2023-08-22 10:24:36 ET
Summary
- Red Robin beat earnings expectations and raised guidance, contradicting the short thesis that they would miss and lower guidance.
- The increase in labor costs is part of a strategic investment to improve service and the guest experience.
- Red Robin is focused on driving profitable sales and higher Adj. EBITDA margins, not high comp growth.
Like so many small cap stocks, Red Robin Gourmet Burgers, Inc. (RRGB) has had a rough August 2023. Month to date, through August 21, 2023, the Russell 2000 (IWM) is down 147 points, which translates to a sharp 7.3% decline. August is traditionally a lower volume month and a time for summer vacations. This year, though, short sellers have been out in force and aggressive sellers, intent on taking advantage of the big shift and flip of sentiment from bullish to bearish. The recent increase in interest rates, renewed Regional banking fears, and persistent economic weakness, out of China, are major drivers of this sentiment shift, from bullish to bearish.
Despite yet another Red Robin beat and a raise, month to date through August 21, 2023, RRGB shares are somehow down 28.5%.
On Thursday, August 17, 2023, Red Robin beat and raised its Adj. EBITDA guidance. The entire report read well as did the Q2 FY 2023 conference call. The only negative that anyone could point to, at least at face value, was the six percent decline in traffic.
To be crystal clear, if anyone did any real work here, at least on the fundamentals of the business, the modest traffic decline was driven by more than a 50% Q2 FY 2023 reduction in 'selling expense (or marketing)', and well as management aggressively moving away from the ghosts of Christmas Past (aggressively discounting to drive traffic).
New CEO, G.J. Hart, has been revamping Red Robin's go-market strategy by focusing on the blocking and tackling, notably targeting a better guest experience. To do this, he and his team, have intentionally invested in labor.
And objectively, the strategy appears to be working, as this quarter, similar to last quarter, some of the key performance indicators, the pulse of the business, are pointing to numerous weekly sales records (see the excerpt below from Red Robin's Q2 FY 2023 conference call).
Simply put, guest feedback and satisfaction scores are improving. I would argue management is correctly playing the long game. And yes, of course, as that is how any investment works (Capex, Labor investments, etc.), the costs are borne up front and the pay-off schedule occurs at some point in the future. The idea of the investment is that greatly improved guest experience leads to greater guest satisfaction and higher customer lifetime value/ more frequent return visits.
So yes, they are adding labor cost, but that is because management is intentionally rebuilding the brand and completely moving away from the low margin and widespread discounting of year's past (the ghost of Christmas Past).
Here is where they invested:
Yes, it is factually correct that labor costs are up by $8 million, in Q2 FY 2023, YoY, but it is more nuanced.
Moreover, selling expense (or marketing was down $7 million).
Would an objective analyst really expect guest traffic to be up in the face of reducing marketing expense by more than 50%, during Q2 FY 2023? And would an objective analyst think traffic would be up in the face of actively phasing out low margin discounting?
Of course not!
Enclosed below, directly from Red Robin's Q2 FY 2023 10-Q, as clear as day, you can see 'selling' expense (or marketing expense) was $6.2 million during Q2 FY 2023 compared to $13.4 million during Q2 FY 2022.
As an analyst you must have the ability to synthesize and objectively evaluate both the qualitative and quantitative facts. Red Robin is working on a multi-year turnaround and revamping of the brand. Management is moving away from the discounting and is investing, in FY 2023, in labor to improve service and the guest experience. Mr. Hart was the CEO of Texas Roadhouse (TXRH), one of the best long term performing restaurant stocks in the entire publicly traded restaurant group universe. And I would argue he knows a thing or two about how to build a healthy and successful brand and what that requires.
Exhibit A - They are moving away from discounting
Exhibit B - Eliminating The Mr. Beast Partnership
The only reason Red Robin slightly lowered its comp guidance (from a range of +200 Bps to +400 Bps to +100 Bps to +300 Bps is because they discontinued their Mr. Beast partnership.
This is 100% consistent with management's focus on improving longer term Adj. EBITDA margin and eliminating complexity!
Exhibit C: Solid Comp Guidance Despite Lapping Last Year's 2nd half 2022 $10 meal deal promotions
Despite RRGB lapping a huge $10 meal deal promotion (second half 2022), management is intentionally saving 'dry powder' and marketing dollars to highlight the new flat top grills, the better service, and upcoming new menu items.
So, again, to belabor the point, yes, Red Robin's guest traffic was modestly down, but for good reason. The company is 100% focused on driving profitable sales and higher Adj. EBITDA margins. RRGB isn't a high comp, early stages growth story, and it was never framed that way. This isn't CAVA Group ( CAVA ) and certainly doesn't trade at a CAVA valuation.
Let's Quickly Review Q2 FY 2023 Numbers
Comparable restaurant revenue increased by 1.5%
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Adj. EBITDA was $15.5 million compared to $11.9 million
And of course, Adj. EBITDA backs out the gain on the sale leaseback.
The Company Raised Its Full Year Adj. EBITDA Range
See here:
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Stock buybacks and debt repayment
The company used the sale leaseback proceeds to retire $15.5 million of debt and buyback 382 thousand shares.
During the second quarter of fiscal 2023, the Company repurchased 382,017 shares of stock under its existing $75 million share repurchase program at an average price of $13.19 for a total of approximately $5.0 million. The Company's Credit Agreement allows for an additional $5 million of share repurchases, for a total of $10 million. Pursuant to the repurchase program, purchases may be made from time to time at the Company's discretion and the Company is not obligated to acquire any particular amount of common stock.
Valuation
There are 15.9 million shares. The fact that you can buy RRGB shares, right now, around $10.40 per share, is kind of ludicrous.
$10.40 per share x 15.9 million shares equals a $165 million market capitalization. As of July 9, 2023, RRGB had $56 million of cash (inclusive of $12 million of restricted cash) and $188 million of debt. So, roughly a $300 million enterprise value. At the Adj. EBITDA mid-point, of $77.5 million, that is only a 3.9X EV/ FY 2023 Adj. EBITDA valuation.
Moreover, they are marketing an additional 20 owned properties for a future sale-leaseback transaction. Potential proceeds could be used pay down debt (buyback another $5 million of stock) and/ or invest in the business.
The Company is currently marketing approximately 20 additional owned properties for potential Sale-Leaseback transactions and anticipates closing one or more transactions in 2023. The Company continues to expect to use net proceeds to repay debt, fund capital investments, and support share repurchase activity pursuant to the Company's Credit Agreement.
(Red Robin Q2 FY 2023 Earnings Release)
Other Things To Consider
Red Robin has been aggressively sold short, throughout 2023. As of July 31, 2023, 18.6% of its entire share outstanding have been sold short. This is a very elevated short interest for a relatively thinly traded stock (outside of the few trading day time periods after the company reports its quarterly earnings).
Secondly, since taking the reins, as CEO, Mr. Hart has been a consistent buyer of the Red Robin shares, on the open market.
Putting It All Together
Small caps have gotten taken to the woodshed, month-to-date through August 21, the Russell 2000 is down 147 points, or down 7.3%. Red Robin is thinly traded, and highly shorted, and is down 28.5% month-to-date despite a recent Q2 FY 2023 Adj. EBITDA beat and full year FY 2023 Adj. EBITDA raise. At this ridiculously low valuation of 3.9X EV/ FY 2023 Adj. EBITDA, I'm not sure I understand the short thesis here. The only slight negative contained within Red Robin's Q2 FY 2023 entire earnings report was a modest 6% decline in traffic, yet that can easily be understood, as Red Robin's management team took down its marketing spend, during Q2 FY 2023, to the tune of down more than 50% (more than $7 million dollars). Secondly, management is focused on playing the long game and getting Adj. EBITDA margin up, hence why they intentionally moved away from low margin discounting.
If you're a small cap investor then you should love and welcome these irrational drawdowns, as they create the opportunities to generate alpha. This is and has always been a conviction game. Lastly, as you might have expected, I have been aggressively adding more shares, in the $10s.
For further details see:
Red Robin: Another Beat And A Raise