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Red Robin's a Risky Flight
Related Stocks:
RRGB09/09/2007:
I live in the Chicago area and recently noticed a new hamburger joint in town. The rookie is Red Robin Gourmet Burgers (RRGB), and it has made itself a home in some notable retail locations including my favorite Woodfield Mall in Schaumburg.
Red Robin features a selection of exotic burgers such as the Whisky River BBQ Burger, the 5-Alarm Burger with spicy salsa and peppers and the Guacamole Bacon Burger. In addition, the restaurant offers a bottomless basket of fries and other items such as soups and smoothies. All of this is provided in a kid-friendly environment with games, balloons, TVs and nostalgic décor.
Why This Stock Might Look Tasty
On a cursory glance, Red Robin looks like it has great potential as a growth stock. Recently the company has been on a tear, opening up close to 30 new stores each year. To help build national brand recognition, Red Robin has launched an aggressive television advertising campaign. According to the company's latest conference call, the campaign has yielded positive results through customer attendance and feedback on comment cards.
In recent years, the company has delivered strong revenue growth of more than 20%. In the most recent quarter, revenue was up 32%. On relative valuation the stock looks cheap, trading near a historically low 17 times 2008 earnings projections. Management also welcomed to its board Pattye Moore, a veteran of high-growth hamburger chain Sonic (SONC).
But there's a darker side to the story. With all of the seemingly good news, the stock's short ratio of 8.5 may make the stock look ripe for a short squeeze. However, I believe the shorts have just done their homework and realize the potential problems brewing with this company.
Beware of This Bird
Revenue growth of 32% seems impressive, but what is the quality of these earnings? Unfortunately, not very good. Most of the increased revenue came from the addition of newly opened stores. Same-store sales were only up 3.1%, a small increase compared to other casual dining heavyweights like Chipotle Mexican Grill (CMG), which boasts 10% comparable sales.
Even more disturbing, of that 3.1% rise only 0.7% was contributed by increased customer turnout (the first positive guest increase after three quarters). The remaining 2.4% was attributable to increases in menu pricing. When dinner for two can easily run a $30-plus check, it is quite likely that customers will respond unfavorably to further hikes.
Franchised units brought even worse performance with a 0.67% same-store sales increase. As newer restaurants get placed in the comp, these same-store sales figures are expected to decrease because of the lower margins associated with newly opened facilities. How long can Red Robin afford to lose customers and maintain high revenue growth by opening up new stores?
Among other threats, I believe the chain's high concentration of mall-based locations makes Red Robin restaurants susceptible to cycles in the retail industry. High oil and agricultural commodity prices and the already saturated hamburger market do not make a good recipe for profits.
Discounted Cash Flow Valuation
To determine how much of the bad news or optimism is factored into the stock, I built a spreadsheet model to check the impact of various earnings and revenue growth scenarios. Red Robin was relatively easy to value with this method because it has a stable debt structure and few unusual one-time charges. (Click here for the spreadsheet.)
On the initial run, I used a scenario similar to analysts' current expectations. I set the revenue growth rate for 2008 at a reasonable 24% with growth, slowly decreasing to a terminal growth rate of 4.5% after 10 years. The predicted stock price from the model was $37.81, almost a perfect match to the current trading price.
The second run of the model anticipated lower revenue growth, a very likely case given the threats mentioned earlier. This scenario yielded a stock price of $22.90. A third run anticipated better-than-expected growth (perhaps if same-store sales improve) and the resulting stock price was $51.72. The third scenario was highly optimistic and I feel unlikely to take place without a strategic change at the company.
Based on my spreadsheet model, I believe that most of the good news is already factored into the Red Robin's stock. The stock price is likely to see a hefty decline in value on any doubt of the company's growth prospects.
With so many analysts suggesting a buy rating, I anticipate they will change their stance in a heartbeat the moment we get a quarter with disappointing results. That would make a short position even sweeter.
The Bottom Line
Management is masking a serious problem in the health of the company's existing stores by diverting attention to the rapid opening of new stores. This cannot continue for very long because it already operates in 38 states and management acknowledged in the last conference call that half of the new locations will be in already existing markets.
As Jim Cramer recently reminded us on his "Mad Money" show, "It's easy to spot overexpansion in retail ... when you see them opening up a massive number of stores relative to their base ... that's a retailer asking for trouble. It's a sign of weakness, rather than strength -- masking something. Just watch the same-store sales numbers to see how much the existing business gets hurt by overexpansion. You'll know the top is coming."
My conclusion: Don't bite into this burger joint!
Full Disclosure: At the time of this writing, Winston does not have a position in Red Robin.
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