Is a Casual Dining Recovery Under Way?
RJ is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
On Tuesday, casual dining firms Texas Roadhouse (NASDAQ: TXRH) and Red Robin (NASDAQ: RRGB) announced fourth-quarter results that were better than consensus expectations. This begs the question: could a prolonged slump in casual dining be nearing an end? Let’s take a look.
For the fourth quarter, Texas Roadhouse posted revenue growth of 12% year-over-year to $310 million, well above consensus estimates. The firm earned $0.19 per share, a 12% year-over-year increase and a penny better than consensus estimates.
The chain also posted same-store sales growth of 4.4% at company restaurants and 4.5% at franchise-owned restaurants. The firm was able to leverage this sales growth into operating-margin expansion of 70+ basis points to 17.6%. Texas Roadhouse capitalizes on America’s love of affordable steaks and Texas-themed food, and while the concept is not necessarily 100% unique, its value proposition remains incredibly attractive to consumers.
However, we’re a bit concerned with the pace of year-to-date same-store sales expansion, which was only 2.2% on a year-over-year basis (mostly driven by a price increase of 2%). This magnitude of a price increase won’t offset expected food inflation of 6%-7%, and there isn’t much room to improve operating margins in other areas, in our view. Raising prices on value-oriented consumers could negatively impact sales — just ask McDonald’s. Yet, the firm anticipates opening 28 new restaurants in 2013, which will help propel earnings-per-share growth. Because restaurants are company-owned, volatile earnings performance should be expected, which management addressed saying:
“Being an 80% company-owned system, small changes in assumptions can have a very meaningful impact on our annual earnings. While impact on cash flow is much smaller percentage terms, assumptions can meaningfully impact EPS. Thus, it is generally difficult for us to provide a meaningful range of expectation for EPS because things like traffic and to a lesser extent, food inflation can greatly impact annual results. For instance, a 1% change in traffic equates to a little over 5% change in EPS and even a 1% change in commodity inflation that can have an approximate 4% impact on EPS.”
Regardless, we at Valuentum think the firm will be able to generate strong free cash flow, even if same-store sales expansion comes in at a low-single-digit pace. Texas Roadhouse generated $61 million in free cash flow during 2012, and we like how management is friendly about returning cash to shareholders. The firm repurchased $29 million worth of stock in the fourth quarter, and it raised its quarterly dividend 33% to $0.12 per share — an annualized yield of 2.6% at current levels. Nevertheless, we think shares look fairly valued, and its 2013 outlook doesn’t warrant consideration for the portfolio of Valuentum's Best Ideas Newsletter.
Red Robin posted very strong fourth-quarter results, with revenue growing 17% year-over-year to $241 million, easily exceeding consensus expectations. This resulted in earnings per share that also exceeded consensus estimates, growing 110% year-over-year to $0.59 (on an adjusted basis).
Company-owned restaurant same-store sales weren’t as strong as we saw at Texas Roadhouse, growing just 1.4% year-over-year. Still, operating margins expanded 70 basis points to 20.6%, and the firm generated a solid $31 million in free cash flow — down from the prior year due to much higher capital spending. The firm spent $8.6 million repurchasing shares during the fourth quarter and retired 803,000 shares during 2012 for an outlay of $24.3 million.
Companies such Red Robin, which boast generous buyback programs, often use share repurchases to drive earnings-per-share expansion. Savvy investors, however, know that shares repurchased above fair value are value-destructive, and shares repurchased below fair value are value-creative. Red Robin’s stock price bounced within the boundaries of our fair value range for most of 2012, so we view the repurchases as value-neutral.
Regardless, Red Robin is poised to have a strong 2013, with the firm anticipating same-store sales growth of 2.5%-3%. Restaurant operating margins are expected to be flat to down only 10 basis points from the 2012 level of 20.7%. Therefore, we could see a substantial rise in earnings. SG&A at the corporate level is expected to remain flat, but again, company-owned restaurant chains can see wild swings in profitability, as explained in the press release:
“The sensitivity of the company’s earnings per diluted share to a 1% change in guest counts for fiscal 2013 is estimated to be $0.23 on an annualized basis. Additionally, a 10 basis point change in restaurant-level operating margin is expected to impact earnings per diluted share by approximately $0.05, and a change of $187,000 in pre-tax income or expense is equivalent to approximately $0.01 per diluted share.”
Though we think free cash flow will be solid in 2013, the company will spend $50 million to $55 million on capital investments, opening 20 new restaurants and devoting significant resources to improve menu choices. Red Robin has some compelling growth markets (Florida, New York, New Jersey, Chicago, Texas) that could help drive strong earnings growth in the years to come. Nevertheless, we at Valuentum believe shares of Red Robin are starting to look rich at current levels, and we do not believe the name warrants a position in the portfolio of our Best Ideas Newsletter.
Valuentum has no position in any stocks mentioned. The Motley Fool recommends Red Robin Gourmet Burgers. 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!