This Steakhouse Stock Could Get Burned


Vito J. Racanelli

Dec 05, 2018

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     After years of 14% average annual profit growth and concomitant stock price appreciation, casual-dining chain Texas Roadhouse faces macroeconomic headwinds in the next 12 months that could rattle its stock.

     Over the past five years, shares of the Louisville, Ky.-based purveyor of steaks, ribs, burgers, chicken, and sandwiches (ticker: TXRH) are up some 140% to about $65, far outperforming the powerful bull market's 50% gain in that time. With 570 units and a nearly $5 billion market cap, it's small enough that many shareholders expect continued gains in growth and have awarded the stock a premium valuation compared with peers.

     But bears say the company faces stiff quarterly comparisons in the next few quarters. If both weaker earnings per share (EPS) growth and increased wages continue, the company could miss quarterly expectations. That could burn investors with a drop of up to 20% possible in 2019.

     Texas Roadhouse missed estimates in the third quarter, but It did report a strong 5.5% same-store sales figure, a headline number that easily topped peers, which averaged about 2%. Same-store sales of 4.5% last year and 3.5% in 2016 consistently beat the industry. Third-quarter sales rose 10% to $595 million.

     However, the rest of the quarter's figures weren't so hot. And the future could hold more of the same. With high expectations built into the stock valuation, that has some worried.

     Earnings per share fell 7% to 40 cents from 43 cents, and the company missed analyst EPS expectations of 54 cents by a wide margin. That's unusual for this formerly steady grower, which last posted lower quarterly EPS in the fourth quarter of 2016. The stock fell from about $68 to $60 on the latest earnings report, but has since recovered to $65.

     More important, operating margins came in 2.1 percentage points below expectations, primarily from higher wage costs. That's due to very tight labor markets in the U.S. as well as minimum wage increases.

     While this is just one quarter, the performance pales in comparison to the company's average 20% EPS growth seen in the previous three quarters. Moreover, the macroeconomic problems that caused it are not going away, bears say. Texas Roadhouse said in a third quarter press release that it expects mid-single digit percentage labor-cost growth next year. Beating the strong comparisons from the fourth quarter of 2017 and the first two quarters of 2018 will be a tall order given the headwinds.

     Sales growth trends are expected to slow further in the fourth quarter and in 2019, and the company has been forced to raise menu prices, notes Howard Penney, a managing director at Hedgeye Risk Management. The company might have to keep raising prices to keep its margins, he adds.

     The latter isn't particularly good for a chain known for its value conscious customers. The average check is less than $17 per person. Increased menu prices could hurt traffic and add a new level of uncertainty to sales growth, says Penney, who rates the stock a short.

     Not only has EPS growth decelerated because of higher labor costs, but much of 2018's profits benefited from extraordinary one-time tax cuts that Texas Roadhouse will lap next year, notes Jeff Farmer, an analyst with Gordon Haskett Research Advisors, an independent research firm. He has an underperform rating on the stock.

     For example, in the third quarter income taxes were just $5.4 million, or 7.5 cents per share, down from $13 million, or 18 cents, in the same quarter of 2017. For the first nine months of 2018, taxes fell by $19 million, 15% of the $128 million in net income. Texas Roadhouse is going to lose that advantage next year and margins will continue to compress, Farmer adds.

     Given the looming issues Texas Roadhouse faces, the earnings consensus for 2019 of $2.54 per share seems high, says Andrew Strelzik, an analyst at BMO Capital Markets. Though the consensus dropped sharply after the third-quarter earnings news, the likely trajectory is for further drops. This year, the consensus expects $2.18 in EPS.

     Moreover, a bearish Strelzik expects the company's vaunted same-store sales growth to drop to 3.5% in 2019 from an anticipated 5.2% this year. "Casual dining valuations correlate very strongly with same-store sales, " adds the analyst, who expects the stock multiple will compress.

     Farmer agrees. On a ratio of enterprise value (net debt plus market capitalization) to earnings before interest, taxes, depreciation and amortization (Ebitda), Texas Roadhouse shares trade at about 13 times his 2019 Ebitda estimate, compared with a casual-dining group trading around 10 times. Farmer sees the shares falling to an 11 times multiple, or $52 per share.

     A Texas Roadhouse spokesman declined to give guidance on future comparable same-store sales growth or future traffic growth. He adds: "Our mid-single digit labor inflation guidance includes the impact of wage inflation and estimated growth in hours due to staffing initiatives, but doesn't include any impact from traffic growth next year." He also declined to comment on the amount of EPS growth attributable to tax reductions.

     The restaurant chain raised prices about 0.3% in mid-December 2017, 0.8% in late March 2018 and around 1.7% in mid-November, 2018. "We may take additional pricing sometime in the first half of 2019 depending on traffic growth, labor and commodity inflation trends and the overall health of the economy," says the spokesman.

     The impediments to the chain's growth appear hard to dodge and investors might want to steer clear of Texas Roadhouse until they dissipate.