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Rising commodity costs take a bite out of Texas Roadhouse profits

A Heard on the Call report following first quarter earnings

Commodity inflation ate into first-quarter earnings at Texas Roadhouse, causing a 9-percent increase in total revenue to turn into a gain of 3 percent in net income and flat earnings per share.

Despite having to lower earnings expectations for 2011, chain officials said higher-than-expected food costs could be mitigated by continuing the brand’s conservative store growth approach, moderate price increases and efforts to shift the menu mix.

“We are very pleased with yet another quarter of strong top-line momentum, driven by rising guest counts and new-restaurant performance,” said G.J. Hart, Texas Roadhouse’s chief executive. “That said, commodity inflation continues to present challenges in the marketplace and, although we have modestly raised prices to address the issue, it has not been enough to fully offset the rising costs.

“If appropriate, we believe we are well-positioned to take further modest price increases to help offset inflation,” he said.

For the first quarter ended March 29, Texas Roadhouse’s net income rose about 2.9 percent to $19.79 million, compared with $19.24 million a year earlier. Its 27 cents per share matched the same earnings per share figure from a year earlier.

Revenues increased 9.3 percent to $283.79 million, compared with $259.62 million a year earlier, reflecting the opening of two company-owned restaurants and same-store sales increases of 4.6 percent at corporate locations and 3.8 percent at franchised units.

Hart added that a 4.2-percent gain in first-quarter traffic from increases in market share helped to drive those results.

Commodities cut into earnings

The company said higher cost of sales, particularly for lettuce and potatoes, reduced restaurant margins by 88 basis points. Texas Roadhouse officials said they now expect commodity inflation to be greater than anticipated in 2011, increasing from 3 percent to 4 percent. That estimate caused the company to revise its earnings per share expectations for the year down from 10-percent growth to between 5 percent and 10 percent.

Same-store sales in the first four weeks of the second quarter started up 5.4 percent, Hart said. The brand’s average check is up about 1 percent so far in the second quarter following a 1-percent menu price increase in March.

Hart reiterated during a conference call with securities analysts that the brand would be cautious about monitoring inflation and traffic before raising prices again this year. He said he wants Texas Roadhouse to be seen as the value player in its segment.

“Not only are we feeling inflation, but our guests are as well,” Hart said. “The last time we had $4 gas prices a couple years ago you can remember what happened. So we really want to get a better picture as to how our guests are going to be affected by what’s going on.”

He did not indicate when Texas Roadhouse would raise prices or by what percentage.

“We’ve indicated with our guidance that to get to the upper end, we’re going to need to take some,” Hart said. “But, you know, when you look at our business model and what’s worked for us in the past, we believe it will continue to work for us in the future.”

Chief financial officer Scott Colosi said the brand expects higher inflation in the second half of 2011 based on current commodity contracts.

About 65 percent to 70 percent of the chain’s basket is locked, including 90 percent of its beef, added Price Cooper, vice president of finance. Hart said it was too early to get a clear picture of commodities in 2012, but he did not think inflation would be as bad next year as it is currently in 2011.

Balancing the menu

Some menu initiatives are being tested to incorporate higher price points into the mix. In addition to increasing menu prices, Hart said, Texas Roadhouse also introduced a new 20-ounce bone-in rib eye, which has a greater perceived quality and can carry a higher price point.

That item currently is in 25 percent of the system but should be in half the restaurants by June, he added.

“We believe it fits a need we have missing in our menu today,” Hart said, adding that the chain also is testing in some stores an 8-ounce sirloin with shrimp. “It could be the opening demographic of some higher-income folks coming and staying with us. I don’t have any data yet to back that up, but we feel very good about these moves and the fact that they are getting us a mix shift that’s beneficial to us.”

Geared up for growth

The chain restated its 2011 outlook that called for 20 new restaurants and comparable-sales growth between 3.5 percent and 5 percent. Texas Roadhouse officials said they have the executives and infrastructure to open as many as 30 locations next year.

Preopening expenses in the first quarter were up $800,000 over the prior year, and Texas Roadhouse expects that line item to be significantly higher throughout 2011, Cooper said.

“We are growing faster, and our pipeline is larger as we are preparing to grow even more restaurants in 2012,” he said.

The 254 company-owned restaurants in the brand’s same-store sales base averaged $78,400 in weekly sales, compared with the 10 restaurants that have been open only six to 18 months, which averaged $82,700 a week in sales. The chain’s 12 newest restaurants, open six months or less, averaged $85,600 in weekly sales.

“As has been the case for several quarters now, average unit volume growth of 4.8 percent surpassed comparable-restaurant sales growth of 4.6 percent, due to the continued strong performance of our newer restaurants,” Cooper said.

Colosi added that Texas Roadhouse is “much more ahead of the game” for 2012, as the pace of restaurant openings is to be more evenly spread throughout the year compared with 2011, in which the majority of new units will open in the third and fourth quarters.

Louisville, Ky.-based Texas Roadhouse operates 276 steakhouses and franchises another 71 units in 46 states.

Contact Mark Brandau at [email protected].

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