Texas Roadhouse Looking Meaty

Investors hankering to add some Grade A meat to their portfolios need look no further than casual steakhouse Texas Roadhouse (Nasdaq: TXRH  ) . Texas Roadhouse is a high-quality small cap whose stock has been pummeled this year, along with chains like Ruth's Chris Steak House (Nasdaq: RUTH  ) , and McCormick & Schmick's Seafood (Nasdaq: MSSR  ) .

Anytime a group like this starts setting 52-week lows, I'm going to be interested, since that's a sign of an indiscriminate sell-off that isn't necessarily an indicator of anything wrong at a specific company. There are some sales softness and cost pressures across the industry, but all told I think the market -- with its fickle sentiment -- has simply decided to throw the baby out with the bathwater. That gives us rational folks a chance to snatch up bargains, and out of the restaurant group I really like Texas Roadhouse.

Room to run
At the end of the second quarter, there were just 272 Texas Roadhouse locations nationwide, and the company is opening around 30 new locations a year. Although the company was founded in 1993, it has taken a measured approach in its expansion and is nowhere near saturating its potential market.

Consider that there are more than 1,900 Applebee's (Nasdaq: APPB  ) , and 600 each of Darden Restaurants' (NYSE: DRI  ) Red Lobster and Olive Garden restaurants. The 272 Texas Roadhouse restaurants look paltry in comparison with those giants of casual dining. Now I'm not saying Texas Roadhouse could, or should, triple in size. There appears to be, however, a lot of opportunity for the company to continue gradually increasing its number of restaurants. This makes Texas Roadhouse a great small-cap growth story for many years to come.

The price is right
Texas Roadhouse went public three years ago and shares today are right where they were when the company made its debut on the Nasdaq. This is even after the company doubled its revenue and profits over the same period. This is a stock that's not just near its 52-week lows; it's near its all-time lows. Importantly, nothing has gone wrong recently to trigger this drop, as same-store sales are up nearly 2% and the top line has continued its robust double-digit pace.

Shares are currently trading at an earnings multiple of 22. That may not look bargain-basement, but keep in mind that this is a company that has had a compound annual earnings growth rate of more than 30% the past three years. Management's goal is to grow EPS by 20% a year. That seems a reasonable target, considering the company is in a growth phase. The pedestrian earnings multiple does not appear to factor in the company's historical growth rate or its future prospects.

From a cash flow perspective, Texas Roadhouse generated $81.7 million in cash flow from operations for the 12 months ended in June. The company booked $106.6 million in capital expenditures during the same period, although it doesn't break out specific amounts for opening new stores versus maintenance capital spending, except to say that nearly all of it relates to new restaurant openings. In its 2007 10-K filing, it states that opening costs run $3 million to $4 million per store, and with about 30 store openings a year, we can account for the capex allocation pretty easily.

If I assume that Texas Roadhouse's existing restaurant base is generating around $70 million in free cash flow, then I find that the market has priced low-single-digit growth into the stock. With same-store sales growth near 2%, I'm comfortable with this.

A Fool wraps up
At dinnertime, there's almost always a wait for a table at the Texas Roadhouse near where I live -- even with an Outback Steakhouse across the street and a Lone Star Steakhouse just a few blocks down the road. Though that's just one anecdotal piece of data, I view it as a good sign that it is able to hold its own in a very competitive business.

This is a small-cap company with a lot of room to grow and it should be a good stock for investors to hold during its expansion. I know there are concerns about rising costs in the restaurant business, along with consumers feeling pinched by high fuel prices and the housing downturn. But I'm not worried, because people simply like to go out to eat and that trend is a tailwind working in Texas Roadhouse's favor.

Texas Roadhouse reports third-quarter earnings Oct. 29. Check to see if the company has maintained same-store sales growth in the 2% range while keeping net margins around 5% to 6%. Those will be signs that the business is staying healthy despite the market's fears.

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