These 2 Restaurants Can Offer Beefy Returns

Leo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

For many investors, restaurants are a tricky industry to navigate. Conservative fast food giants such as McDonald’s and Yum! Brands can be too heavily exposed to weak international markets, while full-service diner companies such as Darden Restaurants (NYSE: DRI) and Brinker International can own strong brands (LongHorn Steakhouse, Maggiano’s), whose gains are offset by weaker ones (Red Lobster, Chili’s).

The rise of bistro restaurants, such as Panera Bread and Chipotle, has also created a popular new class of restaurants wedged between fast food and full-service diners. Meanwhile, rising food costs are weighing down the entire industry, making it tough for weak and mediocre companies to survive.

However, let me introduce one simple way to cut through the confusing problems in the restaurant industry, and it starts with the age-old catchphrase coined by Wendy’s nearly three decades ago: “Where’s the beef?”

Where’s the beef?”

I first noticed the rising popularity of beef-oriented restaurants when I analyzed Darden Restaurants, the parent company of Olive Garden, Red Lobster, and LongHorn Steakhouse, back in March. In its third-quarter, Olive Garden’s revenue grew by an anemic 0.6% year-on-year while Red Lobster's revenue plunged 6%. Same-store sales dropped 4.1% at Olive Garden and 6.6% at Red Lobster from the previous year.

However, beef-oriented LongHorn Steakhouse’s revenue climbed 6.9%, although its same-store sales declined 1.6%. Meanwhile, its high-end steakhouse, The Capital Grille, reported a 0.8% increase in same-store sales. This indicated that mid-range and high-end steak was actually a more stable business than its pasta and seafood businesses.

Recent positive earnings from two other businesses that serve up a lot of beef -- Texas Roadhouse (NASDAQ: TXRH) and Ruth’s Hospitality Group (NASDAQ: RUTH) -- tell me that Americans still love good quality beef. With their relatively simple business models and menus, these two beef-focused companies might outshine the rest of the restaurant industry over the next few years.

Texas Roadhouse

For those investors who haven’t visited Texas Roadhouse, the restaurant serves steak, ribs, chicken, and seafood. Texas Roadhouse places more emphasis on its beef offerings, and the chain often hosts rib and steak cooking championships. Most of the items on the menu are made from the scratch from ingredients supplied by Tyson Foods and Smithfield Foods.

Founder and CEO Kent Taylor once summarized the Texas Roadhouse experience by stating, “We're a casual themed restaurant, we have country music, we cut our own meat in the house and we fresh-bake our own bread.”

That simple, down-home strategy helped Texas Roadhouse post first-quarter same-store sales growth of 3.5% at company-owned restaurants and 4.5% at franchised locations. Total revenue rose 11% year-on-year to $359.7 million, topping the consensus estimate of $358 million. Earnings also rose 19.8% to $0.37 per share, beating estimates by $0.02.

As seen in the following chart, Texas Roadhouse’s strong quarterly earnings are a continuation of a longer-term trend of top and bottom line growth over the past five years.

Investors have taken notice, and the stock has risen nearly 100% over the past five years. However, the restaurant hasn’t finished growing yet. At the end of 2012, Texas Roadhouse owned 397 restaurants, with 321 company-owned locations and 74 franchised ones. The company intends to add 28 new restaurants in fiscal 2013.

The first four weeks of the second quarter have also been positive, with same-store sales rising 5.7% already, indicating strong earnings to come in the second quarter. The company expects to finish 2013 with 6% same-store sales growth.

However, food cost inflation remained high last quarter, at 7.2%, primarily due to higher beef costs. Meanwhile, for the rest of 2013, Texas Roadhouse expects food inflation to hold steady near 7%. These figures should translate into strong and steady returns for the rest of the year and beyond.

Ruth’s Hospitality

Meanwhile, Ruth’s Hospitality Group, the parent company of Ruth’s Chris Steak House and Mitchell’s Fish Market, recently posted solid first-quarter earnings that also demonstrated strong top and bottom line growth. The company’s two main restaurants are considered upscale in comparison to Texas Roadhouse or Darden Restaurants’ flagship brands.

During the first quarter, Ruth’s Hospitality earned $0.25 per share, rising 66.7% from the prior year quarter and topping consensus estimates by $0.05. Revenue rose 7% to $107.4 million and beat the $106 million that analysts had forecast.

Same-store sales at Ruth’s Chris Steak House rose 6.6% due to a 2.9% sales increase in entrees and a 3.6% increase in average guest checks. Mitchell’s Fish Market posted same-store sales growth of 1.5%, due to a 2.7% increase in store traffic and 1.2% rise in average guest checks.

In other words, more people visited its restaurants while spending more per meal. Moreover, the higher numbers from Ruth’s Chris Steak House confirm my previous argument that steak is selling better than seafood or pasta.

Compared to Texas Roadhouse, Ruth’s Hospitality’s growth trajectory isn’t as stable, and its profits have not consistently grown in sync with revenue.

In addition, Ruth’s Chris Steak House is fully exposed to the same rising costs of beef that threaten to undermine the growth of both companies. From the following chart, we can see that beef prices have nearly doubled over the past five years due to rising global demand.

Source: http://www.indexmundi.com

However, shares of Ruth’s Hospitality have risen over 40% during that same period, which suggests that rising prices aren’t really hurting demand. The company has also controlled expenses well during the quarter, with restaurant expenses decreasing 72 basis points to 48.1% of total restaurant sales, while food and beverage costs declined 81 basis points to 31.2% of total restaurant sales.

Unlike Texas Roadhouse, Ruth’s has conservative plans for expanding in 2013, and will add at the most three franchised stores during the year. But investors shouldn’t worry about how much the company is expanding, but admire how well the company has held up despite macro headwinds, lower consumer spending, and rising food costs.

The beefy bottom line

The thesis of this article is simple -- Americans love to eat beef, and while the price of beef might double or triple, it won’t douse their appetite for a thick juicy steak. Considering the resilience of Texas Roadhouse and Ruth's Hospitality in tough times over the past five years, I believe that these two companies could rise to new highs if beef prices decline and consumer sentiment in the United States further improves.

Lastly, their comparatively smaller sizes give them more room to grow in a saturated domestic market that has grown tired of eating at the omnipresent chains of Darden Restaurants and Brinker International. So, in the end, beef might just give your portfolio the beefier returns that it craves.

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Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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