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Restaurant Stocks: Buy This, Not That

By Lawrence Rothman, CFA - Jan 6, 2021 at 9:48AM

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In this notoriously tough sector, here is one company executing well and another to avoid.

The restaurant business is ultra-competitive in normal circumstances -- 80% of new restaurants go out of business within the first five years.

But to make matters worse, these are not normal times. While everyone hopes the COVID-19 vaccines put an end to the pandemic, cases continue to surge as of this writing. That means the restaurant industry must still overcome near-term headwinds with widespread closures or capacity restrictions.

That doesn't mean all companies in this space are in the same boat. Here are two restaurants in the casual dining space that are moving in different directions.

Someone sitting in front of a laptop which has a screen asking for feedback.

Image source: Getty Images.

An appetizing choice

Texas Roadhouse ( TXRH 1.15% ) has over 600 restaurants, primarily under its namesake banner. Its focus on high-quality food at attractive prices is deceptively simple. It is easy to claim but hard to accomplish.

Looking at the results, the company is succeeding. Coming into this year, it had several years of positive same-store sales (comps) growth and earnings gains.

TXRH EPS Diluted (Annual) Chart

Data by YCharts.

However, the company was not immune to the pandemic and the ensuing social-distancing measures government officials put in place. Management quickly adjusted by concentrating on pickup and delivery, in addition to outdoor seating.

As these initiatives took effect and authorities eased restrictions, Texas Roadhouse's results improved. In the third quarter, comps continued to get better each month, going from negative 13% in July to down just 0.5% in September. While local authorities implemented new restrictions late in 2020, this will only affect results in the next few months.

Texas Roadhouse has no secret formula behind its long-term growth. It offers affordable food in a fun atmosphere, and management is replicating this model as it expands the chain's footprint, including international markets where less than 5% of its restaurants are located.

Management sees plenty of opportunity in its ongoing expansion. Historically, the chain has opened about 30 new restaurants annually, and it was on track to open over 20 last year after delays from COVID-19.

With just 620 locations, the combination of new restaurant openings and strong comps can fuel Texas Roadhouse's earnings growth and shareholder returns as the company regains its momentum following the pandemic.

One to pass by

BJ's Restaurants ( BJRI 2.19% ) attempts to distinguish itself in this competitive market through customer service, a slew of its proprietary craft beers, a broad menu that includes about 20 different kinds of pizzas, and affordable prices.

But while management focuses on gaining market share over other casual restaurants, BJ's had mixed results before last year's challenges struck. In 2019, comps rose 1.1%, but this was due to higher guest spending as the company raised prices. Customer traffic actually declined 1.9%.

Heading into 2020, management took steps to boost traffic, offering new, healthier menu options and testing value pricing for certain lunch items.

Given the events of 2020, it's difficult to judge whether these new initiatives would have been successful. However, BJ's did not see the strong recovery in the third quarter that Texas Roadhouse experienced as comparable sales declined over 30% during the period. It also raised prices again this year and cut down on promotions.

Prior to the pandemic, BJ's Restaurants was also grappling with declining profitability as increased food, labor, and occupancy costs drove earnings down in 2019 -- its operating margin declined from 6.2% in 2016 to 4.2% in 2019.

Despite that headwind, the company has ambitious expansion plans of its own. Management wants to double the current number of restaurants to 425, though it only recorded two openings in 2020. It is unclear how long it will take the company to hit this target, but even before COVID-19 shook the industry, BJ's was in a weaker position to rapidly expand.

Trying to predict the future is hazardous. But picking companies that have a strong track record and are best positioned to meet their long-term growth targets is the key to successful investing. In the restaurant industry, that means siding with Texas Roadhouse and avoiding BJ's Restaurants.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

BJ's Restaurants, Inc. Stock Quote
BJ's Restaurants, Inc.
$35.55 (2.19%) $0.76
Texas Roadhouse, Inc. Stock Quote
Texas Roadhouse, Inc.
$88.52 (1.15%) $1.01

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