I started adding to my position in Texas Roadhouse (TXRH 0.18%) and began buying Shake Shack (SHAK -0.87%) during the economic lockdown earlier this year, expecting that both restaurant chains would be just fine once the effects of the COVID-19 pandemic started to ease. So far, so good. Both stocks are back in positive territory for 2020 and have doubled from their late-March/early April lows. And now, after seeing both of their third-quarter updates, I'm still bullish on their stocks.
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A casual diner learns new tricks
Texas Roadhouse handily outperformed the restaurant industry average in the third quarter. According to analyst Black Box Intelligence, across the industry, average comparable-store sales fell by 8.1% and comparable-store traffic fell by 14.6% in the U.S. year over year. Texas Roadhouse may not have delivered growth on those metrics, but company-owned store comp sales fell just 6.3%, franchisee comp sales fell 9.6%, and traffic declined by only 9.3%.
Since Roadhouse operates restaurants in suburban and rural areas, it has benefited from a gradual reopening of dining rooms in recent months. New cases of COVID-19 have been rising steadily to record highs across the U.S. for the past two months, so more shutdowns could be coming, but this casual dining chain has learned some important lessons that I think will serve it well if it does face another period of pandemic-related business disruption. To-go orders historically were not all that meaningful for the steakhouse, but they comprised 23% of the weekly sales average during the summer months -- not a bad quick pivot for the chain. All told, third-quarter revenue and earnings per share fell by 3% and 20%, respectively, with the bottom line in worse shape due to lower comps and higher benefits paid to hourly wage employees.
I'm fine with that. When the pandemic is behind us, shareholders can start fretting about profits again. For now, I'm staying focused on the sales recovery. And in October (the start of the fourth quarter), management said comps returned to positive year-over-year territory with a 0.8% increase. The easing of restrictions on the use of dining rooms helped, but higher in-store traffic didn't eliminate the to-go business, which made up 20% of the weekly store average during the month. Pre-coronavirus, some Roadhouse locations were getting crowded, so the nascent order-ahead business could help the chain in the long term to keep making gains at its busiest stores, which were previously bumping up against capacity issues.
On a final note, Texas Roadhouse ended September with $329 million in cash and $240 million in debt (which it raised this year to give itself an extra cash reserve). But with the company operating in the black again, I expect its conservatively run balance sheet to improve going forward. The net cash balance will also help it support the some 20 new stores expected to open next year, as well as the new Texas Roadhouse Butcher Shop, which the company started when restaurants were shuttered. This slow-and-steady growth chain looks poised to thrive in the years ahead.
Betting on the future of urban fast-casual
Owing to its concentration in the Northeast and other densely populated areas, Shake Shack hasn't been nearly as resilient a story this year. Same-Shack sales (its cutesy name for comps) remained down by 32% in Q3 among stores open for at least two years. Ouch.
But every month has brought an improvement, and October was no exception: Management reported same-Shack sales were off by 21% year over year. Select Shake Shacks have even returned to or exceeded their pre-pandemic sales levels. And thanks to the 33 new locations opened up in the last year, revenue was down only 17% in Q3. The company booked a loss of $6.1 million, which was certainly better than the $18 million loss it racked up in Q2.
The chain's operations are far from perfect, so why the optimism? Beyond the fact that it's progressively rebounding from its deep slump, Shake Shack ended the last quarter with nearly $192 million in cash and short-term securities on the books, and no debt. This is a significantly better balance sheet than the company had pre-crisis, owing to the new stock the company issued over the summer to bolster its liquidity. Since this is a high-growth concern, that cash will come in handy. It expects to open at least 35 domestic Shacks and at least 15 international franchised Shacks in 2021 -- significant growth given its total of about 300 as of the end of Q3.
In addition, Shake Shack is embarking on a revolution and betting on the fast-food industry's emerging digital-first future. In Q3, 60% of sales were made via digital platforms, counting both its own channels and third-party platforms and delivery services. And to capture a more-mobile consumer, it's developing new drive-thru and walk-up formats -- not to mention curbside pickup, which is already available at some 70 Shacks. Given that this fast-casual burger chain is flush with cash to continue pursuing its growth ambitions, I think it's in good shape for the long haul.
