Do These Results Have You Seeing Red?

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There is no question the restaurant industry is a tough business. However, these type of stocks were some of the favorites of famous investor Peter Lynch. He said he liked restaurants because they were easy to understand and easy to follow. They essentially just need to have a good menu, generate success in one area, and then duplicate this success as they expand. As long as the company shows positive same-store sales and doesn't take on too much debt, usually positive results will follow. What is crazy is how simple this formula is, yet how many companies have failed to follow this plan. Red Robin Gourmet Burgers (NASDAQ: RRGB) is one such company.

Red Robin caught my attention when they opened a location in our nearby mall. The place was popular, the food was good, and when I found out they were a public company, I was naturally excited. However, at that time I saw what looked like too much debt, and the stock seemed overvalued. I've kept up with Red Robin since then, and a few months ago the company looked primed for growth. Red Robin at that point reported EPS growth of over 8%, comparable sales were up, and analysts were expecting EPS growth of 17.5%. Unfortunately for investors, things have changed, and not for the better, in the last three months.

One of the most confusing statements during this earnings season was by CEO Steve Carley. He said the company's, “strong results in the third quarter...allowed us to outperform the casual dining category.” I'm honestly not sure what category he believes Red Robin operates in. While Red Robin reported revenue growth of 3.4%, EPS was basically flat. Looking at some of their competition, these results just don't stand up well.

Brinker International (NYSE: EAT), which operates the Chili's chain, reported revenue growth of 2.5%, but their EPS growth was over 20%. Buffalo Wild Wings (NASDAQ: BWLD) showed much better revenue growth of 24.8%, but EPS was cut by chicken prices. Red Robin can't claim that one input cost caused their flat EPS performance. If you compare Red Robin to BJ's Restaurants (NASDAQ: BJRI), which is a much smaller chain, both its revenue growth of 16% and EPS growth of 9% outperformed Red Robin. Though some of these companies reported numbers that disappointed their investors, they were clearly better than Red Robin. When you look at comparable store sales, we find more of the same underperformance by the company.

In the last three months, Red Robin reported that same-store sales at company-owned restaurants were up 1.1% on an 0.8% increase in guest counts and an 0.3% increase in average guest check. At the company's franchised restaurants, comparable sales were actually down 0.6% domestically and up 3.9% internationally. Looking at the competition, these results hardly represent “outperformance.” Brinker showed an increase of 2.8% in comparable store sales, Buffalo Wild Wings reported a 6.2% increase, and BJ's reported an increase of 2.3%. When three of Red Robin's competitors report significantly higher same-store sales, the company has some work to do. While it's clear from sales and comparable sales Red Robin isn't doing as well as their competition, when it comes to their financials the picture is a bit better.

There were a few positives in Red Robin's financial statements for investors to hang on to. First, the company is committed to repurchasing shares, and in the current quarter they retired 266,000 for about $7.9 million. In addition, this share buyback plan has retired 4.83% of the company's diluted share count over the last year. On top of these actions, the company has paid down its long-term debt by over 20% on a year-over-year basis.

If there is one thing that should be a concern for investors it's that over the last nine months, operating cash flow was down slightly. What is an even bigger concern is the underperformance in sales and earnings growth has now made its way to lower growth expectations from the analysts.

Stock analysts have consistently been calling for 17% or better EPS growth over the last few years. However, the disappointing results over the last few quarters have forced analysts to lower this number. While three months ago the stock looked like a value at 16 times earnings, but growing by 17%, now the stock's expected growth rate has dropped to 13.77%. What is interesting is investors seem to not have noticed this lower expected growth rate, as the stock still sells for over 16 times projections.

Unfortunately for Red Robin investors, there just seem to be better options. For instance, Brinker is expected to grow at almost the same rate over the next few years, but pays a dividend of 2.6% as well. In addition, Brinker sells for a forward P/E ratio of less than 12, which is 27% cheaper than Red Robin. Buffalo Wild Wings is valued more highly, but for good reason. The company is expected to grow by 20%+ over the next few years, and comparable store sales have been consistently increasing by at least 6% in the last year or so. Even BJ's, with disappointing earnings recently, looks like a better value. BJ's stock has dropped tremendously since their report, but at 23 times earnings and expected to grow by 20%, the company is priced more attractively than Red Robin.

These results should have investors seeing red, and I don't mean the Robin. Smart investors may want to consider taking profits before this bird falls completely from the tree.

MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of BJ's Restaurants and Buffalo Wild Wings. Motley Fool newsletter services recommend BJ's Restaurants, Buffalo Wild Wings, and Red Robin Gourmet Burgers. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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