Texas Roadhouse Stock: Why I Bought TXRH At The Close Of 2022

Introduction

In this article, I would like to talk about the second buy I made as the 2022 market year ended. In my first article, I explained why I increased my stake in Apple (AAPL) by 25% buying at $129 a share.

Here, I would like to explain my bull case about Texas Roadhouse (NASDAQ:TXRH). In fact, on Friday, December 31st, 2022, I initiated a position in Texas Roadhouse at $91 a share, deploying in this new holding the same amount I spent to increase my investment in Apple. Right now, Texas Roadhouse makes up 1.7% of my portfolio. Clearly, I plan on dollar cost averaging into this new holding to make it a larger holding that I could push up to 5% of my whole portfolio if further and better opportunities arise. A side note: this is my second purchase in the restaurant category, the first one being Starbucks (SBUX), which is my sixth largest holding with a 5.5% weight as of now.

Texas Roadhouse

Texas Roadhouse owns and operates 566 restaurants and has 70 franchised restaurants in the U.S. and 31 internationally. Its menu is centered around beef steaks, as we can see below. However, it has a wide variety of starters, salads, ribs, chicken specialties and desserts.

Regarding the franchised restaurants, it is useful to know that the franchisee pays a royalty fee of 4% of gross sales. The company is also launching two new brands: Bubba’s 33 that serves burgers, pizza and more in general scratch-made food and ice cold beer and Jaggers, a fast-casual restaurant which focuses more on burgers and chicken. While Bubba’s 33 is a bit more developed, Jaggers is still in its early stages.

Texas Roadhouse restaurants have their main focus on dinner. In fact, only half of its restaurants offer lunch on Friday. While this may be seen as a weakness, it also carries some advantages with it, the first being that the company only has to manage one shift per day during the week and can have most of its employees work part time. The consequence is lower expenses.

Texas Roadhouse is also a very U.S. centered company. Actually, it is highly concentrated in some States, since 21% of its restaurants are located in Texas and Florida. These are high-income States whose population can withstand a mild recession better than other lower-income States.

Summary of previous coverage

This company has actually been one of my favorites, from a consumer point of view. However, as a recession started to loom on the horizon, my initial thesis was that Texas Roadhouse would take a hit because of consumers stepping down from steaks to burgers, so to speak. In addition, I thought that, since beef price is climbing upwards, investors would sell out of the company as its margins shrank. I was proven wrong, especially on the second hypothesis. But I actually saw that investors who own Texas Roadhouse don’t seem to have paper hands, but seem to be very reluctant to sell out of this company.

A month ago, I published an article where I said that I changed my mind on this company and I placed it on my watchlist, rating it as a hold that was getting very close to a buy. First of all, the company keeps on achieving revenue growth (14% YoY) driven both by average unit volume growth and store week growth. Even more important, comparable restaurant sales keep on going up at a faster pace compared to the average check growth. Actually, comparable sales grew more in September than in July, showing an upward trend. This means that pricing is not the only reason why this number goes up. The company reports higher traffic(dining room traffic up 3.3% YoY in the last quarter) showing the strength and the appeal this brand has. The key is simple: Texas Roadhouse offers very good value that is truly perceived by customers: its menu is rich and its prices are very reasonable. Besides, eating at a Texas Roadhouse restaurant is truly an experience thanks to the well-trained crew that creates a very fun atmosphere.

Financials

As far as financials go, Texas Roadhouse is very well managed. Surprisingly, its food and beverage costs increased only 9bps in Q3 compared to the prior year. The company is thus really able to offset inflationary pressure both through menu pricing and cost management. One aspect that, at first, I thought would be part of a bear case for the company was that it has stated and proven more than once that it would rather take a hit on its margins in order to preserver customer loyalty. Now, I have come to realize how powerful this strategy is because the lifetime value of a customer is much more important than a margin compression during a phase of the economic cycle. Customers need to eat and have fun experiences in every economic environment. If they know that they will find true value at Texas Roadhouse, they will go there. While many companies are using inflation to hike prices in order to bump up margins, Texas Roadhouse is very careful with its pricing in order to keep on offering a value proposition that is easily understood by its customers.

The company is also very conservative when considering its balance sheet. Its debt increased during the pandemic, when money was cheap. However, its net debt/EBITDA ratio is below 2, which shows the company has enough earning power to cover its debt.

In addition, the company is one of the few I know of that doesn’t do buybacks at random, but it has repeatedly stated that it repurchases its shares only when the stock price is attractive. Thus, by monitoring how the company acts with its buyback program is a way to know how undervalued the management thinks the stock is. Just in the past four quarters, the company has repurchased 3 million shares, with a strong activity between March and June 2022 when it repurchased almost half of this number. This created value for the shareholders because it took advantage of a stock price that wax in the range between $70 and $80.

The dividend is also interesting. It yields 2% looking forward and its 5 year growth rate is 17%. But what I like most is that it is clear that the company, being still in growth mode since it targets to expand from 600 locations to 900, doesn’t throw away to its shareholders the money it needs. However, it is so well-managed that it does already generate excess cash that, though it has a bold expansion plan, it doesn’t need to use. This is the money I like to receive under the form of a dividend or a share repurchase. In fact, at first, I prefer a company to use all the money it can to fund further growth as long as it has a decent return on the capital employed (TXRH has an average return above 13%).

Valuation

Texas Roadhouse trades at a fwd. P/E of 22 and a free cash flow yield of 5.15%. These metrics are pretty much in line with the usual multiples it trades at. However, the fwd. P/E in the low 20s begins to be an interesting point of entry, especially when I consider that in the past decade the company was able to grow its earnings per share at a CAGR above 13%. In addition, the free cash flow yield is quite high, showing that under this metric the company begins to be relatively cheap. Moreover, the growing free cash flow, combined with a dividend payout ratio around 40% suggest that the company will have an increasing amount of excess cash to distribute to its shareholders.

I believe the stock can easily trade around a 25 PE which would bring the stock back to almost $100 per share. But if we consider the free cash flow yield, I think a company that is able to generate FCF with such reliability and growth could easily trade back at a 4% yield, which would mean, based on the current FCF/share, a target price around $112.

For these reasons, I think it is a great fit for my portfolio built to find those compounders that return only excess cash to me.

Conclusion

With this article, I hope to start a new way of sharing my research that can be more transparent for SA readers. In particular, I would like to give real-time updates when the research I publish leads me to a level of conviction that makes me invest in a certain stock. In the case of Texas Roadhouse, the more I looked at the company, the more I saw that my initial bearish thesis was actually a thesis for a swing trade, rather than a long-term investment. This is why I changed my mind and I am now long. I have also seen that it is very useful to discuss with other experienced investors about one’s own portfolio in order to hear suggestions and corrections. Please, let me know in the comments what you think about these two buys and tell me what you did with your portfolio as 2022 ended. I will soon publish another article telling what two stocks I am keeping an eye on during Q1 of 2023 to see whether or not to increase my current positions.