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Summary

  • Red Robin Gourmet Burgers reports an unexpected decline in its earnings.
  • Costs increase and competitive pressures impact the already slim margins.
  • Despite a history of revenue growth, earnings have been relatively small and volatile, creating little appeal.

The sluggish retail and restaurant spending trends made its latest victim in the form of Red Robin Gourmet Burgers (NASDAQ:RRGB) which posted a drop in second quarter earnings.

The sell-off following the report is well-deserved despite a history of sales growth. Historical and current have been quite low and volatile, with shares thereby not warranting the premium earnings valuation in my eyes.

Second Quarter Headlines

Red Robin Gourmet Burgers reported second quarter sales of $256.1 million which is a 7.5% increase compared to the year before. Despite the increase in topline sales, analyst were expecting even greater sales at around $263 million.

Net earnings dropped by 14.4% to $9.5 million. Consequently, reported earnings dropped by twelve cents to $0.65 per share. Non-GAAP adjusted earnings came in at $0.68 per hare.

Last year, the company posted earnings of $0.77 per share as analysts actually anticipated a healthy increase in earnings to $0.90 per share.

A Look Into The Rough Quarter

Reported revenue growth looked solid but it was aided by new openings in particular. The so important comparable store sales growth number came in at just 1.2%.

Traffic has been weak at restaurant and retailers lately, something which has also been the case for Red Robin Gourmet with traffic being down by 2.5%. Average check sizes jumped by 3.7% thereby being the sole driver behind the modest growth in comparable sales.

The restaurant business remains notoriously competitive with operating income totaling just 5.3% of sales. Operating earnings were down by 120 basis points compared to last year. While the company cut absolute general and administrative costs, margins were pressured amidst higher labor costs, operating expenses, occupancy costs and selling expenses.

An Update On The Outlook

Comparable restaurant revenue growth is now seen in the low single digits for the full year. This is rather disappointing, but is logical after the dismal number for the second quarter.

In total 20 new Red Robin restaurants are planned to be opened this year as well as 4-5 Burger Works. Sales from the acquired franchise restaurants are anticipated to add $44 million in sales for the second half of the year, which reduces royalties proceeds by an estimated $1.5 million.

Restaurant margins are seen at 21.3% of sales for the full year. The company notes that the business has very small margins which means that a modest change in the outlook has a huge influence on the bottom line. For instance a 1% change in traffic impacts earnings by thirty cents per annum, as an illustration.

Unfortunately the company did not specify a full year earnings outlook. What is evident is that pressure on margins combined with additional costs related to marketing is having a big impact on the bottom line.

Valuation

At the end of the quarter, Red Robin Gourmet held $60.5 million in cash and equivalents while total debt including capital lease obligation stood at $136.6 million. Despite having a roughly $76 million net debt position, the company has access to sufficient liquidity having replaced its credit facility with a new $250 million revolving credit line.

With 14.5 million shares outstanding which currently exchange hands at $52 per share, equity in the business is valued at roughly $750 million. On a trailing basis sales have come in just shy of $1.1 billion as earnings came in at 33 million.

This values equity of the business at about 0.7 times sales and 22-23 times trailing earnings. Given the pressures identified by the company, forward earnings could come in lower.

Steady Growth, Volatile Bottom Line

Over the past decade, Red Robin posted impressive sales growth increasing topline sales from roughly $400 million in 2004 to roughly $1.1 billion at the moment. The company even managed to cut 10-15% of its shares outstanding in the meantime, yet earnings have been volatile ranging anywhere between a break-even result and current peak earnings of $33 million a year.

This volatile earnings picture leaves shares relatively expensive especially considering the lack of dividends being paid to investors. The valuation in the 20-25 times earnings region combined with historical volatility of reported earnings is not appealing in my eyes.

Final Takeaway

The results were bad, quite bad to say. The very poor traffic numbers almost halted comparable sales which slowed down by 420 basis points on a sequential basis to just 1.2%.

Worse, earnings were impacted heavily by higher spending and gross margin compression which hurts the bottom line big time in an industry with already small operating margins.

The company has ¨bought¨ its way into growth by buying 32 franchised restaurants for $40 million during the quarter, adding $90 million in annual sales. Yet while the leverage situation is not a big problem at the moment, also given the access to credit, leverage is something to keep an eye on especially in low margin industries.

Given the renewed disappointment, the higher valuation in terms of earnings and volatile earnings history, there are no real reasons to be appealed to the shares at the moment. This is despite the solid growth in topline sales, I must admit.

The high valuation and lack of structural earnings growth makes shares not appealing at all in my eyes as this week's sell-off seems well-deserved.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Red Robin Gourmet Burgers - Latest Victim In A Very Difficult Restaurant Environment