Is Red Robin Stock Ready to Sing?

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Yesterday, Red Robin Gourmet Burgers (NAS: RRGB) reported earnings that again blew away Street estimates. But is there a warning lurking behind the headlines?

The burgermeister saw sales tick 7.1% higher to $215.8 million. Cost efficiencies helped to power earnings even faster, up 60% from last year's quarter. You can see the cost savings at the restaurant level, where operating margins soared from 18.3% to 20.8%. Also encouraging was the 56% surge in operating cash flow. Even same-store sales at its company-owned stores went up a solid 3.1%. Those all encourage me that Red Robin was a great selection for my Special Situations portfolio.

The quarter even had the Red Robin CEO Stephen Carley crowing about the company's performance, representing its "fourth consecutive quarter of higher same store sales and third consecutive quarter of higher earnings."

But let's take a closer look at those same-store sales again. The company broke them down: The 3.1% figure was composed of a 4.5% increase in the average check offset by a 1.4% decline in traffic. While customers opted to spend more in the quarter, the decline in traffic is a troubling sign, and I identified it as a key metric to watch in my initial thesis. On the conference call, Carley said he expects traffic to be challenged for the rest of the year.

Other restaurants have had varied performances in the latest quarter, with comps at McDonald's (NYS: MCD) and Wendy's (NYS: WEN) moving higher, while those at Yum! Brands (NYS: YUM) just dragged. Even fast casual peer Panera Bread (NAS: PNRA) saw comps gain solid, at 3.9%, and Chipotle (NYS: CMG) was up a solid 10%. While these chains have had to deal with high prices, like everyone in the sector, their comps have generally been stronger than Red Robin's.

Still, the most encouraging part of this report was evidence that the company has its costs in line, suggesting that even with stagnant sales it will be able to consistently turn a profit. You can see some of that in restaurant-level operating margin, which moved up sequentially from the first quarter, 19.8% to this quarter's 20.8%. The company is still focused on $16 million to $18 million in cost savings by the end of 2012.

The company has upped its plan for store openings in 2012 and is also considering franchising opportunities again. Both initiatives could be big drivers of sales growth in the future, and combined with the company's focus on costs, they could help return Red Robin to the growth stock that it was in the middle of the last decade. With operating cash flow running at an annualized clip of $108 million and expected capex of $44 million, this stock trades at about 8 times free cash flow. And that still looks quite cheap.

Interested in Red Robin or have another stock to share? Join me on my discussion board and follow me on Twitter (@TMFRoyal).

This article is part of ourRising Star Portfoliosseries, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of ourRising Star analysts(and their portfolios)here.

At the time this article was published Jim Royal, Ph.D., owns shares of McDonald's and Red Robin. The Motley Fool owns shares of Red Robin, Panera, Chipotle, and Yum! Brands.Motley Fool newsletter serviceshave recommended buying shares of Yum! Brands, Chipotle, Panera, and McDonald's, as well as creating a iron condor position in Chipotle. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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