A slew of competition
The steakhouse category is a crowded one, making expansion difficult and keeping margins low. The problem Texas Roadhouse Inc (NASDAQ:TXRH) is likely facing is finding locations that have a large enough population and aren’t already saturated with competitors. LongHorn Steakhouse, a chain with 430 stores and operated by restaurant giant Darden Restaurants, Inc. (NYSE:DRI), is roughly the same size as Texas Roadhouse Inc (NASDAQ:TXRH) with $1.2 billion in annual sales. In Darden Restaurants, Inc. (NYSE:DRI)’s 2012 annual report the company states that it will build 37-40 new locations in the following year, quite a bit more than Texas Roadhouse. Darden Restaurants, Inc. (NYSE:DRI) believes that the restaurant could grow to between 600-800 locations, generating up to $2.5 billion in annual sales.
This goal likely also applies to Texas Roadhouse, and with the slower store count growth it will take longer to get there. Texas Roadhouse is not the type of company that will grow to thousands of locations, and investors seem far too optimistic about the future.
Darden Restaurants, Inc. (NYSE:DRI) also pays a dividend, but given that the company has brands such as Red Lobster and Olive Garden that provide consistent earnings and don’t require much investment, it makes sense for the company to pay out a substantial amount of its earnings. After the dividend there is still plenty left over to fully fund concepts like LongHorn and build them quickly into national brands. Darden Restaurants, Inc. (NYSE:DRI) pays a massive 4.6% dividend, one of the highest in the restaurant industry, and is a great dividend growth opportunity.
Another steakhouse operator which recently started paying a dividend is Ruth’s Hospitality Group, Inc. (NASDAQ:RUTH). Ruth’s Hospitality Group, Inc. (NASDAQ:RUTH) is a small company that operates a handful of restaurant concepts, mainly steakhouses. In 2012 the company recorded about $400 million in revenue and $16 million in net income. The stock trades for about 27 times earnings.
Ruth’s Hospitality Group, Inc. (NASDAQ:RUTH) size apparently leads people to believe that fast growth is ahead, but the company isn’t investing very much in its growth. For the last four years capital expenditures have been less than depreciation, not a characteristic of a fast growing company. In addition, just this year Ruth’s Hospitality Group, Inc. (NASDAQ:RUTH) started paying a small $0.04 quarterly dividend. The payout ratio based on 2012 will be about 34%.
Ruth’s Hospitality Group, Inc. (NASDAQ:RUTH) paying a dividend makes no sense if the company plans to expand, and investors paying 27 times earnings are making a serious mistake. Much like Texas Roadhouse, Ruth’s has a growth stock multiple which it doesn’t deserve.
The bottom line
When small, supposed growth companies begin paying dividends its a bad sign for future growth. Texas Roadhouse is growing slower than Darden Restaurants, Inc. (NYSE:DRI)’s competitor, and with the stock trading at lofty valuations it’s hard to see the appeal. It seems that small restaurant stocks are universally being given high multiples by the market, but only some companies deserve it. Texas Roadhouse is not one of them.
The article Why Slow Growth May Be In Store For This Restaurant Chain originally appeared on Fool.com is written by Timothy Green.
Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Texas Roadhouse. The Motley Fool owns shares of Darden Restaurants.
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