#93 | Texas Roadhouse Deep Dive | High Steaks and Sizzling Margins

In this episode of the TDI Podcast, we are doing a deep dive into a company that breaks almost every rule taught in business school: Texas Roadhouse. How does a restaurant become one of the greatest success stories in casual dining when it refuses to serve lunch during the week, does zero national TV advertising, and requires managers to put up $25,000 before they even start?

We explore the inspiring, unconventional journey of founder Kent Taylor, the unique culture that drives their customer loyalty, and the economics behind their free peanuts and fresh-baked bread. From tracking key metrics like Average Unit Volume (AUV) to analyzing the constant threat of fluctuating beef prices, we break down the financials and the core operational strategy. But the biggest question remains: does Texas Roadhouse actually have a sustainable economic moat, or are we just looking at a well-run operation that is one bad CEO away from collapse?

Transcript

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Welcome back to the TDI podcast. I'm your host Seam, and today we are doing a deep dive into a company that I find personally fascinating because it breaks almost every rule taught in business school. If you walked into a venture capital firm today and said, I want to start a restaurant that doesn't serve lunch, refuses to do any national TV ads, and requires my managers to pay me$25,000 before they start, I think most would laugh you out of the room. And yet Texas Roadhouse is one of the greatest success stories in the history of casual dining. Since their IPO in 2004, they have consistently outperformed most everyone in their sector. But is this a sustainable mode, or are we just looking at a well-run operation that is one bad CEO away from collapse? Let's uncover.com. We were tired of not having a platform to do all the research on. We were switching between tabs. We had several subscriptions. We had notes written on paper, we had Google Drive files, everything was scattered. Now, in just a single terminal, you can do it all. We have partnered with Portfolio Dividend Tracker and Fiscal AI to build an all-in-one investing terminal. You now have access to live fundamental data, portfolio tracking, building watch lists, KPIs and segments in real time, a new company deep dive every 14 days, all kinds of professional investing tools, from a DCF, a reverse DCF, or a scenario analysis, a full database of interviews and articles, but that's not all. We built a one-of-a-kind feature called My Journey, which is specifically designed for you, the series investor. It tracks your stats, it tracks your emotional state, your psychology, your decisions, and everything to help you become a better investor. Head on over to tdi-terminal.com. That is tdi-terminal.com. You can also find the link in the show notes. Let's now dive into Texas Roadhouse. To truly understand Texas Roadhouse, we need to look back to the early days of its founder and Taylor. This is because the company's culture, values, and strategy are deeply rooted in Taylor's experiences and beliefs, which have shaped its success. In 1969, Ken Taylor, then 14 years old, started attending Ballard High School with dreams of becoming a professional American football player. However, his slim build, he was about 180 centimeters and just 55 kgs, made this very challenging. After being rejected from football, he tried athletics, but didn't excel there either. Despite these setbacks, Kent didn't give up. He trained harder than anyone else and eventually became a school district and state champion. He learned that hard work often trumps talent, a lesson he later carried into his career. Kent's parents also played a significant role in his life. He faced a lot of rejection, but his parents were always there to support him. Their home was filled with music, which later became an important element in Kent's life and his restaurants. We'll get to that later. After graduating in 1977, Kent went back to his old job at a seafood restaurant instead of working for large companies. His passion for the restaurant industry grew daily. He worked at the restaurant during the day, did night shifts at the disco, and also had a day job at TGI Fridays. It's now 1981. Co-owned a pub called Mabel Murphy's. And this experience taught him about the importance of reliable partners and proper documentation in business, even though it was a very costly lesson. But, not discouraged by any of these setbacks, Kent became a manager at Bennington's restaurant chain in 1983. However, he didn't find the recognition and freedom he sought for his ideas and vision. Determined to realize his own ideas, Kent came up with four different restaurant concepts: a Rocky Mountain Ski Lodge, Salad Bar called Florida Salad Company, the Pelican Head Seafood Company, and the Texas Style Steakhouse, which eventually became, you guessed it, Texas Roadhouse. Despite facing numerous rejections from investors, he persevered and learned valuable lessons about persistence, the importance of a positive environment, and staying true to his principles. These lessons became the foundation of his success as the CEO of Texas Roadhouse. He said, Don't be afraid of rejection. Ask for the moon, and now and then you might just get it. Kent's journey taught him that persistence is key to success. Rejection is not the end, and it's important to surround yourself with positive people. Learn from your mistakes and stay true to yourself. Lessons that would later guide him as the CEO of Texas Roadhouse. Determined to make his restaurant dream come true, Kent worked at Hooters and KFC after several disappointments. Eventually, he convinced John Y. Brown, former governor of Kentucky and founder of KFC, to transform a failing KFC restaurant into his idea, then known as Buckhead Grill and Bar. The sketch of the restaurant's name and logo was drawn by Kent's daughter herself. Years later, Kent's first restaurant took shape, thanks to investments from three doctors, each contributing$100,000 plus an additional$220 plus an additional$250,000 loan. They agreed to Kent's plan and idea, which was still only draw on a piece of paper. And at that time, Kent's net worth was negative$20,000. But the investors didn't know this. Kent worked tirelessly to build Texas Roadhouse, earning a 1% royalty of sales and 30% ownership of the restaurant. From the first day Texas Roadhouse opened, it was a massive success. A welcome change for Kent, who was on the brink of financial collapse and bankruptcy. In his book, Made from Scratch, he describes how he used all his children's savings to buy food and had to move back in with his parents because he couldn't pay his rent. He worked over 60 hours a week at a restaurant chain that was continuously losing money and where he was deeply unhappy. The story in Made from Scratch is incredibly inspiring, and I highly recommend it for you to read if you want to know more about Texas Roadhouse and its founding. Now let's talk about Texas Roadhouse itself. Currently, as the moment of this recording, the company is just under a$12 billion market cap and generated revenue of around$6 billion. It currently runs about 657 Texas Roadhouse restaurants, but they have recently released a couple of other concepts as well. Bubba's 33, which is currently about 56 restaurants, and Jagger's, which sits around 10. Texas Roadhouse is a casual dining spot with pretty reasonable pricing, and they mostly serve steaks, ribs, seafood along with unlimited free peanuts and freshly baked bread. OBUS 33 is similar to Texas Roadhouse, but more of a rock and roll vibe. They serve burgers, pizza, and wings. Jaggers is their latest concept, which is more focused on burgers, chicken dishes, and fresh salads with homemade sauces. The operational strategy for Texas Roadhouse is built on core values set by the founder and former CEO, Ken Taylor, who is no longer the CEO. He passed away sadly. The first core value is high quality and freshly prepared food. Texas Roadhouse has a unique recipe to ensure consistent quality and taste across all locations. A manager checks each dish before it leaves the kitchen for quality, portion size, appearance, and presentation. Kitchen trainers provide ongoing training about recipes, preparation methods, food safety, and overall quality. What is highly unique is that every restaurant has certified chefs, bakers, and butchers to maintain these standards. The bakers make fresh bread daily and the butchers prepare the meat that is displayed in glass cabinets for people to see. Core Value 2 is a cozy, comfortable atmosphere with great service. They maintain a low ratio between tables and waiters, about 1 to 3, so servers can actually focus on their guests. Other fast food restaurants often have a ratio of around 1 to 10, which is a lot cheaper, but it loses the personal touch. Texas Roadhouse servers are expected to know the customer's name, adding a personal connection and maybe a premium price. Core Value 3 is performance-based rewards for managers. Texas Roadhouse offers a performance-based compensation program for managers running the restaurant, with a base salary plus a bonus based on their restaurant's profits. The concept of what they call managing partners, who own 10% of the restaurant, creates a partnership rather than a traditional employer-employee relationship, and this skin in the game principle fosters strong commitment and motivation. Core Value 4 is fair prices. Texas Roadhouse carefully evaluates menu prices to balance affordability and quality. Prices are tailored to each region and kept comparable or lower than competitors. They sometimes opt for very low margins on certain products, compensating with others or in richer areas. Lastly, a focus on dining. Because unlike many chains, Texas Roadhouse focuses mostly on dinner, opening restaurants from 3 pm till 10 pm during the week and expanding to lunch on Fridays. This allows staff to prepare optimally for busy evening service, resulting in more efficient operations and less waste. Shorter shifts keep the employees more energetic, leading to better service and a more unique atmosphere. Its success is rooted in a company culture where employees generally love their work. The founder, Taylor, focused on creating a fun, a stimulating workplace with country music, sports on TVs, and a unique birthday tradition. The strategy of having fewer servers handle fewer tables allows them to provide more personal attention to the guests. This personal contact does not only provide better service, but it also ensures more sales of higher margin products like drinks and cocktails. And this is beneficial for sales and strengthens the company's mode. Consistency and freedom are key within the organization. Branch managers and regional managers are given a lot of freedom within clear guidelines. They must know regular guests by name, a personal touch that is very rare in today's age. Employees can choose between two different t-shirts, a standard Texas Rhode House t-shirt or an I Love My Job t-shirt. This idea was actually inspired by an employee who saw something similar at Southwest Airlines, a source of inspiration for Ken Taylor. Nowadays, the I Love My Job t-shirt is by far the most popular choice among employees. The founder Taylor also wanted to create a positive and fun working environment where employees feel valued, seen, and heard. He introduced various activities like line dancing, also an idea from an employee, and relaxed the dress code. For example, ties and suits are forbidden at the head office. Kent hated them because those types always rejected him and didn't believe in his ideas. He thought it was important to just be yourself and you should decide what to wear. But there's more. Here are a couple other things that make Texas Roadhouse culture vastly different from competitors. They do no national TV advertising. Kent always said, Most restaurants pay 4% on advertising. We invest the 4% in free, unlimited peanuts and bread for all our customers. Community giving. Ken felt it was important to give back to the community. Every single day, all food scraps are given to local charities. This creates goodwill among the local community, making them come back more often. Win-win. Personal visits. Every spring for six weeks, Ken Taylor visited all his Texas Roadhouse restaurants. He talked to managing partners, customers and employees. He wants to know what went well and what could be improved. And the current CEO still does this. They have an in-house baker and butcher, every single restaurant. The baker is responsible for making fresh bread daily, and the butcher ensures that the meat is always as fresh as possible. Meat is never frozen, it's made from scratch. Quality checks. A quality manager checks every single meal. And a waiting list. Because to eat at Texas Roadhouse, you must get on a waiting list. It's so busy that you can only reserve a place via the website. And if there's no room, you'll be put on a waiting list. Nowadays you can always order to go, which is a fairly new concept, and the crowds say a lot about the quality and the popularity of the restaurant. So what protects the steak from the malt? Let's talk about the competitive advantage. Because in the restaurant industry, creating a deep mode is extremely difficult. The relatively low barriers to entry and abundance of competition make it hard to stand out. Imitation is easy. And customers are often price sensitive, making loyalty scarce. For a restaurant company, gross margins and return on invested capital are usually good indicators of a company's mode. With an ROIC of about 15%, Texas Roadhouse has a very solid performance. The chain has a loyal following thanks to their unique brand and atmosphere, consistent quality, and pretty competitive prices. The gross margin hovers around 15 to 20%. This is due to their offering, because they're quite meat-heavy, which is usually lower margin, and the profits are made on drinks. But competition in the restaurant sector is fierce and new trends can emerge quickly. When we compare gross margins to competitors like Chipotle and Shake Shack, we can see that Texas Roadhouse is quite similar to Chipotle. Constantly innovating and responding to changing consumer demands is crucial to maintaining a unique position in the industry. For example, consider the shift in meat consumption. Europe is rapidly moving towards vegetarian alternatives. And Texas Roadhouse menu currently features almost no vegetarian dishes, aside from salads or potato dishes. So does Texas Roadhouse have a mode? I'd say yes, but a narrow one. They have a strong brand name with loyal customers, and as they grow, slight economies of scale may arise. But I wouldn't call it unbreakable at this point. If ever. When looking at Texas Roadhouse, there are a few KPIs you want to keep track of. For most restaurant chains, the most important is same-store sales growth, or what they call comparable restaurant sales. And this KPI basically tracks the change in sales for restaurants that have been open for at least 18 months. An increase here indicates that the existing restaurants are generating more sales, which is important for the health of the business. Historically, this has been pretty strong, with between 6 to 10%. Another important KPI for restaurant chains is average unit volume, AUV, and this tracks the average growth of restaurants that have been open for at least 6 months. Restaurants can boost turnover by opening new locations, increasing prices, or selling a higher volume of products, and AUV reveals whether the volume sold per restaurant is increasing or decreasing. Lastly, the restaurant margin is highly important. This KPI helps identify inefficient restaurants and monitor the performance over time, because restaurants with low margins need extra attention to improve their cost structure. And this restaurant margin KPI can be compared over different periods to see how the profitability of individual restaurants is evolving. The 5-year average is about 15%. Pretty solid for our restaurant chain. Now, where lie the risks and opportunities for this company? Obviously, the most straightforward opportunity is domestic and international expansion. With proven success in the US, Texas Roadhouse has the opportunity to expand globally into new markets that crave American dining experiences. Another opportunity is to increase the number of to-go orders. Having a wait list is cool, and it shows how happy people are with eating there, but you can't really grow sales when people are on a waiting list. To-go sales have gained prominence at Texas Roadhouse, potentially boosting profit margins as well. Lastly, margin increase. Investments in technology, improved efficiency, and expanding to-go options are expected to enhance margins in the coming years. But what about the risks? Managing risks is arguably more important. First of all, competition. While the barrier to entry in the restaurant industry is not insurmountable, it is still significant. Any new entrant with anovition, passion, and capital could challenge Texas Roadhouse market share. It is not hard to just cross the street and eat somewhere else. Another risk is commodity prices, especially beef. Beef prices are a critical concern for Texas Roadhouse, accounting for over 40% of their total costs. Although diversifying the menu with fish, chicken, and pork helps mitigate this risk, fluctuating beef prices remain a very big threat. Additionally, the growing shift towards vegetarian diets, particularly In markets like Europe poses a challenge. Lastly, other major risks include the potential for charging excessively high prices, food scandals like Chipotle Mexican Grill experienced, or the deterioration in the culture or dining experience offered by the restaurants. So let me give you my conclusion and thoughts on Texas Roadhouse. I really like the company, especially the story behind it. But what remains challenging to assess, and this applies to Texas Roadhouse as well as other chains like Chipotle Mexican Grill, is what truly makes their restaurants unbeatable. Yes, they boast a strong brand and culture, along with good margins and economies of scale. But at their core, they are just another chain, selling food and drinks. The possibility of new entrants with substantial capital makes the industry highly competitive. At the same time, it's a very simple business model that can be scaled for a long, long time. Just look at McDonald's or Starbucks, for example. This was our deep dive of Texas Roadhouse. In our written report, we go much much deeper. And if you haven't checked it out yet, consider looking at our all-in-one investing terminal over on tditerminal.com. That's it for now, and we'll see you in the next one.