Preliminary fourth-quarter 2019 results for Red Robin Gourmet Burgers (RRGB -18.12%) are in, and they aren't great. Restaurant traffic was down 3.4%, and quarterly revenue fell 1.2% because of restaurant closures. It's something investors have come to expect, as revenue, net income, and comparable sales have all trended down in recent years. As a result, shares are still down over 60% from 2015 highs.
Red Robin knows it can't go on as it has over the last several years. To stage a comeback plan, the company hired Paul Murphy as CEO, a restaurant executive known for turnarounds. The board of directors also rejected a buyout offer from Vintage Capital, fully hitching the company's wagon to the comeback plan it outlined at the ICR Investor Conference.
But should investors buy it?
Murphy's track record
Red Robin's newly hired CEO Paul Murphy is no stranger to the public markets. He was CEO of Del Taco as the company went public via a reverse merger with Levy Acquisition Corp in 2015. At the time, Del Taco had 10 straight quarters of comparable-sales growth, and was improving margins.
Murphy was hired away from Del Taco in 2017 to help fix a struggling Noodles & Company. As he arrived in his executive chairman role, the company was operating at a net loss, comparable sales were falling, and a slew of underperforming restaurants had just been shuttered. Fast forward to when Noodles & Company reported third-quarter 2019 results, two years after Murphy's arrival. The company is now profitable, and has six straight quarters of comparable-sales growth. Additionally, it's preparing to return to unit growth, targeting 5% growth in 2021.
It wouldn't be fair to attribute improving results at Del Taco and Noodles & Company solely to Murphy. But at the very least, he was involved in the process both times, and he saw what it will take to turn a struggling Red Robin around.
The comeback plan
As is often the case with restaurant stocks, Red Robin's plan starts with growing comparable sales. Right now the company is running a test at 20 locations by tweaking the menu and staffing its stores differently, among other things. Early results show these 20 locations are starting to outperform. Given these results, and Murphy's track record with comparable sales, it's reasonable to expect Red Robin to soon return to comparable-sales growth and guest-traffic growth. It's guiding for low single-digit comp-sales growth in 2020.
Growing comparable sales by increasing guest traffic can improve margins, assuming Red Robin keeps costs under control. Improved margins lead to improved profitability, and potentially generates more free cash flow. The company is targeting $35 million in free cash flow for 2020, and $45 million annually from 2021 to 2023. Net income targets aren't given, but it's targeting slightly positive EBITDA growth in 2020, and 10% to 15% annual EBITDA growth through 2023. Its 2023 EBITDA target is $150 million. For perspective, trailing-twelve-month EBITDA is $102.9 million.
With more cash on hand, Red Robin intends to increase shareholder value by paying down debt (currently $189 million) and buying back shares. It's worth noting that the company has $71.1 million left on its current share repurchase authorization. That's a significant amount for a company with a market capitalization of just $445 million.
Better than $40 per share?
Vintage Capital made an unsolicited bid of $40 per share to buy Red Robin. That's around a 16% premium to where shares currently trade, and a 60% premium to where the stock was valued at the time. Since Red Robin rejected that bid, shareholders hope that the company can do better than a 16% return as an independent company.
Growing comparable sales, improving profitability, and increasing shareholder value from share buybacks all give this stock upside. While a stabilized Red Robin could be worth more than $40 per share in the short term, I question where long-term growth will come from for this company. It already has 561 locations, which is large for a casual-dining chain and limits growth opportunities. But even if there were lots of growth potential, the company has suspended opening new locations for the time being anyway.
In the end I believe investors should view this for what it is: a plan to stop the bleeding. And I believe it will. But I would remain on the sidelines until a separate plan is presented that shows a long-term growth opportunity.