Management is confident from a top line perspective but is appropriately cautious on margins and earnings. Long term, the growth potential seems strong but the risk of prolonged commodity inflation in 2011 and into 2012 may depress earnings power even if sales growth were to meet management’s expectations.
TXRH’s 4Q10 earnings of $0.14 per share came in slightly below the street’s $0.16 per share estimate despite stronger-than-expected company comp growth of +3.1%. The recent trend has been for companies to miss on the top-line and beat on the bottom line and TXRH was one of only a few names this quarter to report better-than-expected comp growth and fall short of consensus EPS estimates. With inflation headwinds becoming more prevalent in the coming quarters, however, this will likely become more common. Additionally, given that TXRH is trading down today, along with the broader market and most other restaurant names, it seems that investor focus is shifting somewhat toward potential margin and EPS performance and away from comp performance alone.
TXRH’s same-store sales growth improved 40 bps during the fourth quarter on a two-year average basis and 1Q11 quarter-to-date comp growth of +3.8% (vs. -1.2% last year) implies that two-year average trends have accelerated another 100 bps since the end of the year. Management guided to 10% full-year EPS growth (from its prior 5-15% range), which assumes 3.5% comp growth, 3% inflation and a 20-30 bp decline in restaurant-level margins. Although the company raised its comp growth assumption to 3.5% from 2-3%, it also slightly increased its inflation outlook from its prior range of up 2-3%. Management commented that it is now only targeting the mid-point of its prior EPS range because the high-end had assumed a +2% menu price increase and they have decided to be more conservative and only implement a 1% price increase by the end of the first quarter.
Like most of the casual dining names, there are risks to TXRH’s guidance. Inflationary pressures could come in higher than anticipated and comp targets could be aggressive. Specifically, TXRH has locked in 65% of its food cost needs for 2011, including more than 80% of its beef. For the food items not yet hedged, however, most notably dairy, produce and some protein requirements for the end of the year, the company’s 3% inflation expectation assumes prices don’t remain at their current levels. If prices stay where they are or move higher, commodity costs will be up more than +3%.
TXRH’s FY11 same-store sales growth target, like most other casual dining names, assumes a continued improvement in two-year average trends throughout the year. The most important comp growth dynamic to watch going forward for the restaurant names will be the impact of price on traffic trends as most companies are taking price for the first time in a while. TXRH’s current guidance only assumes a +1% price increase, but management said they could revisit their pricing strategy and raise prices again if the commodity environment warrants it. It was encouraging to hear that TXRH management understands that it must be conservative with pricing in this environment and they highlighted that if traffic falls off as a result of higher pricing, that it will hurt them on the labor line.
Traffic has been running positive for TXRH for the last three quarters with average check declining slightly. As the chart below highlights, however, the traffic comparisons get increasingly more difficult going forward, particularly come 2Q11, so it will likely prove difficult for the company to hold traffic flat. For reference, flat traffic growth in 2011 would imply almost 100 bps of acceleration in two-year average traffic trends from 4Q10 levels.
Inflation and tougher traffic comparisons will pose problems for most casual dining names in 2011. Given that TXRH’s comp trends outpaced the industry in 2010 as measured by Malcolm Knapp by 2.5% to 3.5% on a one-year basis and 2-3% on a two-year average basis and trends have accelerated quarter-to-date, the company sits in a better position than many of its competitors to raise prices. Additionally, the company has better visibility on its commodity cost outlook than many other casual dining concepts since it has already locked in 65% of its food cost needs for 2011, most importantly, more than 80% of its beef.
That being said, the company’s 3.5% comp guidance could prove somewhat aggressive (I am currently modeling +3%), particularly when you consider the impact the menu price increase could have on already difficult traffic comparisons. Along with my slightly lower comp growth estimate, I am modeling a 40 bp decline in FY11 restaurant-level margins relative to management’s guided -20 to -30 bp range.
At today’s Analyst and Investor Day in NYC, management struck a confident note that the company will be able to find new avenues of growth for investors. The development team has found significant cost cuts in development costs and simply by comparing the number of TXRH units nationwide (346) versus Outback Steakhouses (778), the case could be made that there is some white space for expansion. The fact that AUV growth has outpaced same-store sales growth for the last two quarters also implies that new units are performing well and makes the case for continued growth. Kent Taylor, founder and Chairman, stressed that he visits each prospective site along with other top executives to ensure that each development is given due consideration and assessment prior to committing.
From a sales perspective, TXRH is certainly taking a proactive approach in seeking to drive the top line in any way possible. A call ahead service, designed to allow customers to “get in line” from home and arrive 10-15 minutes prior to being seated has seen strong growth in popularity and a text ahead service is also being considered by management. Furthermore, the company is choosing to focus on local marketing rather than national advertising and other “noisy”, “undifferentiated” channels of communication. One high-class problem the chain has is customers turning away from the door because of wait times. Management is implementing several initiatives to combat this issue but it is unclear that they will make a significant difference. The most compelling was a “pay-at-table ZIOSK” idea that is estimated to shave 2-3 minutes off the total time a party spends at a table.
Howard Penney
Managing Director
