliff headlines. We’ll look to take advantage of those short-term movements in High Octane Trader and continue to buy attractive medium- and long-term holdings in the other services—stocks like Texas Roadhouse (TXRH).
As we talked about, TXRH pays a solid yield of 2.2%, and we’ve focused quite a bit on dividend-paying stocks here in Inner Circle. One of the open questions in the fiscal cliff talks is what the tax rate on dividends will be. The rate is already certain go up as part of the recent healthcare reform, but the increase could be more dramatic depending on how the talks play out. Nevertheless, I still expect dividend-paying stocks to be attractive, and I’m working on a special video for you explaining my thinking. I’ll let you know as soon as it’s ready.
I’ll talk to you again tomorrow in your GameChangers Weekly Update, when we’ll know more about what the Fed decided to do.
Sincerely,
Hilary Kramer
Editor, Inner Circle
P.S. I will be speaking at The World MoneyShow in Orlando, Florida, January 30 – February 2, 2013, and want you to be my guest! This is an unprecedented opportunity to learn the best ways to diversify and grow your portfolios from the best-and-brightest in the investing and trading community. As a valued subscriber, you and a guest will receive FREE admission to this extraordinary event. For complete details or to register for your FREE four-day pass, click here.