Casual Dining Sector Offers Up Compelling Plays Like Ruby Tuesday

I am only 22 and my experience in the market dates back barely a decade, but that is why I am lucky to be influenced by the foresight of investors like Benjamin Graham, who remind me about the popularity factor in stocks. He was around long enough to be influenced by the great depression and throughout his life he followed companies that were around for as long as he was; some doing just as good as him. But even though those companies have been around for so long, the best money and sometimes only money, was made when transactions of ownership were made at the right time.

That is why I am so happy to be getting involved in the market at this particular time. Owning stock in general is just not very popular right now and might continue to be unpopular for a while. For the portion of my life that I did not manage any of my own money a down market killed my mood. But this down market is now what I am looking for. Unemployment is barely over the natural rate, both of which are much lower than pre great depression era, and unlike a lot of other people I have a long time till I am going to retire and a depression is not something I fear or something that will ruin my life. I have barely begun to buy widely and this market is just beginning to open up the opportunities that I want.

That brings me to a point that Jim Cramer brought up last night on his show Mad Money. If you want to build up stake in a company, do it in segments and take advantage of a market that is threatened by losing the investment vehicle popularity contest… ie: maybe the one we are in now? That is the beauty of the stock market now. You can trade ownership in a company for less than $5 plus whatever share of its market value you want. If you think shares of a company are being traded at a discount and they go even lower, don't panic, you now have an un-penalized opportunity to increase your stake at a lower cost.

Graham and Cramer probably managed portfolios with no relation to each other and what is important in combining advice from 2 great investment managers who operated on opposite sides of the century with opposing styles is to make your own inference on where we are now, how to apply it and to most importantly realize that everyone who gives advice has their own interest. Graham sought the cream of the crop of value stocks; that is where the information was widely dispersed. But that was so many decades ago, when transparency translated into value. The market is no longer opaque, between the internet and the multi screen view, I can acquire information in 10 seconds and absorb it with the same effort it would have taken just to acquire it 50 years ago. I believe that many of the extreme value pickers of the past would be much keener to the idea of accepting more risk into their portfolio because of this new found transparency. The "utilities" of the past would be comparable to a much wider range of equities today.

One industry that I am beginning to pay close attention to is Casual Dining because ownership in that field is losing popularity fast. Advertising to my age range is very expensive. We will buy into almost anything commercial. The goal for the commercial companies to is to maximize the money they can get out of us and the casual dining restaurants are at the fore front of that mission, doing a really good job. Casual Dining is like fast food for the 21st century'ers. Large scale commercial casual dining has done a great job of beginning to cement itself globally and I am looking for it to continue to do so.

There are 7 publicly traded casual dining restaurants that if you were to do a regression analysis of their month to month market value returns you would find that the expected variance is pretty low for the last 5 years. Those companies being California Pizza Kitchen (CPKI), BJ's Restaurants (BJRI), Cheesecake Factory (CAKE), PF Changs (PFCB), Brinker (EAT), Darden (DRI), and Ruby Tuesday (RT). In short, the returns all generally follow a humped curve going up and then coming down over the 5 years. There are some charts provided by Yahoo! on the side of this post to check it out. For the sake of time that I can save because I have already begun purchasing very small stakes of Ruby Tuesday I will talk about their financials, expectations, investor expectations and prospects. And explain the logic if there is any, behind why I want to begin to claim stake in these companies. If I am overly incorrect on anything I would appreciate any commentary that any reader is willing to offer.

To start I am looking at the efficiency that is just beginning to be felt in the industry. The fact is the best of them are privately owned. The best are actually only the best in my opinion let me add, and I really have no idea of their profitability, but I am judging that they are doing well by what I am seeing and I am sure that not many people disagree with me. Hillstone Group which owns Houston's seems to have a great recipe for success with huge lines everywhere, and Dunkin Donuts, which was taken over by a private equity group a few years ago, is threatening every business that sells breakfast items from Starbucks (SBUX) to IHOP. It appears the people who are best at blowing up these large scale commercial casual dining restaurants are getting compensated a lot better by assuming the risk themselves instead of getting paid by a public market that doesn't want to dish out the cash. That being said, specialized professional talent is always expanding and getting better and these private stakes present two positive options… 1) Someone else realizes they can get a better return running one of these companies and makes a takeover or 2) the management talent forces the profitability to match the growth.

I said I would talk about Ruby Tuesday because to me the recent history of investor valuation and revenue performance are largely consistent with the business of commercial casual dining and there recent announcement s exemplify the profit maximization that I am looking for. In the beginning of the decade revenue was in the low hundred millions for RT. Revenue growth was huge and investors weren't afraid to pay for the expectation of huge earnings growth. When revenue was above half a billion dollars the p:e multiple was above 50 at times. But, revenue passed a billion dollars and the earnings were not following. Likewise investors got scared and there has been a wide spread sell off. The math doesn't add up so simply and insiders have been taking advantage of the discounts all the way down to below $6. When revenue peaked out at about $1.4 billion annually the earnings actually began to decrease. To add even more fear to the mix, while most of their competition did not seem to report revenue that reflected a mass recession, Ruby Tuesday had a double digit drop quarter over quarter.

But, 2 big things happened to Ruby Tuesday over the same period of time, 1) they redid their restaurants and gave them a much more sleek appeal and 2) even though they had decreasing revenue they managed to increase their profits. The fact that they were able to increase their earnings against decreasing revenue is an initial sign of a possible turnaround in profitability and a sleeker style should only be good for the margins on meals. Ultimately, investor's like to pay for earnings and if RT can keep it up, the management that just jumped on the discounted share price and hopefully I will be able to ride this one out for a nice long term capital gain even if it does continue to trade at a low multiple of around 10 times earnings.

Disclosure: I own Ruby Tuesday

Comments

[Bernard2222]

Well done Daniel, I agree with your thesis. What's interesting to see also is that although it hasn't always been reflected in earnings, RT accumulates a lot of cash from operations every year.

Now that they've finished renovating their restaurants and that their strategy will be to stop growth expenditures (no new restaurants) for the next 3 years, there will be a lot of free cash flow coming in. The CapEx per year is projected to go down from $150M to $20M! This will leave them with a lot of cash to repay their debt, which is probably the market's main concern at this point.

[BuyingRT]

I've been following this as well. I recently graduated form college, and I am just beggining my own investment portfolios.

I have actually bought 100+ shares multiple times in the past few months in the $6-$7 range. Each time I sold them off again at a higher price. Most recently at 8.11, just prior to the Q3 earnings report. In 3 months I have managed to make $150 on an initial $650 investment, and I still hold 110 shares (10 more then I started with).

I just wish I had more capital to play with. Long term I plan to keep my shares, but realistically I don't see the stock making a large turn-around for at least another year.

[Eric Fox]

Good post except for one thing:

"Graham and Cramer probably managed portfolios with no relation to each other and what is important in combining advice from 2 great investment managers..."

Don't ever mention Cramer in the same sentence as Ben Graham. Cramer reminds of a quote I heard in a movie a long time ago

"Learn nothing from that man except how not to behave."

[Eric Fox]

To Bernard222...during the last conference call RT announced the following capital plan:

19 Company-owned Ruby Tuesday openings for the year.
15 to 20 franchise openings for the year.
$60-$65 million in capital expenditures for the year for new restaurants and routine capitalized improvements at existing restaurants.
$50-$55 million in capital expenditures for the above-mentioned remodeling of Company restaurants during the fiscal year.

Where did you get your no new store openings and $20 million number from on CAPEX?

[Bernard2222]

To Eric.. $20M CapEx is for the 2009 FY starting in June

[Bernard2222]

CEO talked about it in the last two calls and the Bear Stearns conference

[Daniel Nathel]

I disagree with you in terms of Jim Cramer. If you actually watch Cramer he constantly tells you how important it is to do your own research because his briefing is not enough, but if all you're seeing is his highlights... don't ever expect to here that. Not that I am accusing you of that because I don't know about your style.

Cramer brings out great stats and fundamentals in the few seconds he talks about a company, but a few seconds can't compare to the days, months and years people along with Jim spend analyzing stocks.

I defend him because even though personality is a reason many people watch his show, there is more to it. He brings out factors that you wouldn't think to look for if you haven't had the experience and he offers it day to day. You can learn a lot or at least have a foundation to begin learning off of from watching.

On the contrary I am a skeptic when he, or any one for that matter gives me investment advice, so don't mistake me for a Cramerican and because it can't hurt I won't use his name with Grahams again unless I have to. Sorry Jim.

[Eric Fox]

Bernard....thanks for the clarification. The quote I posted from management must be for the balance of fiscal 2008.

[Eric Fox]

Daniel....here is my favorite quote from Cramer. It is from a speech he made in 2000:

"We don't use price-to-earnings multiples anymore at Cramer Berkowitz. If we talk about price-to-book, we have already gone astray. If we use any of what Graham and Dodd teach us, we wouldn't have a dime under management."

The speech was called "Winners of the New World" and here is the list of the ten stocks that he was buying then:

724 Solutions - SVNX
Ariba - ARBA
Digital Island - ISLD
Exodus - EXDS
InfoSpace.com INSP
Inktomi - INKT
Mercury Interactive - MERQ
Sonera - SNRA
VeriSign - VRSN
Veritas Software - VRTS

Have you heard of any of them?

[Daniel Nathel]

Eric,

Your point is valid, well taken and those 10 make me even more of a skeptic.

But never having the experience of working in a professional investment house like yourself, any advice I can get is better than none, including yours. And though Cramers advice alone doesn't go far, he brings up stats in one company that I never thought to look at which help me to analyze other companies.

On top of that looking back at the comparison I made between the two of them, Cramer's advice is actually a derivative of advise that Graham showed favor to for the defensive investor in "The Intelligent Investor." (sorry, I had to use them in the same sentence for that one) I can't recall the lady who did the study or the exact name of it but I think it was somewhere along the lines of Dollar-Cost averaging, in which you disregard the current market level and inject the same amount month to month, buying less when prices are high and more when prices are low. Graham did not oppose such a strategy and actually highlighted its success.

[Daniel Nathel]

Sorry for all the Cramer defense. The only people who are out spoken appreciators of him are callers on his show, and I think I just went off the topic of your comment to highlight the contrary. Most importantly though your comments are well taken.

[Paul Price]

Ruby Tuesday may recover and go on to big gains if everyting goes well. However they had violated their debt covenents and had to get waivers from lenders recently to avoid bankruptcy. Unless things get better quickly this is still a big risk.

Your contention that they were able to increase earnings during the bad times is just flat-out wrong. They had a terrible year and have not yet shown signs of a turnaround in EPS.

They cut back drastically on their new unit openings to conserve cash in this very bad environment for their industry.

I like out-of-favor stocks in unpopular industries like this.

I'd rather stick to the clear survivors like CAKE< CBRL< EAT<DRI<RUTH<... then take a shot on Ruby Tuesday where the penalty for failure is death rather than just delayed recovery.

[Paul Price]

At 22 years old I didn't pay enough attention to balance sheets either.

Age and experience are great teachers.

After 30 years of doing this I find excessive corporate debt [especially in a credit strapped economy] can be a deal-buster.

[Bernard2222]

Paul, I agree that excessive debt isn't a good thing but debt repayment can be a great way to gain value though.. equity rises and so do earnings. RT's debt is only due to the bad share repurchases they made over the last two years but with the annual cash flows they collect, liquidity won't be an issue. This is probably why the banks don't mind restructuring the covenants even though the economy is tough. Free cach flows repay the debt, not EPS..

[Daniel Nathel]

Paul,

I miss spoke if I said the EPS was rising. What i was alluding is what Marguerite Duffy, Ruby Tuesday CFO,said during the conference early this month. She mentioned that their restaurant margins beat their expectations to over 18%. She continued to say that they increased their checks, decreased their COGS and cost of payroll.

That does not translate directly into earnings because of the many casualties on their balance sheet and I should have only used the word profits to describe their operations.

Thank you for the correction.

Also, I don't avoid the balance sheet but, I am no where near as fluent at reading it as I would like to be. Sometimes I am not sure if that is just me or if they are just out right deceptive, but that is definitely something I will work on and pay closer attention to in the future.

I have heard a lot about issues of corporate debt recently, one of the most prominent is its unavailability. Another issue I will pay closer attention to in the future.

Thanks for the advice.

[Eric Fox]

This is what management has to say about the debt on the call:

"We are working with our lenders to modify our debt covenants. We have agreed in principle on the amended terms and are currently working on completing documentation."

[Daniel Nathel]

what do you think that implies?

[Eric Fox]

I wouldn't read anything sinister into the comment. I would take it at face value - they are talking to the banks who are probably wanting a larger spread when they roll the loan given the risk situation.

[kurt walter]

I dislike the casual dining stocks now. That is the first area that will get hammered when people cut back spending. The public might be stupid but they can't be so dumb to put that steak dinner on the credit card and pay for it over the next 20 years.

[BuyingRT]

Ruby Tuesday didn't violate their debt covenants. Go back to the Q2 earnings call. They were "At risk of violating their debt covenants". Two completely different things.

They did however rework those covenants with their lenders afterwards to minimize the risk of them violating them in the future.