Red Robin: Sharp Rallies Should Be Sold

Taylor Dart profile picture
Taylor Dart
25.43K Followers

Summary

  • Red Robin Gourmet remains one of the worst-performing restaurant stocks, down more than 70% from its 2021 highs.
  • The poor performance isn't surprising with it being one of the few brands that continue to post net losses, with another year of net losses on deck.
  • Some investors might be interested in going bottom-fishing with the burger chain 70% off its highs, but I still don't see any value here with it trading at 10x EV/EBITDA.
  • Given the combination of a potential miss on its EBITDA guidance mid-point and limited margin of safety, I would view any sharp rallies as selling opportunities.

Red Robin Gourmet Burgers and Brews restaurant. Red Robin is listed on the NASDAQ as RRGB I

jetcityimage/iStock Editorial via Getty Images

It's been a rough year thus far for the restaurant sector, but we have seen a strong recovery in some of the better names over the past two months. This included a sharp rally in Wingstop (WING), a meaningful recovery for Restaurant Brands International (QSR), and a massive rally in Kura Sushi (KRUS). However, Red Robin (NASDAQ:RRGB) has continued to underperform, hanging out at $10.00 per share and ~75% off its 2021 highs. While this might appear to be a tempting long idea as the industry group tries to find its footing and rally after a rough 18 months, I believe this is a stock that's best to continue to avoid.

Red Robin Burgers

Red Robin Burgers (Company Presentation)

Just over a year ago, I wrote on Red Robin, noting that Red Robin was an expensive way to play the restaurant sector, and there was no margin of safety for those buying the stock above $33.00. The stock has slid 70% since then on the back of disappointing performance and negative sentiment towards the industry group and is now getting ready to report its Q2 results this week. While a beat is possible with sales estimates for the group coming down and some better-than-expected numbers from a few restaurant names, I see a beat as less likely for Red Robin. This is because it's less of a trade-down beneficiary than quick-service like McDonald's (MCD) and others, even with its Donatos roll-out. Let's take a closer look below:

Q1 Results

Red Robin released its Q1 results in late May, leaving much desired. Not only was quarterly revenue down more than 10% from pre-COVID-19 levels ($395.6 million vs. $409.9 million) despite a significant roll-out of Donatos across the system, but this was mostly due to menu price increases. Some of this decline was related to the shrinking store count vs. Q1 2019 levels. However, even adjusting for this, same-store sales were up just 4% vs. 2019 levels despite 10% pricing. This suggests that traffic is down sharply in the period, and while the addition of Donatos Pizza doesn't hurt from an incremental sales standpoint, it hasn't done nearly enough to buoy sales.

Red Robin - Quarterly Revenue

Red Robin - Quarterly Revenue (Company Filings, Author's Chart)

The results weren't any prettier from a margin standpoint, with restaurant-level operating profit coming in at just 14%, down more than 400 basis points from Q1 2019 levels. On a three-year basis, labor costs increased from 35.7% to 36.3% despite not being fully staffed, and RRGB's cost of goods rose to 23.9%, up from 23.4% in Q1 2019. The outlook for its food/beverage costs isn't great, with the company revising its outlook to low double-digit commodity inflation for FY2022. Plus, with it still being a tight labor market, I would not be surprised to see some pressure on wages in the future.

It's important to note, though, that this was during a quarter where the average gas price was below $3.90/gallon; 30-year mortgage rates averaged less than 4.30%, and most consumers hadn't seen a sharp drop in home prices, a crash in crypto, and their ugly Q2 quarterly statement for those holding stocks. This combination of higher costs and the reverse wealth effect (consumers are less likely to spend when they feel less rich) is likely to reel in discretionary spending, and one of the areas where we often see a cut in spending is dining out at restaurants.

Retail Gas Prices

Retail Gas Prices (AAA Gas Prices)

In fact, Valassis found that 74% of consumers plan to decrease spending at bars and restaurants, with them being the top choice for discretionary spending cuts. While surveys are not always accurate, the June numbers from Black Box Intelligence suggest that the surveys have been bang-on. This was evidenced by comparable traffic down 4.8% for the month, decelerating from (-) 2.9% in May. Meanwhile, same-store sales growth came in at its lowest levels since February 2021, an alarming figure given that this is despite meaningful menu price increases across the board.

How This Affects Red Robin

The silver lining for Red Robin was that pizza was one of the best-performing categories in June, which could pick up some slack with Donatos rolled out across nearly half of its system. However, casual dining was the worst-performing segment in June, which doesn't instill much confidence in the company's Q2 results. Given that margins have already taken a beating due to rising wages and commodity inflation, any dip in sales leverage could further impact what are already low levels of profitability. So, while Red Robin's CEO Paul Murphy noted that it has "proven value-oriented promotions" on the shelf, this isn't an encouraging point.

The reason is that while value could help Red Robin capture consumer restaurant spending dollars with a backdrop of declining discretionary budgets, a decline in average check could impact margins (lower average check). However, for consumers looking to save money, there are far better value propositions for burgers that save on the tip and can still feed the family. Hence, I believe Red Robin could suffer from the weaker traffic trends we're seeing as of June/July, with the beneficiaries of this pinch on consumer wallets being quick-service restaurants where average checks are lower. Plus, customers don't feel the need to tip on top of their bills.

Red Robin Menu

Red Robin Menu (Company Website)

To summarize, Red Robin is not in an enviable position. If it raises prices to protect margins, it could see negative repercussions, with analysts at Black Box noting that check growth was correlated with a lower intent to return and decreased traffic. However, if it discounts heavily like its $10 gourmet meal deal and bottomless sides, it could see further margin pressure even if it does preserve sales. Finally, if the consumers feel too pinched, Red Robin might suffer regardless of discounting, with consumers simply not as interested in dining out.

Red Robin has noted that it believes it has pricing power, but I would disagree, especially in the current environment. The reason is that I don't see this as an iconic brand like Applebee's (DIN) or Olive Garden that might get away with pricing more than peers. Unfortunately, despite these headwinds from a margin (inflationary pressures) and traffic standpoint, Red Robin doesn't look that cheap at all, and the earnings trend continues to be dreadful, with annual EPS down from $3.32 in FY2015 to estimates of just $0.53 in FY2023 (but net losses per share this year). Hence, I don't see the current valuation as pricing in any margin of safety if sales trends worsen. Let's take a closer look below:

Red Robin - Earnings Trend

Red Robin - Earnings Trend (YCharts.com, FactSet, Author's Chart)

Valuation

Based on ~16.0 million shares and a share price of US$10.00, Red Robin trades at a market cap of ~$160 million (enterprise value: ~$650 million), which would appear to be a very cheap valuation for having 500+ restaurants in its system. However, earnings were trending lower even pre-pandemic, and the company is on track to post another year of net losses per share. Hence, it's hard to find a worse-looking name in the sector from an earnings growth standpoint. This is evidenced by a compound annual growth rate of (-) 20% from FY2015 to FY2023 earnings estimates of $0.70.

Red Robin - Historical Earnings Multiple

Red Robin - Historical Earnings Multiple (FASTGraphs.com)

However, even if we use forward earnings estimates ($0.53) and we look past this year's expected net losses per share, Red Robin isn't cheap from this standpoint. This is because the stock has historically traded at ~22.2x earnings, and it currently trades at ~19x FY2023 earnings estimates at a lower growth rate. Based on what I believe to be a more conservative multiple of 14 based on the margin erosion we've seen, I see a fair value for the stock of $7.40 per share, suggesting that the stock is fully valued after its recent rally. The same is true from an EV/EBITDA standpoint, with Red Robin trading at ~7x FY2022 EV/EBITDA estimates, a figure that's 30% slightly below its 5-year average (~10x) which is justified given the worsening margin profile.

Red Robin Gourmet - NTM EV/EBITDA Ratio

Red Robin Gourmet - Forward EV/EBITDA Ratio (TIKR.com)

Based on the current outlook and worsening traffic trends for casual dining, I believe that the current guidance (adjusted EBITDA mid-point of $85 million) and FY2023 annual EPS estimates ($0.53) may not be conservative enough. So, with the company potentially in a position to miss estimates/guidance and the stock fully valued, I don't see any way to justify owning the stock. In fact, investors can own a name like Restaurant Brands with ~45% gross margins (RRGB: ~16%) for an even lower earnings multiple (17x FY2023 estimates) and collect a nearly 4.0% yield. Hence, I don't see any way to justify owning the stock from an absolute or relative value standpoint.

Restaurant Brands International - Historical Earnings Multiple

Restaurant Brands International - Historical Earnings Multiple (FASTGraphs.com)

Technical Picture

Finally, looking at the technical picture, the reward/risk ratio has degraded considerably from June when the stock was in a low-risk buy point near support, especially with a high level of short interest that could prompt a short-covering rally. This is because, after a 40% rally, RRGB trades in the middle of its expected trading range, with strong resistance at $13.20 and no support until $7.00. This translates to $3.00 in potential downside to support and $3.20 in potential upside to resistance - a reward/risk ratio of 1.07 to 1.0.

RRGB Daily Chart

RRGB Daily Chart (TC2000.com)

Regarding small-cap stocks that are industry laggards, I prefer a minimum 6 to 1 reward/risk ratio to justify entering new positions. In most cases, I prefer to avoid them altogether. Based on this criterion, RRGB would only become interesting below $7.80 per share, but given that the stock's conservative fair value comes in near $7.00, it still wouldn't interest me from a long standpoint. Hence, I see no way to justify chasing the stock above $10.00, and I don't see any reason to rush in and buy the dip if we see a decline following the Q2 earnings report.

Summary

Cheap stocks that are well off their highs often lure in some investors, but typically, they are cheap for a very good reason. In the case of Red Robin, this couldn't be more true. While the stock is down 75% from its highs, it never belonged above $40.00 per share in the first place (let alone $30.00) in 2021, and I don't have a lot of confidence in a turnaround here. So, while the stock could rally due to its high short interest, I continue to see it as an Avoid, and I would view any sharp rallies as selling opportunities.

This article was written by

Taylor Dart profile picture
25.43K Followers
"A bull market is when you check your stocks every day to see how much they went up. A bear market is when you don't bother to look anymore."- John Hammerslough - Disclosure: I am not a financial advisor. All articles are my opinion - they are not suggestions to buy or sell any securities. Perform your own due diligence and consult a financial professional before trading or investing.

Disclosure: I/we have a beneficial long position in the shares of QSR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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