RED ROBIN (RRGB) reports Q1 – STOCK DOWN CLOSE TO 15% – IS IT THAT BAD?

Conclusion:

The stock has reacted so violently not so much because the results were disappointing but because management couldn’t provide comforting guidance going forward. Management refrained from describing the sequential progress (or lack thereof) in the year to date. While, during the conference call, management said “…still expect to deliver on our year end earnings targets”…analysts have obviously thought that an “adjustment” to expectations is more realistic. The upgrading of the Red Robin dining experience continues to be a work in progress, and money managers now consider RRGB to be a “show me” situation. At about 7x the current EBITDA run rate, RRGB could become a takeover candidate in an easy money environment (think Buffalo Wild Wings) but private equity firms also like predictability, and the stock could sell materially lower before the potential becomes adequately compelling. BWLD had the franchising (and re-franchising) component which is not nearly so prominent here. BWLD’s balance sheet was also far less leveraged than that of RRGB.

The best overview of the situation is likely provided by management, as described on the conference call:

• The January administrative reset was described as “consistent with our pivot away from being a unit growth driven organization to one focused on value, affordability, and improved four wall economics”.
• “The first quarter of 2018 demonstrated the continued evolution of RRGB’s business model that was largely dependent on sales to a business model that has multiple ways to deliver sustained earnings performance and return on investment… built on every day value, affordability, long term profitability and prudent investment of capital.

The Q1 report:

Before getting into the details of the report, this commentary is meant to not only describe the developments at Red Robin but provide our readers with feedback relative to operating trends (and challenges) that are broadly affecting the industry. This full service burger segment, most directly including Applebee’s and Chili’s, but also affecting chains above and below the price and service points, is one of the most competitive. Potential problems become vividly demonstrated. It’s like skiing a “double black” trail. Weaknesses in technique quickly become obvious. Management here is doing their collective best, but it’s hard to run up an escalator going the other way. So much for the metaphors.

The quarter was only mildly disappointing in terms of sales and traffic. Comp revenues were down 0.9% with comp guest counts up 0.1%, once again outperforming peer group trends. There was a 1.0% decrease in average check, comprised of a 2.0% decrease in menu mix, offset by a 1.0% increase in pricing. Importantly, off premise channels were up almost 40% YTY so dine-in traffic was down about 3%. “Adjusted” earnings per diluted share were $0.69 compared to $0.89, but GAAP EPS was $0.34 vs. $0.89. Income from operations was $7,019k vs $17,458k, after a charge of $6,287k in Q1’18 for “home office reset and establishment of a litigation reserve for employment-related claims”.

The operating details include restaurant EBITDA at 20.0%, down about 130 bp YTY. Cost of sales was up 90 bp to 23.8% (higher Tavern mix, higher cost of Steak Fries and ground beef, lower nonalcoholic beverage sales). Restaurant labor was better by 70 bp to 34.5%, due to hourly labor productivity, partially offset by higher manager salaries and bonus). Other operating expenses were up 70 bp to 13.3% as a result of increased technology expense, to-go and catering supplies and third party delivery costs, partially offset by lower repair and maintenance. Occupancy costs increased 40 bp to 8.4% due to higher property taxes and insurance costs. D&A was up 20 bp to 6.9%. G&A improved by 50bp to 6.8% due to the home offset reset. Importantly, the January reset was described as “consistent with out pivot away from being a unit growth driven organization to one focused on value, affordability, and improved four wall economics”.

Within the conference call dialogue were the following bullet points:

(1) Off premise dining, including curbside pickup, third party delivery, and catering, all of which have sales potential, have their own sets of operating challenges and margin implications. There may or may not be cannibalization of dine-in business, but if you don’t do it, your competitors will.

(2) There continues to be a huge battle to provide “value” to the guest in terms of quantity and quality of food (and of course the service). It is hard to improve operating margins when your most popular platform is at $6.99, including the challenge of attracting well qualified servers when tips are so modest at a low price point.

(3) It is desirable to control the off premise business yourself, for the purpose of gathering customer information as well protecting the brand and  profit margin, but third party delivery services are a necessary fact of life for the time being. 70% of RRGB locations have third party delivery.

Roger Lipton