This quarter was one Red Robin Gourmet Burgers, Inc. (RRGB 7.85%) would rather forget. You'll find all the headline numbers here, but the short version was that the company missed on both the top and bottom lines, with management lowering full-year earnings-per-share (EPS) guidance.
In response, shares of Red Robin fell 29% in the post-announcement trading session, wiping out the company's strong year-to-date performance. As of this writing, shares of the restaurant are down 17% year to date while the greater market, as benchmarked by the S&P 500, is up by 15%.
For investors, however, it's prudent to look beyond short-term stock movements. Often the market can harshly sell off a stock on temporary weakness, allowing patient long-term investors to get a better deal. To that end, here are the three key takeaways investors should know before making an investing decision about Red Robin.
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1. Surprisingly, this quarter looked better than it really was
At first sight, the quarter looked better than last year's. Versus 2016's comparable third quarter, the company grew its top line 2.3% and was profitable, producing $0.21 in EPS. Last year the company reported losses of $0.10, so at first glance it appears the company is growing its bottom line with stronger operations. It's understandable if you thought the sell-off was unwarranted.
However, in 2016's comparable quarter, the company reported a one-time charge of $9.3 million in asset impairment and restaurant closure costs. Without that charge, the company would have produced $5.1 million in operating income. This year, the company reported $4.1 million in operating income with no such charges. This quarter was weaker, at least operationally, than last year's.
2. Labor and sales costs are increasing at a faster rate than revenue
A key reason for the weaker quarter was that costs increased at a higher rate than revenue. The two biggest line items -- cost of sales and labor -- increased 3.1% and 3.8%, respectively, versus the top-line increase of 2.3% on a year-over-year basis. This could partially be due to the company's franchise royalties and fees dropping 9%, as this revenue does not include labor or cost of sales. However, with franchise royalties totaling 1% of revenue, it's likely the difference here is a de minimus amount.
Sluggish revenue growth was due to a negative sales mix from the company's decision to build out its value-priced Tavern menu. During the conference call, CEO Denny Marie Post noted the expansion to nine items with three choices at $6.99. Later, CFO Guy Constant said that comparable sales were down 0.1%, which was composed of flat traffic and a 0.1% decrease in the average guest check due to the use of the Tavern menu. In fact, the bulk of the 2.3% sales growth was due to new restaurant openings.
Red Robin notes it took market share in the casual dining space, but the company should evaluate if chasing market share is a wise strategy in light of cost growth outpacing revenue growth.
3. Off-premise is a big focus for the company; new restaurants -- not so much
Red Robin is focused on growing its off-premise business, with Post noting it's grown 41% over last year. Still, at 7.6% of sales, it's a small percentage for a company known for its sit-down experience and bottomless fries. Off-premise has trade-offs, like a lower average ticket cost. Yet it is a way to increase sales, and it appears the company is doing well growing that channel.
What the company isn't interested in doing, at least in the short term, is planning to build new restaurants. Post noted during the conference call, "Consistent with the need to reconsider what has traditionally worked in the past, we recently decided to pause new unit development as of the end of next year. We will still open nine new corporate units in 2018, but will hold beyond that for now." For a company struggling to grow revenue with few new stores, this could be an issue in the years to come.
A harsh sell-off that was probably warranted
Make no mistake -- this was a tough quarter for Red Robin. The conference call appears to show a company afraid to increase prices while labor and other costs are climbing. Additionally, the company's big push for off-premise dining will result in lower ticket prices and is far removed from the company's sit-down value proposition.
However, you can't blame management for the harsh sell-off. It just appears that the stock got ahead of itself with outsized expectations and fell when they weren't met. Post-sell-off, shares of the company trade at 14 times forward earnings, according to data from Thomson Reuters, versus the S&P 500's 21 times. However, the question is, can Red Robin hit the $3.38 EPS target analysts expect? Due to the recent 2017 EPS guide-down of 24%, color me skeptical.
