Is There An Opportunity With Red Robin Gourmet Burgers, Inc.'s (NASDAQ:RRGB) 22% Undervaluation?

March 27, 2024

Key Insights

Red Robin Gourmet Burgers' estimated fair value is US$9.03 based on 2 Stage Free Cash Flow to Equity
Red Robin Gourmet Burgers' US$7.06 share price signals that it might be 22% undervalued
Analyst price target for RRGB is US$13.25, which is 47% above our fair value estimate

Today we will run through one way of estimating the intrinsic value of Red Robin Gourmet Burgers, Inc. (NASDAQ:RRGB) by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. It may sound complicated, but actually it is quite simple!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

Check out our latest analysis for Red Robin Gourmet Burgers

Step By Step Through The Calculation

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$15.0m	US$14.4m	US$14.2m	US$14.1m	US$14.1m	US$14.2m	US$14.4m	US$14.6m	US$14.9m	US$15.2m
Growth Rate Estimate Source	Analyst x1	Est @ -3.76%	Est @ -1.94%	Est @ -0.67%	Est @ 0.21%	Est @ 0.84%	Est @ 1.27%	Est @ 1.58%	Est @ 1.79%	Est @ 1.94%
Present Value ($, Millions) Discounted @ 11%	US$13.5	US$11.6	US$10.2	US$9.1	US$8.2	US$7.4	US$6.7	US$6.1	US$5.6	US$5.1

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$84m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.3%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 11%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$15m× (1 + 2.3%) ÷ (11%– 2.3%) = US$169m

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$169m÷ ( 1 + 11%)¹⁰= US$57m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$140m. In the final step we divide the equity value by the number of shares outstanding. Relative to the current share price of US$7.1, the company appears a touch undervalued at a 22% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf — NasdaqGS:RRGB Discounted Cash Flow March 27th 2024

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Red Robin Gourmet Burgers as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 11%, which is based on a levered beta of 2.000. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Red Robin Gourmet Burgers

Strength

Debt is well covered by earnings.

Balance sheet summary for RRGB.

Weakness

No major weaknesses identified for RRGB.

Opportunity

Forecast to reduce losses next year.

Good value based on P/S ratio and estimated fair value.

Threat

Debt is not well covered by operating cash flow.

Has less than 3 years of cash runway based on current free cash flow.

Total liabilities exceed total assets, which raises the risk of financial distress.

Not expected to become profitable over the next 3 years.

Is RRGB well equipped to handle threats?

Moving On:

Whilst important, the DCF calculation shouldn't be the only metric you look at when researching a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact the company's valuation. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. Why is the intrinsic value higher than the current share price? For Red Robin Gourmet Burgers, there are three relevant aspects you should further examine:

Risks: Take risks, for example - Red Robin Gourmet Burgers has 3 warning signs we think you should be aware of.
Future Earnings: How does RRGB's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.