Red Robin Not Bobbin' Along; Casual Dining Suffers

By Ann Northrop

Red Robin Gourmet Burger's (RRGB) customers moved to cheaper alternatives at an accelerating pace in 1Q09 -- a trend that we expected. We are maintaining our Sell recommendation.

The family-friendly casual dining chain reported a 42% drop in EPS to $0.25 in 1Q09. Excluding $0.5 million to close unprofitable restaurants and $4 million to repurchase under-water stock options from its employees, EPS was unchanged from a year ago at $0.43.

To stop customers from trading down to cheaper fast food alternatives, many casual dining chains are luring cash-strapped customers with promotions, a tactic Red Robin has avoided in favor of increased advertising. Three concepts of Brinker International (EAT) -- Chili's, On The Border, and Maggiano's -- have each launched their own value menus. California Pizza Kitchen Inc. (CPKI) has a thank you card promotion, Denny's (DENN) offered free Grand "Slamwiches" to customers who bring a friend. O'Charley's (CHUX) has added value meals at two of its bar and grill concepts recently.

The intensifying price competition is draining Red Robin's guest visits and limiting its ability to raise prices.

To be sure, customer traffic at company-owned restaurants fell 10.2% from a year ago and was offset by just 2.1% price increases, pushing same-restaurant sales down 8.1% in 1Q09.

Exacerbating the company's customer flight is its concentration of restaurants (28%) in areas hardest-hit by the real estate collapse -- California, Arizona and Nevada -- which are significantly under-performing those in other areas.

Unit expansion -- which takes 18 months from planning to opening -- will not provide meaningful revenue growth in 2009 or early 2010. Modest unit growth in 1Q09 was tempered as the company continued to close unprofitable units.

Red Robin's minimal price increases in 1Q09 were not enough to cover rising commodity costs. As a percentage of sales, food costs surged 160 basis points to 24.5% in 1Q09. And as sales volumes declined, fixed occupancy costs squeezed margins, rising 70 basis points to 7.1% of sales. As a result, the company's restaurant margins shrank 250 basis points.

We believe shares of RRGB will under-perform both the larger market and the restaurant industry. Red Robin's traffic began declining long before the onset of rising gas prices in October 2007 began choking business in the casual dining sector -- a victim of poor site selection in new markets.

In spite of its poor performance, the company has retained and even added to these sites as it repurchased 60 franchises since 2005 (15 in April). Moreover, 2009 consensus EPS estimates are 8% higher than ours, and we think our estimate may prove aggressive if the recession is more protracted than we currently anticipate.