Is Ruby Tuesday a Dead Duck?
Ruby Tuesday’s (RI) potential continues to go unrecognized by Wall Street.Ruby Tuesday is a restaurant concept in the bar and grill segment of casual dining. Ruby Tuesday recently rolled out its first ever advertising campaign to target the 68% of the population that's never heard of the chain, which operates 700 stores in 40 states. A revived menu seems to be working and the advertising is bringing in customers. We have seen same store sales jump and sell-side analysts are raising their ratings and numbers (like Bear Stearns did on 1/25). In addition to being a profitable cash generating business, Ruby owns about half of the real estate it operates on.
Although Ruby could face heated competition from Applebee’s (APPB) and Chili’s (EAT), we conclude a basket of themes will propel the stock above the $30 level.
One, consumer trends favor Ruby Tuesday’s strengths. Ruby Tuesday is the only chain with a full service salad bar. They also are the first chain to provide nutritional information for almost every menu item, which resonates with the current healthy foods/organic boom.
Market trends point to sizable growth for Ruby Tuesday — there is a long term trend in the US restaurant industry for consolidation. According to Technomic, the industry’s top 100 companies controlled 52% of total chain restaurant sales, while the next 100 controlled only 5% of total chain restaurant sales. In a word, a buyout or merger isn’t as remote a possibility as you may think.
Lastly, Ruby Tuesday’s valuation story is far from ugly. Shares trade hands at 16 X next year's earnings, a discount to what its biggest rival and peer group trade at (18x F2007 results). A premium multiple may be warranted, considering that Ruby spits out a healthy return-on-equity(18%) and still carries considerable brand awareness within the casual dining segment. Ruby has also been using its free cash flow to buy back stock.
Ruby trades at 9x EBITDA while enjoying 12% operating margins. Darden Restaurants (DRI), which has 9% operating margins, trades at a higher EV/cash flow multiple. We view this as an anomaly investors have inadvertently created, thus driving shares of Ruby down to a level where the valuation looks attractive. If one wants to play this restaurant's turnaround attempt, we believe now is the time to get in (shares are approaching a 52 week high).
Risks to our thesis include changing and unpredictable consumer trends, an economic downturn (resulting in lumpy earnings), short selling pressure (21% of float is short), and balance sheet considerations: Ruby has only $8M in cash, but over $350M in debt. Frankly, we'd like to see Ruby Tuesday clean off some debt.
We are maintaining our hold rating on the stock, as well as our expectation that the stock will trade up to 18 or 19x earnings within the next 60-90 days.
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