RRGB has moved 15% higher over the last month relative to the casual dining group’s nearly 11% move. This recent outperformance follows months of underperformance as RRGB has declined 13.1% over the last 3 months relative to the group’s relatively flat performance over the same timeframe. Year-to-date, RRGB has only improved 8.4% relative to the group’s nearly 90% move higher. Just last week, a group filed a 13-D on the company, disclosing its 5.7% position after “Representatives of the Reporting Persons met with the Issuer's Chief Executive and Chief Financial Officers on December 15, 2009 to discuss the performance of the Issuer and business strategy.” This filing along with the stock’s recent outperformance signaled that RRGB was deserving of a closer look.
The glaringly obvious hole in the story is that RRGB’s same-store sales are in free fall with the company’s gap to Knapp getting increasingly wider in terms of underperformance (shown below). Comparable sales declined 14.9% in 3Q09 with traffic down 13.8%. These declines are more similar in magnitude to what we have heard out of the higher end concepts, but with an average check of $11.57 in 3Q09 and with what the company calls its unique brand positioning between casual and fast casual, RRGB is not going after the same discretionary dollars and is therefore, losing share within the casual dining segment.
On a 2-year average basis, comparable sales trends deteriorated further in 3Q09, down 260 bps sequentially from 2Q09. On its 3Q09 earnings call management stated that trends improved sequentially during the first four weeks of 4Q09 as they were down 11.6%. Management attributed the better number to its being on air with TV advertising in 10 markets (covering about one third of RRGB’s company restaurant base) for two of the four weeks. On a 1-year basis, -11.6% is obviously better than the reported 14.9% decline in 3Q09 but considering the -8% number in the first four weeks of 4Q08, this points to another 125 bp sequential decline in 2-year average trends from 3Q09. The company is lapping a more difficult comparison for the remainder of the quarter. Even with the overall casual dining industry as measured by Malcolm Knapp seeing better numbers in November, I am not expecting RRGB’s numbers to improve on a 2-year average basis in 4Q09 as the company will no longer be on television supporting its fall LTOs after those initial two weeks of the quarter (reflected in the -11.6%).
I have criticized RRGB in the past for its reliance on TV advertising to drive traffic as I don’t think the cost of a national campaign makes sense for its 400-plus unit concept. In the past, the company has only done brand specific advertising and would not quantify the returns of the spending. Brand-only advertising does not typically work to drive traffic so I was encouraged to see that with the company’s most recent TV advertising that the ads were focused around a specific price point, in this case a $5.99 Chicken Caprese Sandwich and $5.99 Wise Guy Burger. Additionally, management quantified the impact of the advertising saying that during the three weeks of TV media that same-store sales improved by more than 900 bps sequentially from the four weeks prior in the 10 TV markets (again covering about one third of RRGB’s company restaurant base) when comparable sales were running -12.4%. This is a substantial improvement and highlights that advertising around a price point is more effective than brand advertising only.
Since the TV support only impacted one-third of the restaurant base for two weeks, it was not enough to drive materially better comparable sales through the first four weeks of the quarter (as I said already, trends continued to get worse on a 2-year average basis). The LTO promotion ran through November 8 but was only supported with TV media for 2 weeks of the fourth quarter. If one third of the restaurant base was running close to -3.4% for half of the first month of the quarter and we assume that level of same-store sales growth for the entire month that would mean that the remainder of the restaurants were down nearly 16%. I would assume that same-store store sales growth fell off rather significantly after the 2 weeks of media support and that the remainder of the store base came in slightly better than -16%, but this significant outperformance in the markets with TV support demonstrates why advertising can become so addictive to companies.
That being said, RRGB announced earlier this month that based on the results of its fall LTO promotion that it would spend $6.7 million to expand its television media to advertise its new spring 2010 LTO menu promotion beginning in mid-February using national cable television, together with local television in select markets. If the advertising does prove successful, the next question will be what the cost is to maintain trends. Although the company said that no decision has been made about whether it will use TV advertising to support the remainder of its 2010 LTOs, I think it is a pretty safe bet that the advertising budget is going higher in 2010.
RRGB is facing its easiest restaurant level and EBIT margin comparisons in 4Q09 on a YOY change basis. EBIT margins declined more than 300 bps in 4Q08 with restaurant level margins down in excess of 400 bps. These easy comparisons, however, will not translate into YOY margin growth in 4Q09 and to that end, have not mattered for quite some time (EBIT margins have only increased on a YOY basis during two quarters since 2Q05). Restaurant level margins should come down about 200 bps YOY in 4Q09 and EBIT margins will be down close to another 300 bps.
Sustained declines in margins combined with declining returns on incrementally invested capital lead me to believe that despite the fact that RRGB cut its new company unit growth in half in 2009 relative to 2008, it is still growing too fast. Returns look like they might be less negative in 2010 and a bottoming of returns often leads me to become incrementally more positive on a name, but I think we might still be a little early from a timing standpoint.
When RRGB reports 4Q09, we will likely learn that the company continues to underperform the industry with 2-year average comparable sales trends coming under increased pressure. We may hear about trends in early 2010, but if the company continues to only provide numbers around the first four weeks of the quarter, the results will not include the company’s planned spring LTO supported by national cable advertising, which is not scheduled to begin until mid-February. So I would not expect to learn about any material impact from the advertising until the company reports 1Q10 numbers. EBIT margins will continue to get worse during the fourth quarter and will likely come in below 3% (a number I do not want to be out ahead of).