The Problem That Texas Roadhouse and Chipotle Mexican Grill Have in Common

In this segment from MarketFoolery , host Chris Hill is joined by Motley Fool Director of Small-Cap Research Bill Mann to take a look at two popular restaurant operators, neither one of which is getting a ton of love from Wall Street lately.

First up is Texas Roadhouse (NASDAQ: TXRH) , which reported comps growth most chains can only envy. But shares sank anyway, because one thing it's doing to improve its performance is raising wages, and those added expenses aren't going to go away.

Then, they shift to Chipotle (NYSE: CMG) , which is once again facing a food-borne illness scare. The apparent contamination is confined to a single store, which the company has closed for what can be assumed to be comprehensive sterilization, but until the chain demonstrates that its new procedures are working and that this was an isolated incident, investors will react with muscle memory. What else can the company do, and how should long-term investors be responding? The guys have some ideas on the subject.

A full transcript follows the video.

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This video was recorded on July 31, 2018.

Chris Hill: Let's start with the restaurant news. It's Texas Roadhouse and Chipotle, they're both falling, but for different reasons.

Let's start with Texas Roadhouse. Second quarter results. You tell me. Why is this stock down? I get that there are results that they posted that are below expectations. But I see a restaurant in the middle of 2018 posting same-store sales growth of nearly 6% at company-owned locations. Most every restaurant that is publicly traded would kill for those kinds of numbers.

Bill Mann: Yeah, maybe. You started the story by saying that the two restaurant chains were down for different reasons, that's a little bit true, but there's something that they both have in common, and that's labor costs. Kent Taylor came out in the conference call and said, "Everything is going great at the restaurants. We've been putting investments into a lot of things, including training our staff, and we're paying them more". Some of that is coming from them choosing to pay more, which is great, that's the Costco model; and some of it is the reality that the labor market is tight.

When the market sees that, they say, "This isn't a cost that's one-time in nature. It's probably a sustained pressure on the business." That's OK. It really is. Texas Roadhouse, both as a stock and, as you mentioned, a company, has had a fantastic few years. Labor costs have gone up, and I think that's really primarily the issue, because the results were fantastic.

Hill: One thing on the same-store sales, because, they have company owned-locations, they have franchised locations. The franchised comps were about 2% lower than the company-owned ones.

Mann: It's because they're holding all the good stuff for themselves! [laughs]

Hill: I think, for someone who might be new to restaurants, they might look at that and ... is that a cause for concern? Or, is that an opportunity for Kent Taylor and his team to go to the franchisees and say --

Mann: "Look at us!"

Hill: -- "We have some tips, if you're looking to boost your comps a little bit."

Mann: It's a really good question. One of the interesting things about how Texas Roadhouse is managed is that they do a really, really good job of taking ideas that come from franchisees and then rolling them out across their stores, and then back out to the franchisees. Maybe there's an Easter egg in there, and some franchisee has told them something amazing that's in the process of being rolled out to everyone else.

But, generally speaking, it's a pretty sustainable gap, that you'll see a little bit better performance at their company-owned stores than you see with the franchisees. It's not a huge gap. It would be great to say, "Yes, they could pull this level and it'll be flat," but I don't think that's the case.

Hill: Before we move on to Chipotle, I should say, later in the podcast, we'll be dipping into the Fool mailbag. I just got an email the other day from Rich Smith --

Mann: The Rich Smith?!

Hill: I think it might be the Rich Smith, who's a writer here at The Fool. But it was a different email address, so maybe it's a different Rich Smith. Maybe it's just a listener Rich Smith. But, basically, Rich Smith saying, "Hey, I'm traveling and I'm close to a Bubba's 33," because Texas Roadhouse has a sports bar model called Bubba's 33. As I've mentioned before on this podcast, there's not one within a couple of hundred miles of here. So, Rich is going to do a little boots-on-the-ground research and send his thoughts.

Mann: I'm very excited to hear what he has to say about Bubba's 33.

Hill: Do you remember when Kent Taylor was here? Was it last year for FoolFest?

Mann: Yeah.

Hill: We were sitting with him before your interview on stage, and he started talking about Bubba's 33. And you and I were like, "What is that?" And one of the people with him --

Mann: Travis, I think.

Hill: -- reached into his bag and pulled out a menu. And you and I were like, "What?! Can we go there now? This looks fantastic!"

Mann: We're not close to Cincinnati ... I don't know where the closest one was.

Hill: Fayetteville.

Mann: Fayetteville, that's right!

Hill: That's why Texas Roadhouse is down. Chipotle shares are down about 7% today because of the news that Chipotle has temporarily closed a restaurant in Ohio after --

Mann: They're back!

Hill: -- customers reportedly fell ill after dining there. I feel like we've seen this movie before.

Mann: We have! I have a really hard time figuring out exactly what to do with this information. 170 people got sick at some level. We don't have all of the information yet. Chipotle immediately voluntarily closed the store.

Two things about this. One is, it was a single store. That suggests to me that the protocols that they have in place as a system are probably OK. If it was multiple stores, this would be an absolute disaster. So, something happened at that store, which is probably more solvable.

Now, because Chipotle has had those problems, in 2015 in particular, it's not a great look for them. But, it's a single store. I'm not sure whether my instinct is underreacting to this or my instinct is overreacting to this. I'm sure it's something.

Hill: Clearly, investors are reacting, in terms of selling off the stock. That might be a mistake. I looked at the story this morning, and what went through my head -- after the initial, here we go again -- was, this is a spotlight moment for relatively new CEO Brian Niccol. This is Brian Niccol's chance --

Mann: Here's your close-up.

Hill: Yes. We're ready for your close-up, Mr. Niccol. As you said, we still don't know all the facts. But once Chipotle has all the facts -- and, I'm no longer a shareholder of this stock. But if I were, I would want to see a very strong statement from Brian Niccol. He has to be in front on this and basically do the opposite of what Steven Ells did in late 2015.

Mann: I think that's exactly right. The instinct has to be, "We're on top of it, we know exactly what this is, here's the process." They're actually trying to, depending on the local health authority, they want to reopen the restaurant today. I suspect that they are on top of it in an entirely different way than the last regime was.

This is actually true for both Chipotle and Texas Roadhouse -- keep in mind, you have to keep the stock drops in a little bit of perspective. Both of those stocks have had fantastic years. So, the fact that it has pulled back, it's 7% as we record, it'll be a couple of percents within that, we hope, by the end of the day, or by the time the podcast is released. It's just, this doesn't feel like the market is treating it like the debacle that existed in 2015.

Hill: Absolutely. As you said, this is one location.

Mann: Something happened. Because it's Chipotle, because of their history, it's big news.

Hill: They don't get a pass.

Mann: They don't get a pass, no.

Hill: I think Niccol and his team probably know that.

Bill Mann has no position in any of the stocks mentioned. Chris Hill has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Chipotle Mexican Grill and Texas Roadhouse. The Motley Fool recommends COST. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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