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Red Robin Maintained at Neutral

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We are maintaining our long-term Neutral recommendation on Red Robin Gourmet Burgers, Inc. (RRGB), a casual dining restaurant chain operating more than 450 restaurants.

The Seattle, Washington- based company reported earnings of 71 cents per share in the first quarter of 2012, breezing past the Zacks Consensus Estimate of 66 cents as well as last year's 58 cents per share. Results in the quarter benefited from cost improvement resulting due to margin expansion.

Total revenue jumped 4.4% year over year to $299.5 million, benefiting from a 4.7% leap in restaurant sales, partially offset by a 8.8% decline in franchise royalties and fees revenue.

Comparable restaurant sales inched up 0.5% year over year at company-owned restaurants in the reported quarter, due to a dip of 3.6% in guest count. Restaurant operating margin at company-owned restaurants expanded 140 bps to 21.2%.

The company’s Project RED, which focuses on revenue growth, expense control and capital deployment, continues to drive the performance of the company. To drive revenue, the company implemented a guest loyalty program called Red Royalty with a goal to increase customer frequency. Moreover, it took initiatives to rebuild the bar business by recapturing adult guests and improving beverage sales through the enhancement of audio-visual packages and revamping the decor.

It also encouraged the sale of gift cards and deployed a Limited Time Offer (:LTO) strategy supported with television advertising as well as a social media campaign to drive traffic and create brand recognition. The company’s loyalty program has achieved early success and has been implemented at 49 franchised restaurants along with all the company-owned restaurants. In 2012, the company plans to expand the program across the franchise system. Moreover, with the Olympics in the summer and the national election in the fall, 2012 will be a significant year for building the brand for future growth through media.

To control expenses and expand margins, the company is taking a host of initiatives, and targets a cost cut of $16–18 million by the end of 2012. In 2011, the company achieved savings of $12 million from its goal of $16 million to $18 million by end of 2012, much ahead of its target. The company expects to surpass its cost saving target in 2012 and enhance restaurant level operating margins by 20–30 bps.

We are also encouraged by Red Robin’s plan to use its capital for the development of new restaurants, enhancement of shareholder value as well as for future refinancing activities. In 2012, the company expects to open 13 to 15 restaurants, which would include four additional smaller prototype units, seven to eight full-sized restaurants and two to three midsized prototypes. We believe that small size restaurants will accelerate the company’s growth into non-traditional locations and also improve return on invested capital.

However, we remain cautious on the stock based on the continuous deterioration in guest count. The guest count has been negative for four straight quarters. In the first quarter of 2012, the company reported a dip of 3.6% due to poor performance of Red Robin’s promotional activities and hefty discounting environment, particularly during lunch. Thus, a turnaround in traffic remains challenging. Going forward, sales comparisons will also become tough. Moreover, for 2012, Red Robin trimmed down its guidance for comps growth to up to 1% from the earlier projection of low-single-digit growth.

Furthermore, like all restaurant companies, Red Robin is susceptible to higher food costs. The company expects commodity inflation to continue in 2012. Red Robin expects cost of sales to increase in 2012, as ground beef and other commodity prices continue to rise, partially offset by lower average dairy and produce prices, along with the benefits from supply-chain initiatives. A spike in labor expense and tax rate is also estimated.

Additionally, there are also concerns stemming from the uncertain economic environment, resulting in lower consumer spending and cut-throat competition from peers like Brinker International Inc. (EAT) and Chipotle Mexican Grill Inc (CMG) particularly related to price.

The Zacks Consensus Estimates have not budged in the 7 days, implying no clear directional pressure on the stock.

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