Texas Roadhouse: Strong Business Fundamentals, Able To Navigate Short-Term Declines

jetcityimage Investment Thesis When conducting a fundamental analysis, I look to see if a company is trading under fair value given key fundamentals such as revenue growth, earnings growth, returns on invested capital, and margins. Texas Roadhouse, Inc. (NASDAQ:TXRH) is a casual restaurant chain that has restaurants throughout the US and some internationally as well. Over the last twelve months, TXRH has seen a stock price appreciation of over 50%, with 40% of that appreciation occurring since January. Based on fundamental analysis including a discounted cash flow model to estimate fair valuation, I believe the fair value for TXRH to be between $123.71 to $168.51, and I am designating this as a cautious buy rating because of the strong business fundamentals. Given the good quality of the company, any short-term decline may open up a long-term investment opportunity for investors. Company Outline and Performance Founded in 1993, Texas Roadhouse is a casual restaurant chain mainly based in the United States and is known for providing handcrafted food such as steak dinners, ribs, and fresh breads. The company’s mission is to provide legendary food and service, according to their website. Over the last 12 months, TXRH has performed significantly well, gaining over 50% in stock appreciation compared to the market’s modest ~25% return as noted by the 12-month chart of SPDR® S&P 500® ETF Trust (SPY). Moreover, compared to peers over the last decade, TXRH has provided over a 550% return for investors and has far outpaced other fast casual restaurant chains like Yum China Holdings, Inc. (YUMC), The Cheesecake Factory Incorporated (CAKE), and Brinker International, Inc. (EAT). Peer comparison of other consumer discretionary restaurants including TXRH. (Seeking Alpha) Earnings Call In their most recent earnings call, Texas Roadhouse, Inc., beat earnings per share estimates slightly but had missed on revenue estimates even though they had strong year-over-year revenue growth of over 12%. During this quarter, they had increased their menu prices by 2.2% while also posting a strong 8.4% growth in same-store sales. This may indicate that the company has modest pricing power, and this would be something investors should focus on at the end of July during their next earnings call. They were also able to avoid some inflationary pressures on margins, with a higher average check price by about 4.1% and increased foot traffic of about 4.3%. These are all signs of a popular brand with strong holds on the consumer, given that the economic environment has not led to a cautious consumer with lower check prices on average as we have seen with other consumer discretionary restaurant companies. Fundamental Analysis Texas Roadhouse currently trades at a trailing twelve-month PE of 34.76, a forward PE of 28.75, a price to sales of 2.40 over the TTM, and an EV/EBITDA ratio of 18.67 on a forward basis. These factors are all significantly higher than the sector median values. Moreover, the company has a current forward dividend yield of 1.42% with a payout ratio of 45.75% and a 5-year growth rate of over 17%. However, as you will see with other fundamentals during the pandemic, the company cut dividends during that time to maintain operations in a difficult economic environment. Otherwise, when removing this year, you see consistent dividend growth over the last decade. Revenue Over the last decade, Texas Roadhouse, Inc., has continued to grow their revenue by an annualized rate of 12% per year and by 94% since 2018. However, since 2018 costs have grown by 99% and gross margins have declined by 10%. These are fundamental factors investors should pay attention to over the next few quarters to see if margins continue to decline, which may have an impact on the company’s total returns on investment. TXRH: Revenue, costs of goods sold, and margins over the last decade. (GuruFocus) Per Share Value Over the last decade, Texas Roadhouse, Inc., has provided significant value to shareholders with growing earnings, book value, free cash flow, and dividends. Over this time, these factors grew by an annualized rate of ~12%, 7%, 16%, and 12% respectively. As you can see in the chart below, book value has significantly increased since 2013, by a total of 116%. However, as the company has continued to grow, and faced a difficult economic environment due to the pandemic, debt levels have grown significantly over the last few years. In 2013, total debt per share was less than $1, but now over the trailing twelve months, total debt is around $11.88 per share. Debt per share rose significantly in 2019 and 2020, and has remained at this level since then. Despite the higher debt levels, this company has continued to show high returns on invested capital (ROIC) and high returns on equity (ROE). TXRH: Per share values for earnings, debt, free cash flow, and book value (GuruFocus) Investment Returns TXRH has continued to provide high returns on invested capital (ROIC) when compared to weighted costs of capital (WACC) over the last ten years. When looking at this ratio of (ROIC-WACC), it currently stands at a positive 4.35 over the last twelve months and has been a positive ratio every year except for 2020 when the company was impacted by the pandemic. Great companies typically have a positive ratio, and this is one indicator that management is making smart decisions with capital to provide value for investors. However, although this is a positive ratio, and ROIC is over 10%, investors should pay attention to the slightly higher level of WACC in the last five years when factoring in other fundamentals. TXRH: ROIC and WACC over the last decade. (GuruFocus) As a positive ROIC-WACC ratio is a good indicator of a great company, high returns on equity (ROE) will also prove as an indicator. As you will see in the chart below, TXRH has consistently provided high ROE, returns on assets (ROA), returns on capital employed (ROCE), and returns on retained earnings (RORE). The linear trend line shows consistently higher ROE over this time, even when accounting for the slowdown from the pandemic in 2020. The company demonstrated not only durability but adaptability by rebounding so quickly the following year once they were able to resume operations as normal. Further, as you can see the modest growth year-over-year in these fundamental indicators, investors should focus on any drastic changes here that would indicate something is changing either with the company’s management or the macroeconomic environment. TXRH: returns on equity, assets, capital employed, and retained earnings over the last 10 years. (GuruFocus) Fair Valuation Using discounted cash flow models based on the most recent earnings per share of $5.02, I have calculated two separate fair value models based on a given discount rate to account for changes in the economy and business fundamentals. I believe TXRH is a solid company, with a very consistent growth rate where we can expect similar returns year-over-year, because of this, I used a discount rate of 5% in the second model rather than the 8% that was used in the first. Given these discount rates, and making the assumptions that EPS growth will be 12% for the first decade, and 5% for the decade after that during the terminal growth stage, I have calculated the fair value for the company to be between $123.71 to $168.51 per share. Other assumptions are made for variance in growth rate and calculations on the right-hand side of each model under the assumptions sensitivity section. Given that the company is close to the upper range of this calculation, I believe that investors will have a chance to buy TXRH at slightly lower prices in the short term and be able to build a long-term position in this great company. TXRH: DCF model based on earnings per share with an 8% discount rate. (Author’s Calculations)TXRH: DCF model based on earnings per share with a 5% discount rate. (Author’s Calculations) Limitations This investment thesis is limited in the fact that it is a fundamental analysis based on past company performance and does not project into the future about those key fundamentals in order to not make speculations about future company performance. Additionally, the argument is limited in the DCF model that’s based on earnings per share, as the assumptions were made by me about the company’s future performance. The economy and business are dynamic, and the assumptions may prove to be invalid if anything changes such as we saw during the pandemic year of 2020. Finally, as this argument is mostly focused on quantitative data, it leaves out subjective arguments from company reports or company projections. It is solely focused on fundamental returns and growth in order to find a company trading below what is determined to be fair value with strong business characteristics. Conclusion Texas Roadhouse is a fast casual restaurant chain that provides dinners including steak, ribs, and other country dinners. Based on the fundamental analysis above, TXRH is currently trading within the fair value estimates on the upper end, but are trading higher than their five-year average and sector averages. However, given the fundamentals of this company such as high ROE, high ROIC-WACC, and growing revenue, this company should be considered in any short-term market declines. TXRH has demonstrated they could successfully navigate a tough economic environment during 2020 and should be able to navigate other short-term declines. I believe this company is a cautious buy right now, given that they might be slightly overvalued at this time compared to their 5-year averages. This article is solely based on my own research and calculations. Investors should consider their own valuation metrics and own research before making any investment decisions.

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