The pandemic has certainly taken its toll on different industries in different ways. One group that was punished severely is restaurants, a sector that was nearly completely shut down for a portion of this year. The group has come roaring back, however, and the strong stocks within the group look pretty attractive, even after the massive rally.
One such stock is one of the best-run restaurant chains anywhere, Texas Roadhouse (TXRH). Texas Roadhouse has been a sector leader for years thanks to its nearly perpetual same-store sales growth and strong margins. As we can see below, Texas Roadhouse has rallied back to near its previous high, but remains about 15% below it. With the recent pullback from $66, I think Texas Roadhouse looks like a buy for long-term holders.
We can see in the middle panel that the restaurants have outperformed the broader market by a significant margin in the past several weeks, building a ~10% lead since the beginning of August. This relative strength is very attractive, and we can see that Texas Roadhouse has performed well against its peer group this year. This strength on strength is exactly what I want to see from a stock, and Texas Roadhouse continues to exhibit strength, even in a very strong sector.
A track record of success
Texas Roadhouse has shown for the past few years that it can continue to grow, even as its footprint expands and therefore, the comparable base grows. The top line, as we can see below, has moved steadily higher, with the exception of this year for obvious reasons.
Source: Seeking Alpha
Texas Roadhouse has achieved these results in part due to an expanding store base. The company has spent years building out its store base, with most of it being company-owned, plus a small number of franchises. At the end of calendar 2018, the company had 575 stores, and today, it has 620. That period includes a construction halt due to COVID, but still represents ~8% growth in a period of 18 months or so. This is commensurate with the company’s long-term store base growth rate in the mid-single digits, and I fully expect the company to continue to grow at about that rate moving forward. That 5% or so tailwind to revenue is key to the bull argument.
The other source of revenue growth is comparable sales, which Texas Roadhouse has excelled in for many years.
Keep in mind that this period includes some pretty nasty industry numbers as consumers pulled back on restaurant spending for brief periods in the past few years. Texas Roadhouse has not only outperformed those benchmarks, but just about every competitor it has. Of all of the things Texas Roadhouse has going for it, this is probably the most important, and impressive one.
The company’s comparable sales gains not only build the top line but also help boost margins as well as store costs are leveraged down. Comparable sales are obviously tanking for 2020, but looking forward, we’ll likely see a retracement of this year’s losses next year, plus some additional gains. There is no reason to believe Texas Roadhouse won’t be able to continue its comparable sales gains as it has focused on building its takeout business to cope with COVID, and its menu innovation continues to drive traffic.
Speaking of margins, I think there is a fairly compelling case that this will be a source of earnings growth for the next couple of years, at least.
EBIT margins spent years in the area of 8% to 9%, but will be very close to zero in 2020. Plummeting revenue will do that, but of course, it should be temporary. Looking into 2021, however, the current estimate is for just 6.5% EBIT margins, which is meaningfully below its historical norms. In other words, analysts aren’t expecting a full rebound in profitability until 2022 or later, meaning either Texas Roadhouse can surprise to the upside next year, or there is a longer tail to the earnings rebound. Either way, those are good outcomes as we can reasonably expect the comparable sales rebound to produce a simultaneous rebound in margins.
A reasonable valuation and strong dividend growth
This market is littered with great companies that are simply too expensive. Texas Roadhouse is definitely a great company, and while I wouldn’t consider it cheap, necessarily, I do think it is fairly valued for how much growth is coming.
Source: Seeking Alpha
EPS will obviously be close to zero this year, but given the circumstances, I don’t really care about this year’s numbers. Looking forward, we have EPS of $2.26 for next year, which is a huge rebound off of this year’s numbers, but still off from the $2.46 the company produced last year. In other words, despite the fact that conditions should have largely normalized by then, expectations for Texas Roadhouse are still pretty subdued. I love low expectations because it gives the company runway to surprise to the upside. If any restaurant chain can surprise to the upside, I have full faith it is Texas Roadhouse.
Looking out into the future a bit further, as margins reflate and revenue grows, the company is slated to hit new EPS highs in 2023. I think there’s a good chance the company hits $3 in EPS in 2022, but even if I’m wrong, the stock is fairly valued for buyers.
At 28 times forward earnings, I wouldn’t say it is cheap. However, given the EPS growth numbers we’re talking about – 20%+ annual growth through at least 2023 – 28 times earnings is quite reasonable. If I’m right and EPS surprises to the upside, all the better.
As a bonus, you also get very strong dividend growth with Texas Roadhouse.
Source: Seeking Alpha
The company’s payout has grown at mid-teens rates or better for the past several years, resulting in huge payout growth. With strong earnings growth coming from the COVID rebound, I could see Texas Roadhouse producing long-term dividend growth of 10% to 15% annually for the foreseeable future. To be clear, I think the stock is a buy with or without the dividend growth, but it is a nice bonus if you’re bullish anyway.
The bottom line is that the crisis hasn’t impaired Texas Roadhouse’s long-term outlook, and with expectations low and the stock reasonably priced, it looks quite attractive to me. During this current bout of market weakness, it may come a bit lower, but beginning to build a position in the low-$60s looks like a good idea if you want to own it.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.