Red Robin (RRGB) Plummets as Higher Costs Dampen Q2 Earnings

Colorado-based casual dining restaurant operator Red Robin Gourmet Burgers Inc.'s RRGB shares dropped 18.5% in the trading session on Thursday after the company reported dismal results, wherein both earnings and revenues missed the Zacks Consensus Estimate.

The company's adjusted earnings of 68 cents per share missed the Zacks Consensus Estimate of 90 cents by 24.4% and declined 11.7% year over year. Adjusted earnings excluded an after-tax adjustment for executive transition costs of 3 cents per share. Earnings in the quarter were affected by lower-than-expected revenues and lower margins.

Although revenues grew 7.5% year over year to $256.1 million, it missed the Zacks Consensus Estimate of $264 million by 3%, which was due in part to sluggish comps.  

Behind the Headline Numbers

During the quarter, restaurant revenues went up 7.4% year over year to $251.8 million, led by positive comps growth. Franchise royalties and fee revenues increased 13.2% to about $4.3 million.

Company-owned restaurants' comps grew 1.2%, lower than prior-quarter comps growth of 5.4%, due to 2.5% decline in average guest count partly offset by a 3.7% rise in average guest check.
 
Restaurant-level operating profit margin declined 110 basis points (bps) to 22.2%, primarily due to increase in food and beverage expenses, other operating costs and occupancy as a percentage of sales.

Cost of sales was 25.3%, a 60 bps increase from the year ago quarter, mainly due to an 11% year over year hike in ground beef costs.

General and administrative costs were $20.4 million, down 6.5% year over year, mainly due to a decrease in incentive compensation. In the reported quarter, general and administrative costs included executive transition costs of $0.5 million related to the departure of the company's former chief operating officer.

Pre-opening and acquisition costs in second-quarter fiscal 2014 were $2.3 million, up 76.9% year over year. Acquisition costs totalled $0.7 million in the quarter related to the purchase of 32 Red Robin franchised restaurants.

Store Update

At end of the second quarter of 2014, Red Robin operated 502 restaurants, of which 365 were company owned, 7 were Red Robin Burger Works – the company's simpler prototype restaurant – and 130 were franchised. In the reported quarter, the company opened three Red Robin units and two Red Robin Burger Works restaurants. Moreover, one franchised Red Robin restaurant was opened during the quarter.

On Jul 14, 2014, Red Robin completed the acquisition of 32 franchised restaurants in the U.S. and Canada for approximately $40 million.

2014 Outlook

For 2014, Red Robin expects that comps would be up in the low single digit range. Restaurant-level operating profit margins in fiscal 2014 are expected to be approximately 21.3%

Red Robin expects a 1% change in guest counts for fiscal 2014 to impact earnings by 30 cents on an annual basis. Additionally, a 10-bps change in restaurant-level operating margin is expected to impact earnings per share by approximately 7 cents, and a change of approximately $0.2 million in pre-tax income or expense is equivalent to approximately a penny per share.

Capital investments in fiscal 2014 are expected to be more than $100 million, excluding approximately $51 million related to acquisitions. The company also plans to remodel at least 65 Red Robin restaurants as part of its brand transformation initiative.

General and administrative costs are expected to be approximately $94 million, while selling expenses are expected to be approximately 3.2% of sales in view of increased gift card sales. Pre-opening and acquisition costs are expected to total nearly $9.0 million in fiscal 2014 of which $2.5 million is related to acquisition and integration costs.

The casual dining restaurant operator remains on track to unveil 20 units along with 4 to 5 Red Robin's Burger Works in 2014, resulting in operating week growth of approximately 6.5% for fiscal 2014. The newly acquired restaurants are expected to add $44 million in revenues in the second half of 2014 and will reduce franchise royalties by approximately $1.5 million.

Our Take

Red Robin missed the Zacks Consensus Estimate for both top-line and bottom-line figures, due to higher costs. With the food inflation in the U.S. showing no sign of slowing down, Red Robin's earnings should continue to be under pressure. Moreover, the company's aggressive expansion strategies add to the already escalating costs. The sluggish economic recovery in the U.S., which is lowering consumers' discretionary spending, further adds to the woes.

Red Robin currently has a Zacks Rank #5 (Strong Sell). Better-ranked stocks in the restaurant industry include BJ's Restaurants, Inc. BJRI, Chipotle Mexican Grill, Inc. CMG and Jamba, Inc. JMBA. All these stocks sport a Zacks Rank #1 (Strong Buy).