Texas Roadhouse Inc (TXRH), Darden Restaurants, Inc. (DRI): Why Slow Growth May Be In Store For This Restaurant Chain

When a company starts paying a dividend, investors often view the announcement as good news. But a dividend represents money that is not reinvested back into the business, and it’s an admission by management that growth opportunities may be drying up. A fast-growing company should be shoveling all of its earnings back into the business, not paying off investors.

This leads me to steakhouse operator Texas Roadhouse Inc (NASDAQ:TXRH). The stock currently trades for around $25 per share, and with earnings of $1 per share last year this puts the P/E ratio at a lofty 25. Texas Roadhouse Inc (NASDAQ:TXRH) operates about 400 restaurants, and in 2012 recorded $1.26 billion in revenue. It seems that the company is being valued at a high multiple like many other small to mid-sized restaurant chains. But there’s a big problem.

In 2011 Texas Roadhouse Inc (NASDAQ:TXRH) initiated a dividend, and in 2012 it paid 36% of its earnings out to investors. It has raised its dividend twice in the past year, and barring another increase will pay out $0.48 per share in dividends over the next year. Based on the average analyst estimate of $1.15 for 2013 EPS, the payout ratio for this year will be about 42%.

Not enough growth

For a company that only generated $71 million in net income in 2012, paying out over 40% of that as dividends leaves very little to invest back into the business. The second quarter of this year saw flat earnings on 10% revenue growth, and if this trend continues full year earnings could come in lower than analysts expect. This would lead to an even higher payout ratio and even less cash to invest back into the business.

A dividend is an admission that management has nothing better to do with the money, and the aggressive dividend hikes so far lead to me believe that growth is going to slow down at Texas Roadhouse Inc (NASDAQ:TXRH) in the future. In 2013 the company expects to open 28 new restaurants, around a 7% store growth rate. With margins being compressed by higher food costs, earnings growth in the short term will be slow, with a longer term low-teens growth rate the best case scenario.

I don’t know about you, but I find it difficult to pay 25 times earnings for a modestly-growing steakhouse that is spending half of its earnings on a dividend instead of on expansion. The stock price and the P/E ratio have become inflated, and I don’t expect it to last.