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Which Is The Better Restaurant Stock?

It’s been a volatile year for the restaurant industry group (EATZ), which found itself down over 29% for the year before its recent recovery. This rebound can be attributed to hopes that inflation has peaked combined with short covering, with the small-cap and mid-cap restaurant names having elevated short interest relative to other industry groups.

Following this rally, some investors might be looking for names that haven’t participated in the recovery. However, underperformance is often related to underlying problems with a business, so it’s essential to look at industry trends, sales performance, and other key metrics to ensure one isn’t buying into a value trap.

In this update, we’ll look at two restaurant brands with above-average short interest and see which is the better stock to own – Restaurant Brands International (QSR) or Red Robin Gourmet (RRGB).

Scale, Business Model & Unit Growth

From a scale standpoint, Restaurant Brands International (“RBI”) and Red Robin differ materially. RBI has more than 29,000 restaurants under four different brands (Burger King, Tim Hortons, Firehouse Subs, Popeyes Chicken), and Red Robin has 525 restaurants under one brand: Red Robin Gourmet Burgers.

Typically, the smaller-scale company would be the more attractive one assuming it was a high-growth concept and a similar business model. However, Red Robin is inferior in both categories.

Not only has Red Robin seen its store count decline by 10% over the past three years while RBI’s store count has increased 15%, but Red Robin operates a casual dining concept, and its brand is nowhere near as iconic as RBI’s top-rated brands in the coffee, burger, and chicken category, which are Tim Hortons, Burger King, and Popeyes, respectively.

Meanwhile, only 20% of Red Robin’s system is franchised vs. 100% for RBI, meaning that Red Robin is much more sensitive to inflationary pressures, seeing a sharp decline in earnings when it’s seeing food and labor costs rise.

So, while Red Robin does win from a scale standpoint, benefiting from considerably more whitespace, this doesn’t help if it isn’t growing. In addition, RBI benefits from much higher margins (43% gross margins vs. 16%) and a 5% unit growth rate vs. a declining store count for Red Robin, with no reversal of this trend in sight.

Restaurant Brands – 1 / Red Robin – 0

Positioning In A Recessionary Environment

From a positioning standpoint in a recessionary environment, there are also major differences that must be considered.

While RBI benefits from three quick-service restaurants with average tickets below $7.00 (Popeyes, Burger King, Tim Hortons), and one fast-casual concept (Firehouse Subs), Red Robin has casual dining restaurants.

The latter segment of the restaurant industry tends to massively underperform in recessionary environments, given that consumers are looking to trade down. However, if they are looking for a meal, takeout is the much cheaper option, saving money on alcohol (home vs. restaurant) and the tip. This is not ideal for casual dining names which rely on drinks/appetizers/desserts to boost margins.

Meanwhile, RBI is a go-to name in a recessionary period, with many consumers looking to trade down if they want convenience. Given the similarly priced menu to brands like McDonald’s (MCD), it’s no surprise that while casual dining traffic was down over 6% in June, quick-service restaurants like RBI’s brands were flat year-over-year.

This is related to the sharp rise in energy costs, fuel costs, mortgage rates, and grocery prices, all contributing to shrinking discretionary budgets. So, if we do head into a prolonged recession, RBI’s margins and the fact that quick-service/pizza will allow it to outperform in weaker economic environments give it the edge by a wide margin.

Firehouse Subs is a fast-casual and higher-ticket brand ($10.00+ price per check), but this makes up just ~1,200 of RBI’s ~30,000 restaurants, so I do not see this as an issue. Red Robin benefits from Donatos Pizza being rolled out across its system, but the sales contribution is too small (less than 5% of sales) to make a meaningful difference.

Restaurant Brands – 2 / Red Robin – 0

Valuation

Finally, if we look at both names from a valuation standpoint, RRGB trades at ~8x EV/EBITDA while RBI trades at 13x EV/EBITDA, suggesting that RRGB is much more attractive from a valuation standpoint.

However, one wouldn’t expect to buy a Ferrari for the price of a Ford, and this is a case of RRGB being cheap for a reason. Not only does the company return no capital to shareholders (QSR pays a 4.0% dividend and buys back 2% of stock per year), but it has weaker margins, a declining store footprint, and is in a less attractive segment of the restaurant industry (casual dining vs. quick-service).

So, while the stock is far cheaper strictly on an EV/EBITDA basis, RBI is much cheaper on a PEG basis, trading at a PEG ratio of ~1.6, while RRGB trades at a PEG ratio of ~2.2.

Meanwhile, RBI investors are getting a guaranteed return of 4% per year from dividends alone to help weather general market volatility, boost total returns, and see continued earnings per share growth through opportunistic buybacks.

Restaurant Brands – 3 / Red Robin – 0

Final Verdict

To summarize, I see RBI winning in the valuation category as well, with RRGB being a case of a low-quality name trading at a fair price. Conversely, RBI is a high-quality name trading at an attractive price for investors with a long-term outlook. T

herefore, I see RRGB as an Avoid losing 0-3 to RBI, and I would view any pullbacks in Restaurant Brands International (QSR) below $57.00 as buying opportunities.

Disclosure: I am long QSR

Taylor Dart
INO.com Contributor

Disclaimer: This article is the opinion of the contributor themselves. Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information in this writing.

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