THE HEDGEYE EDGE
Texas Roadhouse (TXRH) is unique in the restaurant industry for its consistent growth in customer traffic. They have been able to achieve this by running great restaurants and keeping prices on the menu low. Unfortunately, there is a price to be paid for this strategy when sales trends slow and you are left holding the bag of higher inflation, profitability suffers.
With TXRH having to narrow the value gap, by raising menu prices, what is going to happen to the brand’s industry leading traffic trends? Our belief was that sales trends were going to slow regardless, so the increased prices add a new level of uncertainty to the trajectory of sales.
We continue to be broadly short the Casual Dining Industry, and that includes TXRH. Why? The Casual Dining industry is a mess.
The charts below speak for themselves. The eight-month run of positive same-store sales ended in February with a (0.6%) decline. Weather may be a reason, but we suspect there is more to the decline than just weather. First, one of the biggest issues the industry is facing is aggressive pricing, with guest check-up 40bps sequentially to 3.1%. Given the aggressive pricing across the industry, we saw a (3.7%) decline in same-store traffic.
It’s important to note that February was the last month of easy comparisons for the industry. For the balance of 2019, same-store sales increased 1.1% on average per month.
The restaurant industry had been experiencing a bit of a tailwind since tax reform in 2018. Consumers benefited from lower tax rates and a number of large companies re-invested tax savings into their employee base in the form of one-time bonuses and base pay increases. Unfortunately, this benefit is ‘one-time’ in nature.
On top of this, we are now seeing inflation accelerating in the USA, which will also limit spending by consumers on discretionary purchases such as eating out. Current inflationary trends in gas, shelter and other critical expenditures will limit spending upside on discretionary items. Lastly, employment continues to slow, and it has been proven historically that sustained sales growth is hard to maintain when employment is headed lower.
Furthermore, the industry’s excessive discounting is not sustainable. When big chains get in trouble the recovery process usually entails making bold moves that can be very disruptive to the overall industry (i.e. $1 alcoholic drinks at Applebee’s). The excessive discounting that is running rampant across the industry is not a sustainable way to grow sales and can put franchisees in dire financial conditions. We have already seen Applebee’s second largest franchisee file for bankruptcy protection. There are surely many more on the brink.
We believe irrational promotions by some competitors will also negatively impact steady performers such as TXRH in the near to medium term. Instead of discounting, TXRH has opted for an everyday value menu. But what will happen once consumers start to see steak show up on Applebee’s 2 for $20 menu, and then they realize they have $1 Long Island Iced Teas? It’s hard to see how some consumers won’t shift to Applebee’s at least temporarily to take advantage of the extreme value, especially as wallets are weighed down by increased gas prices and rent.
Another TXRH headwind: Competition is heating up across the entire food landscape. Consumer habits are changing at a very rapid pace and it’s be proven to be very difficult for large chain restaurant brands to adapt to that changing behavior. Restaurants continue to be impacted/attacked from all angles, whether it be from traditional restaurant competition (QSR value/quality competition is intense), prepared foods/meal-kits at supermarkets, or the very competitive independent restaurants that tend to provide a higher quality more experiential environment for customers.
And finally, TXRH’s valuation. Given the market has placed a premium on TXRH operational consistency, TXRH has the most to lose in an increasingly competitive casual dining environment. On top of that, if industry sales trends continue to slow as we expect, that could put additional downward pressure on sales and profitability.
ONE-YEAR TRAILING CHART
