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Looking at the headlines, TXRH had a strong second quarter.  Earnings were in line with expectations but comps came in better-than-expected and were positive for the second consecutive quarter after nine negative quarters.  And, traffic was positive, +2% in the quarter.  Restaurant-level margin increased YOY and came in better than I anticipated given the expected decrease in benefit from food costs deflation.  However, cost of sales as a percentage of sales was still down about 70 bps YOY (versus -185 bps in 1Q10).  This positive margin growth, combined with positive same-store sales, put TXRH in the “Nirvana” quadrant of our sigma chart for a second consecutive quarter.  Management raised its full-year comp and EPS guidance.  The increased comp guidance of +1% is definitely achievable and the street’s FY10 EPS estimate of $0.82 implies 22% EPS growth, above management’s upwardly revised range of +16% to +20%.

So, that all sounds good.  When you look at the underlying trends, however, the +1.4% same-store sales growth for company-owned restaurants in the second quarter, which was better than the street’s +0.9% estimate, implies a 70 bp deceleration in two-year average trends.  The third quarter-to-date comp trend of +3%, which is lapping a -5.5% to -6% comp from the same period last year, points to a continued slowdown in two-year average trends of 10 to 40 bps from the 2Q10 level.  There were a lot of questions on the earnings call about whether management is being conservative with its full-year +1% comp guidance given that same-store sales were up more than that in 2Q10 and in the third quarter-to-date.  This deceleration in two-year average trends may be the reason for management’s conservatism; though management said its weekly trends have been pretty consistent over the last couple of months.

Restaurant-level margin compares get increasingly more difficult in the back half of the year on a YOY basis, but management guided to increased food cost deflation in the third and fourth quarters.  We will have to see how same-store sales trend from here but the tougher restaurant-level margin compares will make it more difficult for the company to remain in “Nirvana” for the balance of the year.  Same-store sales growth will likely remain positive during the third quarter, but comparisons get more difficult in 4Q10 and the company is expecting a slightly negative impact on comp performance from a Christmas timing shift during the quarter (falling on a Saturday in 2010 relative to a Friday in 2009).

Despite TXRH’s conservative comp guidance, management’s sounded optimistic and encouraged by the positive trend in new unit volumes.  To that end, management stated that it will be increasing its unit growth in FY11, above the14 to 15 units expected in FY10, and that it expects unit growth to move even higher in FY12.  Improving new unit growth is a good proxy for the health of the concept, but management also spent some time on the call yesterday talking about how trends have improved, “due in part to moderating [the company’s] development schedule over the last 12 months.”  I am interested to learn to what extent management increases its unit growth (company said it would provide more details on its 3Q10 earnings call) as it will be important that the ramped up growth does not offset the positive trends that have resulted from the slowdown in unit growth. 

TXRH – IN NIRVANA FOR NOW - txrh sigma

Howard Penney

Managing Director