RED ROBIN GOURMET BURGERS, INC. (RRGB) – UPDATED WRITEUP – INFLECTION POINT COULD BE AT HAND

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RED ROBIN GOURMET BURGERS, INC. (RRGB) – UPDATED WRITEUP – INFLECTION POINT COULD BE AT HAND

CONCLUSION:

 It’s still very competitive in this segment of the full service restaurant industry but Paul Murphy, new CEO, has a history of success with challenging situations, most recently at Noodles (NDLS) and before that at Del Taco (TACO). Considering that the current Enterprise Value at RRGB is only just over 5x trailing (depressed) Adjusted EBITDA, the upside potential of RRGB could be substantial from this level. Activist investors have periodically circled this situation, attracted by the re-franchising potential, but that’s a lot easier said than done when the stores are doing poorly. On the upside, however, if sales improve, in addition to the earnings leverage from Company locations, re-franchising becomes far more practical. Systemwide unit growth can then be expected as well. We think it is a reasonable bet that Paul Murphy, supported by CFO, Lynn Schweinfurth and the operating team will make progress over time. Without minimizing the challenge of improving an underperforming brand in an unforgiving environment, if they succeed to any reasonable degree, the percentage gain from this stock price could be substantial..

 THE COMPANY:

 Red Robin Gourmet Burgers, Inc. (RRGB), founded in 1969, primarily operates, franchises, and develops full-service restaurants in North America. There were 556 locations in total at 12/31/19, 454 of which are Company operated.  Red Robin is famous for serving more than a dozen fresh, never frozen, burgers and Bottomless Fries in a fun environment welcoming guests of all ages. In addition to burgers, which accounted for 66% of their entrée sales in 2019, Red Robin serves an array of other American favorites that appeal to a wide range of guests. The most popular of the non-burger menu items are Red Robin’s Shareable Appetizers and their unique Milk Shakes.

A strategic repositioning of the brand, was implemented in 2019, led by highly respected CEO, Paul Murphy III and CFO, Lynn Schweinfurth. Among the objectives are: improving the service model, streamlining and enhancing the food offerings, strengthening the overall guest experience, better connecting with the guests, all in the hope of increasing frequency and loyalty. Specific operating initiatives include the use of server hand-held point of sale devices and headsets, the partnership with Donato’s pizza (to be installed systemwide) and an increased focus on off-premise sales.

UNIT LEVEL ECONOMICS COMMENTARY:

AUV for 2019 of $2,714,000 was virtually flat with that of 2018. COGS decreased 30 basis points in 2019 as compared to the same period in 2018. The decrease was primarily driven by favorable pork and Steak Fry costs, partially offset by unfavorable ground beef costs. Labor Costs increased 70 basis points in 2019 compared to the same period in 2018. The increase was primarily driven by higher average wages and increased manager staffing levels within the restaurants. Other Expenses increased 70 basis points in 2019 as compared to the same period in 2018. The increase was primarily due to higher third-party delivery expense driven by growth in off-premise sales as well as an increase in restaurant maintenance spending. Occupancy Costs remained flat for the year ending December 29, 2019 due to Red Robin’s fixed rate contracts.

Store Level EBITDA decreased 110 basis points primarily as a result of the increase in Labor Costs of 70 basis points and an increase in Other Expenses of 70 basis points offset by the 30 bp decrease in COGS.

DEVELOPMENT COMMENTARY:

 During fiscal 2019, Red Robin Company-operated restaurants refranchised 12 locations and closed 18 underperforming locations for a Company-operated end of year total of 454 units. The franchise community opened 1 new location for a franchise-operated end of year total of 102 locations. Net total restaurant locations for fiscal year ending 2019 was 556 units.

SAME STORE SALES COMMENTARY:

Restaurant comparable sales at Company-operated restaurants declined (0.6%) in fiscal 2019. The decline was partially offset by a 4.7% increase in check average and a 1.8% increase in menu pricing. It was partially offset by a 3.4% decrease in guest count. Quarterly same store sales are shown in the statistical table at the top of this report.

 RECENT DEVELOPMENTS: per Q4’19 report and conference call

 There was measurable progress in Q4’19 in terms of implementing the new strategic plan. Comp sales were up 1.3%, the second quarter of positive sales. The lower level of discounting was reflected by the 1.1% increase in menu mix, a 1.8% increase in pricing, a 1.8% increase from lower discounting and a 3.4% decrease in guest counts. Off-premise sales increased 26.9% to 13.9% of restaurant revenues. The GAAP loss per diluted share was $0.60 compared to a loss of $0.82. Adjusted loss per diluted share was $0.36 compared to a profit of $0.43. Importantly, Adjusted EBITDA in Q4 was a positive $26.7M vs. $28.4M.

Q4 results, line by line: Cost of Sales (primarily due to lower pork and steak fry costs, partially offset by higher beef costs) was down 60 bp to 23.0%. Labor (due to lower group insurance costs, partially offset by wage rates and higher manager staffing levels) was down 20 bp to 34.5%. Other Operating expenses (primarily due to third party delivery fees and higher restaurant technology costs) were up 110 bp to 14.7%. Occupancy (primarily due to higher general liability costs, partially offset by lower rent due to closures) was up 20 bp to 8.9%. Restaurant level EBITDA was down 50 bp to 18.9%.

Below the store level EBITDA line, depreciation was down 40 bp to 6.8%. G&A was up 40 bp to 6.4%, Selling expense was down 30 bp to 5.4%, Other Charges was 1.4%, bringing Income from Operations to 0.5%. After Interest of 0.6% and Income Tax Expense of 2.4%, the Net Loss was (2.5%).

It is worth emphasizing that Depreciation on 454 Company operated stores was a substantial $20.7M (in Q4), much more than the GAAP loss. Also, there remains very substantial earnings per share leverage (which works both ways) at RRGB, with $1.3B of Restaurant Revenues and only 13M fully diluted shares outstanding. One comp point of $13M could conservatively add (or lose) 30-40% or $4-5M, on the pretax bottom line and change the EPS picture substantially.

Paul Murphy commented in the release on the unwinding of product discounts and the focus of staffing, training and retaining of Team Members. The beginning of the Donato’s rollout took place, a new service model was installed, and off premise/digital was an important focus. The positive sales trend is continuing into Q1’20.

Guidance going forward includes comp revenue growth in the low single digits, potential restaurant level increased EBITDA to be offset by pre-opening expenses, marketing and growth initiative expenses, Net Income at least $2M (including a $10-12M tax benefit), Adjusted EBITDA approximately flat at $101M, Capex of $50-60M (including restaurant support and maintenance, Donato’s, technology and growth initiatives). There could be margin pressure in the first half, then less in the second half of 2020, due to the various initiatives and the Donato’s rollout.

On the conference call, Murphy talked about improving, and building upon, the loyalty program, one of the largest in the industry with more than 9M members, and which represents 30% of sales. Turnover of store level management and staff is trending downward, and guest satisfaction is improving. Off-premise sales (up 26.9% in Q4 to 13.9% of revenues) is a key part of the plan, including catering (up 12% in Q4, but  only 1.5% of sales) and delivery (about 5% of sales), which is ordered directly through Red Robin but provided by a third party. The To-Go portion of sales is about 6.7%. Donato’s is being received well, fits into the delivery side of the business, as well as the appetizer portion of the menu, and sales (a 3.5% lift) seem to be largely incremental.

Lynn Schweinfurth discussed the balance sheet changes in Q4. $24.2M was spent on capex, primarily related to information technology, facilities improvement and the rollout of Donato’s ($145K/store plus 20K pre-opening expense). The rollout of handheld POS terminals was also completed in Q4. At 12/31/19, there was $30M of cash on the B/S, with a lease adjusted leverage ratio of 4.72. After drawing $18M on the revolving credit facility, there was debt of $206M in addition to letters of credit of $7.5M. In early January, a new $300M five year credit facility was put in place, which provides ample liquidity through 2025. The intention is to use at least 50% of free cash flow to delever the balance sheet and repurchase stock under the existing $75M authorization. In Q4, $1M of common stock was bought back.

CONCLUSION: Provided at the beginning of this article.

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