Will Red Robin's Quick-Serve Strategy Lead to More Value?

Red Robin's future growth plans include an assault on the hamburger quick-serve segment through its limited service Burger Works outlets. With competition in the space getting tougher, though, will it create value for shareholders?

Feb 12, 2014 at 11:54AM

Red Robin Gourmet Burgers (NASDAQ:RRGB) has found success in the casual-dining space by capitalizing on consumers' desire for a better burger, a trend that has also led to fast growth in recent years for premium quick-serve burger operators, like In-N-Out Burger and Five Guys Burgers & Fries. 

While Red Robin sees more growth ahead for its traditional stores, it is also plotting a course in the quick-serve restaurant (QSR) space via its smaller, limited menu Burger Works outlets.  That strategy, though, has the company going up against the aforementioned niche operators, as well as a concentrated group of formidable multinational players like McDonald's, Burger King Worldwide (NYSE:BKW), and Wendy's (NASDAQ:WEN). So, will Red Robin be able to create value for investors?

What's the rationale?
Red Robin has found considerable success by offering customers a selection of roughly two dozen unique burgers at relatively inexpensive price points, evidenced by an average guest check of $11.73 in its latest fiscal year. Red Robin complements its trademark burgers, which account for nearly half of its sales, with popular complementary items, like its bottomless steak fries and Mad Mixology alcoholic-beverage lineup. The company's favorable long-run growth trajectory has largely been a byproduct of the favorable value proposition of its freshly prepared food, vis-a-vis its fast-food competitors, culminating in its current network of 485 stores throughout the U.S. and Canada.

In FY 2013, Red Robin has continued building on three straight years of top-line growth, reporting a 5.3% increase that was a function of higher comparable-store sales and modest additions to its store network. More importantly, the company's gross margin benefited from some relief in key commodity prices, as well as a greater percentage of sales from higher-margin alcoholic beverages, leading to an uptick in operating profitability. The net result for Red Robin was improved operating cash flow during the current period, providing funds to reimage a subset of stores while affording it the ability to invest in growth initiatives, like its Burger Works concept.

Burger giants go proactive
Of course, Red Robin's Burger Works unit is primarily competing against the major burger chains, which have anecdotally seemed to figure out that a big advertising budget and thousands of stores don't guarantee a higher stream of customers. Burger King and Wendy's, in particular, have made the hard decisions, undergoing radical reconstructions of their business operations in order to instill a sense of urgency and a renewed customer focus among their rank and file.

Burger King, the larger of the two, used a leveraged buyout in 2010 to kick start the rejuvenation process, which has included reimaging its North American store base and pursuing greater international store growth via lower-risk joint ventures. The company also sold off all but a few company-owned stores, thereby freeing it from management and allowing it to focus on menu development, including the introduction of healthier fare like salads, wraps, and smoothies.

In FY 2013, Burger King's efforts have been producing the desired results, with rising comparable-store sales and a sharp increase in operating profitability. While the company's North American segment has been a tough place to find top-line growth, solid performance in its international segments has offset the former segment's weakness. More importantly, Burger King's higher profitability has led to better operating cash flow, providing funds to accelerate its store reimage campaign, slated to be 40% complete by the end of 2015.

Not surprisingly, Wendy's has more recently copied Burger King's transformation blueprint, agreeing to sell off a large swath of company-owned stores and initiating a store reimage program of its own. In addition, the company has been spending some quality time in the kitchen developing new products, with several successful debuts in 2013, including its Pretzel Pub Chicken Sandwich and Bacon Portabella Melt. The net result for Wendy's has been a decent facsimile of Burger King's current year performance, with rising comparable-store sales and higher operating profitability.

The bottom line
Investors have certainly liked Red Robin's recent financial results, pushing its shares up sharply over the past 12 months. Part of the euphoria, rightly or wrongly, may be a belief that Red Robin can leverage its brand to success in the hamburger QSR segment through its Burger Works unit.

However, with the major burger chains trying to woo customers with premium burger menu options of their own, in addition to their traditional value-priced fare, the hamburger QSR segment seems to be getting a little too crowded, which will likely lead to lower profit margins for all participants. As such, Red Robin may be jumping into a frying pan with its strategy, and investors should probably start looking for an exit plan.

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Robert Hanley has no position in any stocks mentioned. The Motley Fool recommends Burger King Worldwide. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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