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.