DRI - Red Robin Gourmet Burgers' Impressive Turnaround Momentum Could Torch The Shorts

2023-07-12 16:33:25 ET

Summary

• Red Robin is one of my core holdings. The company is exhibiting strong turnaround momentum, has a really strong CEO, and is executing well.
• The company trades at a steep valuation discount, to its peer group, and its balance is improving.
• The stock is highly shorted, at 18.6%, of its entire share count.
• As an added positive, there has been consistent insider buying.

Before we discuss Red Robin Gourmet Burgers Inc. ( RRGB ), please indulge a quick aside. Back in the 1970s, Sir Warren Buffett (I'm paraphrasing) said it so well - The Efficient Market Theory is a bunch of groupthink by academics that aren't actual market participants. I would argue that ivy tower theory is great, in practice, often, being on the front lines is more important.

See his 1985 Letter:

Most institutional investors in the early 1970s, on the other hand, regarded business value as of only minor relevance when they were deciding the prices at which they would buy or sell. This now seems hard to believe. However, these institutions were then under the spell of academics at prestigious business schools who were preaching a newly-fashioned theory: the stock market was totally efficient, and therefore calculations of business value - and even thought, itself - were of no importance in investment activities. (We are enormously indebted to those academics: what could be more advantageous in an intellectual contest - whether it be bridge, chess, or stock selection than to have opponents who have been taught that thinking is a waste of energy?)

(Source: Berkshire Hathaway 1985 Annual Letter)

Let's Talk About The Impressive Red Robin Turnaround

I want to start with Red Robin's high short interest. Red Robin has 16.1 million shares outstanding. As of June 15, 2023, nearly 3 million shares were sold short. From a valuation perspective, at $15 per share, we're talking about only a $241 million market capitalization. As of April 16, 2023, the company has $49 million of cash and $203 million of debt.

However, on May 24, 2023, we learned that the company is very close to completing a sale-leaseback on 10 owned restaurants.

Here are the details:

The Company previously announced it was evaluating a Sale-Leaseback transaction, in consultation with its advisor CBRE Group. During the first quarter of fiscal 2023, the Company marketed an initial tranche of 10 owned properties to investors. Through multiple rounds of competitive bidding, the Company selected a winning bid and is currently progressing through the final stages of documentation and diligence. The transaction is expected to close in the second quarter of fiscal 2023 and generate gross proceeds of approximately $30 million. The Company expects the transaction will add an occupancy expense of approximately $2.0 million annually, and has incorporated an incremental Occupancy expense of approximately $1.2 million in its updated financial guidance for fiscal 2023 in anticipation of closing the transaction.

( Source: Red Robin's Q1 FY 2023 Conference Call )

For perspective, as of December 25, 2022, RRGB owns 36 (meaning the real estate and structures) of its 414 restaurants. Also, there are 511 restaurants, in the entire chain, as 97 are franchised, as of 12/15/22.

As of December 25, 2022, 378 of our 414 Company-owned restaurants are located on leased premises.

(Source: RRGB FY 2022 10-K).

So, post sale leaseback, RRGB will have about $78 million of cash and $203 million of debt. At $15 per share, we're talking about $367 million enterprise value (excluding operating leases). Again, though, the company will still own 26 restaurants. These 10 restaurants sold for $3 million each. So, to be super conservative, even if we haircut the other 26 locations, and only value them at $2 million each (and they could be worth more), that is an additional $52 million of liquidity.

Blowout Q1 FY 2023 Numbers and Raised Guidance

On May 24, 2023, RRGB reported much better than expected numbers. This was highlighted by impressive comps and $36.1 million of Adj. EBITDA (which was $8.1 million better than Q1 FY 2022).

After the big Q1 FY 2023 beat, management raised its full year guidance. The conference call was ridiculously good (as I listened to it live, on May 24, 2023, from 5 PM to 5:30 PM).

(A big beat and a raise is the nightmare scenario for the shorts and something that gives them cold sweats.)

Let's think about valuation

On May 4, 2023, Darden ( DRI ) bought Ruth's Hospital Group for a 9.2X FY 2023 EV/ EBITDA multiple. Per SA's press release , the group trades at roughly 7.4X FY 2023 EV/ EBITDA.

Let's do some math.

$75 million of FY 2023 Adj. EBITDA x 7.4 multiple equals $555 million.

Depending on how you treat and think about operating leases, on a traditional enterprise value basis (so market capitalization plus debt net), as I covered in the above sections, at $15 per share, RRGB's enterprise value is $367 million.

$555 million less the current $367 million enterprise value (at $15 per share) equals $188 million. $188 million / 16.1 million shares equals $11.67 or $26.67 per share for RRGB shares to trade at 7.4X FY 2023 EV/ Adj. EBITDA parity.

Therefore, be clear here, given the impressive turnaround momentum here, if we simply get to market parity, or 7.4X, RRGB's stock would have to get to $26.75 (or a 78% increase).

Moreover, given how impressive the turnaround is, and I will cover this next, by highlighting commentary from the Q1 FY 2023 conference call, the market is probably going to anticipate FY 2023 Adj. EBITDA could get to $80 million (or maybe even $82 to $85 million, as management appears to be sandbagging, at least in my view).

The Q1 FY 2023 Conference Call Highlights

G.J. Hart is about ten months into his tenure as CEO of Red Robin. He comes to RRGB from Texas Roadhouse ( TXRH ), where he was the President and CEO from 2004 - 2011.

Nothing for nothing, TXRH is one of the best-performing stocks and operators in the entire sector.

Bill Belichick style blocking and tackling:

Exhibit A

We are encouraged to see early proof points of success. First, guest satisfaction scores have now increased 5 percentage points as compared to 2022. We are seeing gains across the full portfolio with the greatest increase in our bottom quartile restaurants as we would expect. Second, guest wait times and false waits have declined substantially as we staff our restaurants properly. A year ago, more than 10% of our guests reported waiting more than 15 minutes to be seated. Now that it's down to only 2% of our guests. Shorter wait times result in happier guests and reduced walkaways. Third, first quarter results exceeded the Black Box Casual Dining industry benchmark for both same-store sales and traffic. That beat increased as the quarter progressed. We attribute the speed to the benefits of capturing sales that we previously lost due to false waits and extended wait times.

(Source: RRGB's Q1 FY 2023 Conference Call)

Exhibit B

As a point of comparison, based on our point-of-sale sales data, our comparable restaurant sales increased 10% in the first 13 weeks of the quarter. We also celebrated over 700 new sales records established in the first quarter. These are hourly, daily and weekly high watermarks per restaurant. In a brand that is nearly 50 years old, to set more than 700 new records is a testament to the incredible work of our restaurant teams and the overall direction of our company.

(Source: RRGB's Q1 FY 2023 Conference Call)

5 Point North Star Program

1) Empower and provide tangible incentives for store managers to perform (and reward them for strong performance).

2) Elevate the guest experience:

Key changes add back bussers, hosts, bartenders and expo roles that were eliminated or reduced in Red Robin's past and reverting back to our more traditional hospitality standard where servers have fewer tables and do not rely as heavily on server assistance. We made significant progress in the first quarter and are more than 50% complete with these additions. We expect to be substantially complete by the end of the second quarter.

Look at the smart, yet effective innovation:

The first step in upgrading our cooking platform from a legacy conveyor belt-driven system to a flat-top grill. Changing the cooking method alone delivers our guests a 20% larger, juicier and more flavorful burger. We tested the flat-top grills in the first quarter of the year and began the system-wide rollout in April. We have moved very quickly and already installed flat-top grills in nearly 300 restaurants and expect to complete the system-wide implementation in the second quarter. Not only does this change provide great flavor, quality and value to our guests, team members are excited by this change, have a greater sense of pride for their work and report it is easier to execute. Finally, we expect the flat-top grills will significantly reduce repair and maintenance costs, cleaning costs as compared to our legacy system.

3) Remove Cost and Complexity

Our supply chain team has done a great job identifying and now capturing opportunities that provide our guests a parity or better product at a reduced cost. In addition, many vendors have partnered with us to restructure contracts that provide more favorable rates and the opportunity for both sides to benefit as our business grows.

4) Optimize The Guest Experience

We are fortunate to have an incredibly strong Red Robin Royalty loyalty program, now with 11.5 million members, up from 11.3 million members a quarter ago. We have begun the work to engage and evolve the program further by focusing on rewarding our most loyal guests rather than what was primarily a discount strategy in the past.

Our new Chief Marketing Officer, Kevin Mayer, and the team have hit the ground running, and I'll share more progress in the future.

5) Driving Growth in Comparable Restaurant Revenue and Unit Level Profitability

Q1 results demonstrate what we can accomplish when we have the right strategy in place and execute accordingly, and we have only just begun .

(Source: RRGB's Q1 FY 2023 Conference Call)

More Tailwinds… (Moderating Food Inflation and Labor Inflation)

Commodity inflation was approximately 8% in the first quarter of 2023 and moderated faster than expected from the 13% we experienced in the fourth quarter of 2022. We anticipate year-over-year inflation will continue to sequentially step down through the balance of the year.

In labor expenses, hourly wage inflation was approximately 6% . We also invested approximately $3 million in the quarter to add staffing in the operational roles G.J. mentioned earlier. Additionally, incentive compensation expense for our restaurant management teams increased over $1 million versus the first quarter of 2022 due to the significant gains in sales and profit performance the restaurant teams produced. While these are added costs we see real evidence of the benefits of these investments in guest satisfaction, sales and profit results.

(Source: RRGB's Q1 FY 2023 Conference Call)

Forward Looking Q2 FY 2023 Commentary

As we look to the balance of the year, comparable restaurant sales have remained positive and better than the industry benchmarks to start the second fiscal quarter.

Due to typical seasonal sales shifts and the accelerated investments, we expect second quarter restaurant level operating profit margin to take a step back from first quarter levels, then sequentially increase through the balance of the year as cost savings achieve a full run rate.

(Source: RRGB's Q1 FY 2023 Conference Call)

Subtext And Qualitative Commentary by G.J. Hart:

See here:

See here:

Very High Short Interest (18.6%) For An Illiquid Stock

As of June 15, 2023, there are nearly 3 million shares of RRGB sold short. This company's average daily trading volume is only about 300K shares per day. Therefore, 18.6% of the entire share count is sold short, and it would take almost ten days to cover, based on 300K of average daily trading volume.

See the stock chart and average daily volume (280K for 10 days and 420K for 90 days)

Insider Buying

Red Robin insiders have been buying shares, when their insider trading windows open up.

Risks

For further details see: