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RRGB HAS TOO MANY BALLS IN THE AIR

“One of our strategies moving forward is to shift to a balance between our legacy of being family-friendly and adult-focused guest experiences, referencing our legacy. There is no assurance that this shift will be successful or that it will not negatively affect our family guest experience.”

-          RRGB 2012 10-K, Risk Factors section

 

 

We are adding Red Robin Gourmet Burger to our Best Ideas on the short side.  The stock has gotten ahead of the company’s fundamentals and future growth prospects.

 

Company Overview

  • 468 full-service casual dining restaurants – 335 co-op and 133 franchised
  • 5 limited service Red Robin Burger Works concepts
  • Core concept is “family-focused”
  • Seeking to strike balance between family legacy and “adult-focused experiences”
  • FY13 estimated revenue growth of 4% to over $1 billion
  • Operating margins, ROE, ROA, some of the lowest in casual dining
  • 2.99x Debt/EBITDA
  • 22% debt/Total Assets

 

 

PERFORMANCE VS THE S&P 500

The stock has outperformed by almost 60% over the past year and its strong performance versus peers has continued as earnings growth estimates have stagnated. 

 

RRGB HAS TOO MANY BALLS IN THE AIR - casual dining vs XLY

 

RRGB HAS TOO MANY BALLS IN THE AIR - price vs EEG 

 

 

Current Setup

  • Stock surging on increased expectations for a successful Red Robin “brand transformation”
  • Additional investment will be required to secure brand transformation
  • Capital spending unit growth is being accelerated in 2013
  • Industry is still experiencing a secular declining traffic trends
  • Guidance is for EPS an EPS recovery in 2013 and 2014
  • Traffic negative in 1Q13 and comparisons get difficult for the balance of 2013
  • Restaurant margins have improved 290bps over the last 2 years

 

 

Traffic Problem is Biggest Fundamental Red Flag

The company is in desperate need of a “brand transformation” to stem the decline in traffic

 

RRGB HAS TOO MANY BALLS IN THE AIR - RRGB traffic

 

 

Capital Allocation

 

Capital allocation is one of the most important metrics for casual dining companies. In terms of RRGB’s capital spending, the following bullets and charts offer insight into the effectiveness of the company’s capital allocation decisions.

  • Capex has been growing for three years
  • Expected to increase 17% in 2013
  • ROIIC likely to decelerate in 2013
  • Unit growth accelerating with Red Robin, mid-size, and new Burger Works concepts

 

RRGB HAS TOO MANY BALLS IN THE AIR - rrgb roiic ttm

 

RRGB HAS TOO MANY BALLS IN THE AIR - rrgb ebitda vs capex growth

 

 

Repeating Others’ Mistakes

 

The foot print expansion is leading to declining returns for the company. The question that we, and others, have about the strategy is why so many different initiatives need to be pursued at once. Specifically, the company is growing Red Robin in two different sizes, expanding its Burger Works QSR concept which seems to be producing mixed results, and trying to transform the consumer’s perception of Red Robin as a brand. In our view, this amounts to the company taking on more tasks than it can complete effectively while managing its capital prudently.

 

Brand transformation is difficult to achieve, for several reasons. Below are some of the concerns we have about RRGB’s particular strategy.

  • Moving away from core customers carries risk
  • Bar remodel had limited impact
  • Guiding to strong returns in “full transformed” units (only?)
  • Red Robin brand perception is entrenched, significant messaging required to adjust
  • Bar Works off to a difficult start as real estate and financial performance refinements ongoing

 

3Q12 IS RRGB’S WATERLOO

  • Difficult SRS comparisons
  • Lowest revenue quarter of the year as incremental expense continues to build
  • Expenses in 4Q likely to grow significantly thanks to new costs
    • Brand transformation expenses
    • Incremental pre-opening expenses for new units
    • Beef prices post a risk to margins, particularly in 3Q
    • Industry sales benchmarks continue to be sluggish

 

Valuation and Sentiment

 

Short interest in RRGB has been coming down since 2008 but remains the fourth highest in casual dining at 10.5%. The valuation that consensus is awarding the stock has risen sharply in recent months. The sell-side is fairly cautious on the name with 37.5% of analysts rating the stock a “buy”, 50% “hold”, and 12.5% “sell”.

 

RRGB HAS TOO MANY BALLS IN THE AIR - rrgb valuation over time

 

RRGB HAS TOO MANY BALLS IN THE AIR - rrgb SHORT interest

 

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst


Morning Reads on Our Radar Screen

Takeaway: A quick look at stories Hedgeye's research team are reading this morning.

Morning Reads on Our Radar Screen - radar

 

Keith McCullough – CEO

Kuroda Stares Down Bond Volatility With Stimulus Unchanged (via Bloomberg)

Shenzhou-10: China launches next manned space mission (via BBC)

 

Howard Penney – Restaurants

Krispy Kreme Sloppy Joe Sandwich Debuts At San Diego County Fair (via Huffington Post)

Nestle’s Nespresso to Face New Mondelez Copycat Capsule (via Bloomberg)

 

Daryl Jones – Macro

Is This Who Runs Prism? (via TPM)

Is The Eurozone Crisis Set To Flare Up? (via streettalklive)

Turkish Police Retakes Square Amid Clashes (via Bloomberg)

 

Kevin Kaiser – Energy

Encana Taps Former BP Executive as CEO (via WSJ)

Polar Petroleum, Frozen (via The Aleph Blog)


Josh Steiner – Financials

Bank of America’s Laughlin Says Accord Talks Were Tense (via Bloomberg)

Fannie Mae Shareholders Challenge U.S. Takeover in Suit (via Bloomberg)


LULU: They Blew It

Takeaway: LULU needed to shore up confidence after 1Q product issues. They blew it. There's margin risk. Maybe not a short. But definitely not a long.

This note was originally published June 10, 2013 at 21:02 in Retail

Conclusion: LULU had to do one thing and one thing only this qtr -- instill confidence in the investment community that the recent product issue was a one-off, and it that management is on offense. Unfortunately, LULU blew it. Its quarter was hardly squeaky clean, the outlook is cloudy, and the CEO tendered the most surprising resignations we've seen in retail in a while. This remains a great global growth story in retail -- one of the best, actually. But there's margin risk to the downside. That matters at 33x earnings. It might be a lousy short. But we'd avoid it long.

 

LULU: They Blew It - lulu1

 

DETAILS 

In the wake of the Luon pant fiasco throughout the first quarter, there was one thing and one thing alone that LULU needed to do with this print -- and that's instill confidence with the investment community that the right team is steering this ship, and that the issues that caused the stumble are temporary and not a sign of more systemic issues at the company. Unfortunately, the company dropped that ball with the announcement that Christine Day is resigning her post of CEO after 5 1/2 years on the job.

 

Quite  frankly, we were stunned by the announcement. For investors, this is the corporate equivalent of being bitten by your Golden Retriever. There was no warning. Usually when something happens so suddenly, it is the Board's decision, but this one sounds like it was all Christine. Could it be that the Luon pant debacle took its toll on her? Perhaps. But she already canned LULU's Chief Product Officer in April, and the company is in the process of broadening its executive team.  We'd be surprised if her departure was due to this issue alone.

 

Our sense is that Ms. Day -- who is held in extremely high regard by the investment community -- simply sees that the next leg of growth will be tougher to come by. To her credit, she saw the company through the period in '09 when it was a $3 stock and drove it up to $80. That's $11.2bn in value creation -- or a 27-bagger for those keeping score.

 

While LULU had several wins this quarter, like golf, tennis, men's and e-commerce, in the end, this quarter was hardly squeaky clean. Aside from the Luon issue, the company noted certain misses from a styling perspective, higher expected landed costs in 2H due to factory/production issues, SG&A deleverage through 2H14 as LULU ramps up its East Coast distribution center, and difficulty in finding store locations to facilitate Hong Kong expansion.

 

We still think that LULU is one of the few iron-clad brands in retail that can put up 20%+ organic top-line growth on a consistent basis for the next 3-5 years (the others are RH, FNP, UA and KORS). But unlike these other brands, we think that LULU has risk to the downside in its mid-20s margin as the company spends more to facilitate its growth. If we compare it to UnderArmour (or FNP or RH), for example, we see that UA has only an 11% margin, and even it is stepping up spending on the margin to maintain top line growth. We think that LULU will maintain a significant premium to UA, NKE, RH and FNP. But in doing so we still think that the risk is to the 20% range as margins (and even high teens) look to find a final resting place.

 

This still nets us a respectable 20%-ish EPS growth rate by any stretch (25% top line growth less 500bp due to margin erosion). But with the stock trading at 33x earnings (per the after-hours sell-off) we find it really tough to get excited about on the long side.


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CALL AT 10:00am; What's Next For Europe?

CALL AT 10:00am; What's Next For Europe? - whereseuropeDial 06.11.13

 

We will be hosting a conference call TODAY, June 11th at 10:00am EDT titled "Where Does Europe Go From Here?"

  

 

CALL OBJECTIVE

Highlight the best investment opportunities in Europe and assess the overall economy of the region.  

 

 

KEY TOPICS WILL INCLUDE

  • Contextualizing the fundamental and structural headwinds in the region
  • The key actions of the ECB and its impact across markets
  • European bifurcation will remain, with clear winners and losers
  • Updates from the periphery and other risks investors should be aware of
  • Our investment outlook across asset classes over the intermediate term

 

CALL DETAILS

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 187759#
  • Materials: CLICK HERE

 

If you would like more details about this call please email .

 



UGLY GLOBAL MACRO MORNING

Client Talking Points

ASIA

Overnight the Yen rips +1.6%, while the Weimar Nikkei falls -1.5%. We actually covered our Yen (vs USD) short yesterday on our signal as the risk range for USD/YEN just shifted to 96.05-99.55. It should be manageable now, but the meltdown in the rest of Asian Equities might not be. Check out all the red: Thailand -4.7%, Philippines -4.6%, Indonesia -4% as both the KOSPI and HangSeng remain below both our TRADE and TREND lines.

GREECE

Hello Greece. It's been a while. Welcome back to the matrix. Greek stocks -3.6% this morning after getting smoked yesterday and now move swiftly back into full-blown crash mode (Athex -21% since May 17th). What does it mean? Illiquidity in global equity markets is for sale here, big time (especially in emerging markets).

UST 10YR

Both illiquid securities designed to chase yield and Gold absolutely hate bond yields rising like this. This morning’s most important macro move is the 10yr ripping an overbought signal up at 2.26%. Above 2.41% starts driving the convexity function in my model (which leads to higher-levels of volatility). The next 15bps (up or down) really matters here.

Asset Allocation

CASH 30% US EQUITIES 25%
INTL EQUITIES 20% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 25%

Top Long Ideas

Company Ticker Sector Duration
NSM

Financials sector head Josh Steiner is the Street’s head bull on residential mortgage originator/servicer Nationstar, projecting $9 in earnings for the company in 2014.  This is well above the company’s own guidance range, which tops out at around $7.50.  NSM had a successful start to the year as it won servicing bids on substantial mortgage portfolios.  They also reported significant increases in their profit margins on those portfolios, and double-digit increases in their own originations.  Housing prices are ramping significantly higher, as Steiner predicted, as demand continues to exceed supply in both new and existing homes.  Steiner says this quality mortgage company could ride the crest of a sustained wave of sector improvement.

MPEL

Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016.  

WWW

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.

Three for the Road

TWEET OF THE DAY

Central planners who think they can "smooth" economic gravity will lose control, in the end

@KeithMcCullough

QUOTE OF THE DAY

“Success seems to be connected with action. Successful people keep moving. They make mistakes,but they don’t quit.”

- Conrad Hilton

STAT OF THE DAY

$7 billion: The amount of money Citigroup stands to lose if the dollar gains against the yen, euro and currencies in emerging markets, which provide about half the firm’s profit. (Bloomberg)


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