Friday, March 02, 2007

"Mo-Cheese-than-Burger" at Red Robin

The Red Robin Gourmet Burger (RRGB-$39.13) legacy began in the 1940’s with Sam’s Tavern, a small tavern perched on a Seattle hilltop near the University of Washington campus. The owner, Sam, sang in a barber shop quartet and could frequently be heard singing the song, “When the red robin goes bob’ bob’ bobbin’ along.” In fact, Sam loved the song so much that he eventually changed the name of his tavern to Sam’s Red Robin, and over the years it became known simply, as Red Robin.

“When The Red, Red Robin Comes Bob, Bob Bobbin' Along.”

When the red, red robin comes

Bob, bob bobbin' along, along,
There'll be no more sobbin' when
He starts throbbin' his old, sweet song.

Last week, the burger chain reported its
annual results for the fiscal year ended December 31, 2006. Earnings beat Street expectations by 10.8% for the year.

Wake up, wake up, you sleepy head;
Get up, get up, get out of bed.
Cheer up, cheer up - the sun is red.
Live, love, laugh and be happy.

Today, Red Robin Gourmet Burgers, Inc., headquartered in Greenwood Village, Colorado, serves its ‘Guests’ an imaginative selection of more than 22 Gourmet Burgers in a variety of recipes with all-you-can-eat Bottomless Steak Fries. Its menu also includes salads, soups, appetizers, entrees, desserts, children’s fare and signature Mad Mixology specialty beverages.

What if I've been blue,
Now I'm walkin' through fields of flow'rs.
Rain may glisten, but
Still I listen for hours and hours.

Red Robins’ primary
sources of revenue are from the sale of food and beverages at company-owned restaurants and royalties and fees from franchised restaurants, which represented 97.5% and 2.5% of sales in 2006, respectively.

I'm just a kid again,
Doin' what I did again,
Singin' a song
When the red, red robin comes
Bob, bob bobbin' along.

-- Written by Harry MacGregor Woods (1926) / Recorded by Sophie Tucker; Al Jolson.

Restaurant revenues increased by $131.5 million, or 27.9%, to $603.4 million, from fiscal 2005. Net income was $29.4 million, or $1.75 per share, up from $27.4 million, or $1.64 per share, in the year-ago period.

Management glowingly cited an increase in the average guest check of 1.9% and an increase in guest counts of 0.5% over 2005 as reasons for a 2.4 percent increase in comparable restaurants sales (on a comparable-basis of 53 weeks) for fiscal 2006 and 2005.

New restaurants can take up to three years or more to achieve the average unit sales volumes and profitability of comparable restaurants, Red Robin does not enter these new units, whether company- owned or franchised, into its comparable restaurant base until their fifth full quarters of operations.

As of December 31, 2006, approximately 41% of its restaurants (excluding acquired restaurants in 2006) had been opened less than three years.

Management warned in its annual filing “as these less mature restaurants enter the comparable restaurant base, [its] comparable restaurant sales volumes could continue to be negatively affected.”

Average weekly sales volumes, which represent the total restaurant revenue for a population of restaurants in both a comparable and non-comparable category for each time period presented divided by the number of operating weeks in the period, increased an anemic 0.8% to $63,729 in 2006. Management believes that its average weekly sales growth was materially impacted by a higher weighting of 23 less mature restaurants entering the comparable base in 2006.

At the end of 2006, there were 148 comparable restaurants compared to 125 comparable restaurants in 2005.

As of December 31, 2006, too, the Company owned and operated, or franchised 347 Red Robin restaurants in 38 states and Canada, of which 208 were company-owned and the remaining 139 of which operated under franchise agreements.

By comparison, comparable sales increased 3.9% and 7.5%, for 2005 and 2004, respectively.

In 2006, non-comparable restaurant volumes declined 5.0% from 2005 levels.

Red Robin’s areas of highest concentration are Arizona, California, Colorado, Ohio, Oregon, Virginia and Washington. In accordance with its expansion strategy, management intends to open approximately 40% of new restaurants in 2007 in existing markets.

FY 2007 Outlook

Red Robin communicated on its conference call that new markets present old operational challenges, such as brand recognition (i.e. lack of familiarity), lower concentration of trained team members, and generally higher operating costs.

As about 60% of new units will be opened in new geographic markets, management warned its shareholders that “[a] greater concentration of less mature restaurants in our comparable restaurant base and a larger percentage of operating weeks from new restaurants will [adversely] impact profitability.”

In fiscal 2007, growth in restaurant revenue is expected to continue as the Company looks to open between 24 and 27 new restaurants and realize a full year of revenue from 17 acquired Red Robin franchised restaurants in the state of California.

Management believes, too, that a new national media campaign scheduled to begin in 2007 will increase revenue by improving guest counts.

For fiscal 2007, it expects share net of $1.75 - $1.85 on revenues of $715 - $735 million. According to Reuters estimates, analysts on average are expecting the Company to report sales of $714 million and earnings per share of $1.83 for fiscal 2007.

These projected results are based upon certain assumptions, including an expected comparable restaurant sales increase of approximately 2% to 3.5% for full fiscal year 2007.

Citing the aforementioned challenges and "limited visibility" of new-restaurant performance, however, the company did say it no longer would provide quarterly revenue, earnings or same-store sales projections. Hhmm….

10Q Detective Comments

A look at the Company’s recent 10-K filing suggests (i) financial results at the burger chain for fiscal 2006 were smothered with more cheese than burger meat and, in our view, (ii) management will probably lower its full year 2007 EPS outlook and revenue guidance come this Spring.

  1. 2006 was a 53-week fiscal year. In fiscal 2006, the fifty-third week added $14.4 million to restaurant sales and $0.11 to diluted earnings per share.
  2. Earnings benefited, too, from a 3.0% drop in its effective tax rate to 30.6% for 2006. The decrease was primarily due to more favorable tax credits and state apportionment factors resulting from a shift in income to states with lower tax rates—aggregate state income tax rate fell 1.9% to 2.6% in fiscal 2006. This creative accounting boosted income about 6 cents per share. Management anticipates that its 2007 effective tax rate will be approximately 32 percent.
  3. In 2006, Red Robin reduced the expected life of its outstanding option grants more than 50% to 2.6 years! By cutting the time it thinks its ‘team members’ will hold options, the burger maker was able to trim compensation costs.

We estimate that the three aforementioned factors added at least 22 cents to Red Robin’s bottom line in 2007.

Margin Analysis

In 2006, as a percent of restaurant revenue:

  • Cost of sales, comprised of food and beverage expenses, improved 60 basis points to 22.6%, due primarily to lower commodity costs and menu mix changes to lower costs items, as well as the leverage from price increases implemented since June 2005.

In 2007, cost of sales should benefit from an announced 0.9% price increase on selected menu, of which it expects to realize 50% to 70% of this price increase in actual revenue increases.

  • Labor costs include restaurant hourly wages, fixed management salaries, stock-based compensation, bonuses, taxes and benefits for restaurant team members. Labor costs increased 30 basis points to 34.2% as a result of increases related to hourly and salaried labor costs, as well as approximately $894,000 of stock compensation expense related to Red Robin’s adoption of SFAS 123R.

Management expects to see more increases in labor as a percentage of restaurant revenues during 2007, compared to 2006, due to state minimum wage increases, as well as to the continued weighting on its labor costs from less efficient new restaurants.

  • Operating costs include variable costs such as restaurant supplies, advertising and energy costs, and fixed costs such as service repairs and maintenance costs. The 50 basis point increase in operating costs to 15.7% in 2006 reflected higher energy expenses. The higher energy costs were driven by increased rates charged to restaurants as well as increased usage, which resulted from severe weather in the northwest and the southwest operations. Supplies expense also reflected higher petroleum-based materials costs, fuel surcharges and transportation costs.

Management is optimistic that the impact of energy costs will lessen in 2007. [We doubt it!]

Nonetheless, incremental costs of its expected national advertising campaign will probably offset the expected energy savings.

Liquidity and Capital Resources

Long-term debt to total stockholder equity stood at 46.8% at fiscal year ended 2006. However, add in operating lease commitments, and leverage jumps to about 198% to equity.

Net cash provided by operating activities increased $13.3 million year-over-year to $78.5 million, due to increases in non cash expenses (e.g. stock-based compensation) offset by income tax refund receivable and a decrease in accounts payable and accrued liabilities.

Free cash flow was $(17.1) million, due to the construction of new restaurants, refurbishing existing restaurants, and an expanding corporate infrastructure to support the Company’s growth model.

In fiscal year 2007, capital expenditures are expected to be approximately $85 million to $95 million, funded by existing cash flow and a revolving credit agreement.

Valuation Analysis

Red Robin’s share price is selling for about 21.2 times the high-end of its 2007 share-net guidance, which puts the stock in bargain territory—based on FY ending multiples of 30.9x, 37.5x, and 29.9x for 2005, 2004, and 2003, respectively.

Nevertheless, with slowing organic growth, investors might want to temper their expectations—given the coming cycle of lower margins, increasing financial leverage, and stated risks that go with the expansion into new markets.

In our view, given the lackluster performance of new restaurants, Red Robin is “Mo-Cheese-than-Burger,” and its stock warrants no better than a Market Perform.

Editor David J Phillips does not hold financial interests in any of the companies mentioned in this posting. The 10Q Detective has a Full Disclosure policy.

1 comment:

Davis Freeberg said...

Great article, you raise a number of interesting points. It will be interesting to see how this pans out.