2023-05-31 13:04:30 ET
Summary
- Red Robin Gourmet Burgers, Inc. is expected to see sales growth driven by factors such as price increases, improved guest experience, regional advertising efforts, and more accountable restaurant-level staff.
- The company's Q1 2023 earnings exceeded expectations, with revenue growth of 5.7% YoY and adjusted EPS of $0.25, showcasing strong performance due to price increases, improved guest traffic, cost savings, and sales leverage.
- The outlook for Red Robin is positive, with potential for margin expansion, revenue growth, and an attractive valuation, leading to a buy rating on RRGB stock.
Investment Thesis
Red Robin Gourmet Burgers, Inc. ( RRGB ) is expected to see sales growth driven by several factors, including price increases, improved guest experience and food quality through the company's turnaround plans, regional advertising efforts to boost traffic count, and a more accountable restaurant-level staff. These factors contribute to a positive outlook for revenue growth. While there are concerns around broader macros, a shift in consumer spending from products to services should help the company. The company is also gaining market share thanks to improved execution.
On the margin front also, the prospects appear promising. Red Robin is expected to benefit from expanding margins due to the carryover impact of price increases, sales leverage, cost-saving initiatives, and moderating inflation. These factors contribute to the company's potential for improved profitability.
I gave the company a neutral rating in my last coverage as I preferred to wait for the company’s turnaround plans to gain traction. I believe the company’s last quarter results indicate that the new management can deliver on its turnaround plans. Further, the stock price has also corrected since my last coverage. Hence I am raising my rating on the stock to buy.
Q1FY23 Earnings
Last week, Red Robin announced its first-quarter results for 2023, which exceeded expectations. On a reported basis, revenue increased by 5.7% compared to the previous year, reaching $418 million. On a same-store basis, revenue grew by 8.6% year-over-year. These figures surpassed the consensus revenue estimates of ~$405.5 million. Adjusted earnings per share ((EPS)) for the quarter were $0.25, a significant improvement from the negative EPS of -$0.12 reported in the same period last year. The adjusted EPS also exceeded the consensus estimate of -$0.57. Red Robin's restaurant-level operating margin saw a year-over-year increase of 70 basis points, reaching 14.7%.
The revenue growth experienced by Red Robin was primarily due to the implementation of price increases and an improvement in guest traffic count. This improvement in margin was driven by various factors including cost savings, sales leverage, and price increases. The positive impact of these factors contributed to the growth in adjusted EPS and margin as well. Overall, the company's first-quarter results showcased strong performance, with revenue, adjusted EPS, and margin all exceeding expectations. These positive outcomes were driven by a combination of factors such as price increases, improved guest traffic, cost savings, and sales leverage.
Revenue Analysis and Outlook
In my previous article on Red Robin Gourmet Burgers, I discussed the company's new management turnaround plan, which has the potential to drive revenue growth in the future. However, I preferred to remain cautious and observe the progress of the turnaround plan before giving a buy rating on the stock. Despite gaining good traction on its turnaround plans in Q1, the stock price has corrected by ~11% since my last coverage.
During the first quarter of 2023, the company's management focused on improving the guest experience as part of its turnaround plan, which contributed to revenue growth. The implementation of better staffing measures led to a positive guest traffic count. Additionally, revenue growth was supported by an increase in the average guest check through price increases and a favorable menu mix. As a result, revenue for the quarter increased by 5.7% year-over-year to $418 million. On a comparable restaurant basis (same-store sales), revenue grew by 8.6% year-over-year, with the price increase accounting for a 7.2 percentage point benefit, a favorable menu mix contributing 0.8 percentage points, and a 0.6 percentage point increase in guest traffic.
RRGB’s Historical Sales (Company Data, GS Analytics Research)
Looking forward, RRGB should be able to post revenue growth in the coming years as it benefits from price increases, improving guest satisfaction and traffic count, menu and food quality enhancement, and more accountable restaurant-level staffing.
RRGB has been increasing prices to offset unfavorable inflationary costs, which has been beneficial in growing the average check and supporting comparable sales growth. These should continue to benefit comparable sales growth moving forward and the company expects price increases to contribute to mid to high single digits in the full year's sales growth.
In addition to average check growth, RRGB is also focused on improving the overall guest experience. The previous management reduced the number of restaurant managers to only two even during the busiest times of the day. They also removed bussers and bartenders. These poor cost-cutting measures affected the guest experience and negatively impacted sales. However, the new management’s decision to properly staff the restaurants with 4-5 restaurant managers and bring back the bussers, bartenders, and hosts is bearing fruit. The table servers are getting more time to focus on customer engagement and provide smooth service throughout their dine-in. The guest satisfaction is increasing which is evident by the improving guest traffic count. In fact, dine-in sales increased by 16% YoY in Q1 FY23. Moreover, the company also saw the percentage of guests leaving due to long wait times, decline from 10% in the previous year’s quarter to now only 2%. The company tracks this metric through its internal surveys and this meaningful decline in guests leaving without enjoying RRGB’s services and an increase in dine-in sales indicates that the company’s turnaround plan is working. I expect continued training of the new staff to further improve guest engagement.
RRGB is also changing the cooking system from conveyor belts to traditional flat tops in order to produce 20% larger burgers and overall better quality food. The company has already installed the flat-top grills in ~300 restaurants and expects completion by the end of the second quarter. This should enhance the guest experience by adding value to their meals. The company is also bringing new menu items across different price points to improve the menu mix which should help in average check growth and offer customers a variety of options according to their budget. This should also help in growing sales moving forward.
The company expects that these efforts to improve guest experience should help in acquiring new customers and help support traffic count through word of mouth. RRGB has also switched to local advertising from national advertising to better resonate with customers and make them feel more welcome than ever before. This should also help in new customer acquisitions and support traffic count. In terms of existing customers, RRGB is focused on providing offers and discounts to its most loyal customers through its Red Robin Royalty-loyalty program, which now has 11.5 million members, up from 11.3 million members a quarter ago.
Lastly, the focus of the turnaround plan to improve the accountability of the restaurant staff should also help in delivering sales growth. The company launched a market partner program for all multiunit operators at the start of the second quarter. This program alters the compensation structure for these partners in order to compensate them based on the profits of the restaurants they oversee. These leaders are incentivized and rewarded for driving and delivering results as an outcome of this change. Based on the success of the current multiunit operator program, the company plans to incorporate this program into a single-unit operator at the beginning of 2024. So, I expect a restaurant-level increase in accountability to also help RRGB’s sales moving forward. Hence, I am now becoming increasingly optimistic about the company’s revenue growth prospects.
Margin Analysis and Outlook
In Q1 2023, RRGB achieved margin expansion through various factors, including price increases, sales leverage from better-than-expected sales volume, and the initial impact of cost-saving measures implemented as part of the turnaround plan. These positive developments helped offset the challenges posed by inflationary commodity and labor costs, as well as additional expenses related to hiring and compensating new staff. Consequently, the company recorded a year-over-year increase of 70 basis points in its restaurant-level operating margin, bringing it to 14.7%.
RRGB’s Historical Restaurant-Level Operating Margin (Company Data, GS Analytics Research)
Looking ahead, I anticipate that RRGB should experience margin growth. The impact of inflationary costs is expected to moderate, as the company experienced a lesser headwind from higher commodity costs sequentially. In Q4 FY22, inflationary commodity costs posed a 13 percentage point year-over-year headwind to margin growth, which declined to approximately 8% in Q1 2023. With the company projecting mid to high single-digit inflation for the full year, I expect further moderation in inflationary costs, supporting margin expansion. Additionally, RRGB should benefit from the carryover of price increases implemented in the second half of 2022, as well as recent price adjustments, which will help offset higher commodity and labor costs and contribute to margin expansion.
Furthermore, an increase in cost savings efforts should contribute to margin growth. RRGB successfully renegotiated contracts with many supply vendors, securing more favorable rates compared to before. This resulted in $1 million in cost savings during the first quarter, and the company expects cost savings to accelerate in the coming quarters, reaching their peak in the fourth quarter as the renegotiated contracts fully materialized.
Management has raised its guidance for restaurant-level operating margin by 50 bps, and now expects at least 13.5% restaurant level margins. This adjustment in guidance reflects the better-than-expected sales leverage achieved in the first quarter. As RRGB's revenue continues to increase, and as cost-saving measures and inflation moderation progress, the company should sustain sales leverage in the upcoming quarters. Therefore, I believe that the revised guidance is attainable.
Valuation and Conclusion
After years of mismanagement, RRGB is now making positive strides under the leadership of its new management team and its turnaround initiatives. RRGB’s current market cap is around $220 million, and as of the last quarter, its long-term debt was ~$203 mn, and cash and cash equivalents were $49 mn. So, its EV is around $375 mn. The company has guided for adjusted EBITDA of between $70 mn and $80 mn this year. If we take the midpoint of this EBITDA guidance, its EV/EBITDA comes to around 5x which is cheap. With further prospects of operating improvements, the company’s valuation looks attractive. Hence I have a buy rating on the stock.
For further details see:
Red Robin: Turnaround Plans Are Gaining Traction (Rating Upgrade)