RUTH – Madison Dearborn to the rescue, but still on the Bankruptcy watch list

RUTH was already in a tough position relative to its debt covenants as evidenced by both its sale-leaseback transactions and its recently announced cost reduction initiatives, but October’s same-store sales decline of 15% has further complicated the situation. RUTH ended the quarter with long-term debt of $167M (reduced by $17M from the proceeds from the sale-leaseback transactions) and a total debt/adjusted LTM EBITDA ratio of 3.23x relative to its maximum debt covenant level of 3.5x.
RUTH announced last week that it has entered into a purchase agreement to sell its support center in Heathrow, Florida, which the company hopes to close by year end. The sale is expected to generate $12M in proceeds and could provide a 20bp cushion to the company’s debt/EBITDA ratio at the end of the year.

Management stated, however, that if the sale of the support center does not happen in Q4 and same-store sales remain down 15% for the balance of the quarter that remaining below the 3.5x covenant “will be tight.” Management even reiterated this point later in the call in response to a question regarding its debt covenant, “Well, David, first, in terms of Q4, I didn't say safe. I said tight and we think we can get over the top but I don't want to suggest that it's a layup, if you will.”

The company’s only flicker of hope, outside of completing the sale, relies on strong gift card sales in Q4, which added $12-$13M of revenues to 4Q07. Management is expecting about the same level of gift card sales in this year’s fourth quarter as a result of RUTH’s increased units and the addition of Mitchell’s (so a decline in gift card sales/unit).

When asked about bank relations, management stated they have a good relationship with their bank lenders and although premature to speculate, that if a default did occur, the strong relationship they have (combined with the strong relationship their largest shareholder, Madison Dearborn, has with the bank lenders) would help to provide a favorable outcome…if it came to that.

So as I highlighted last week, these are clearly desperate times for RUTH.

Strong Side: Australian Jobs

The job market down under has been remarkably resilient so far … this morning’s unemployment report hammered home another win for Glenn Stevens and co., who continue to manage monetary policy the way that the objective economists out there admire.

The Australian markets received a bullish surprise in October’s employment numbers which saw a 34,000 increase while official Unemployment registered unchanged at 4.3%.

With a cooling global market for metals and energy commodities, no one seriously expects that unemployment levels won’t rise in the coming months. In a statement today Deputy Prime Minister Julia Gillard acknowledged the positive job data but cautioned that "while we are better placed than most other countries, Australia is not immune from the global financial crisis. The global crisis will impact on growth and employment here, and the government does expect to see unemployment rise."

We are long Australia via the EWA ETF. Despite the reality of slowing demand for commodities and a volatile currency environment we continue to think that the market there is among the strongest in the developed world.

If you have been reading our work since we started, you know that we have been fans of central bank chief, Glenn Stevens, for a long time now. Under Steven’s management the Reserve Bank held rates high while the Australian economy experienced the biggest market boom in decades. Now, with metal and energy prices slashed back to 2007 price levels, Stevens has room to maneuver that poorly prepared market students like Ben Bernanke do not. So far, his recent rate cuts appear to be providing a soft landing down under.

Keith McCullough & Andrew Barber
Research Edge LLC

Eye On the UK: Shock Therapy!

British housing numbers that were released today didn’t surprise anyone with a pulse, but the BOE’s reaction did!

The BOE’s 150 basis point cut today, took the benchmark rate to its lowest level since Winston Churchill’s second term as Prime Minister. We attached a long-term chart of Rates and GDP growth below to put the present situation in context.

Mervyn King is not the only central banker pumping liquidity into the system today – both Switzerland (which we are long via EWL) and the EU cut rates today by 50 basis points each, but he does appear to be the most desperate. The British economy has been reeling under the weight of worsening data: HBOS housing numbers declined by almost -15% year over year, the worst performance since 1983, while yesterday’s industrial production numbers confirmed that manufacturing contracted in August, adding to the longest losing streak since 1992.

In a theme which is echoed in other markets where lawmakers have rushed to bail out failing banks, Gordon Brown’s administration is exerting increasing pressure on banks who participated in the government recapitalization program to begin actively lending again and pass lower rates through to borrowers rather than hoarding capital.

We continue to be short the UK via the EWU ETF. As one of the more levered and poorly managed economies in Europe we anticipate relative weakness there for the seeable future.

Andrew Barber


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Shippers Need Their Cash Too!

One of the great advantages that is emerging from our growing (exclusive) network of research contacts, are the daily insights. Below is a data point from one of our contacts in Asia on shipping, liquidity, cash, etc...

just spoke to a few friends of mine in the commodity contract shipping business in the south pacific/australia region.

most of them allow 90 days for payment for shipping services rendered
- and tomorrow's the day that a significant number of accounts on the "shippee" side are due. according to them, something like half of their clients have already said they won't have the cash to pay up on product that has already been shipped, and are thinking that bankruptcy is their only option.

guess they're sitting on inventory they bought 90 days ago - often on revolving credit lines - and can't recoup their costs thanks to a huge dip in both demand and prices.

they're actually calling tomorrow "black friday".

so heads up.
-Friend of the Research Edge Network

Schwarzenegger: "We'll Be Out Of Cash By February"

No, that's not good! That's "we" as in the Golden State of California...

If that's not the most bearish headline of the day, I don't know what is.

Cost of long term capital will continue to increase as access to cash continues to tighten.
Be careful out there,

WRC: A Balloon Can’t Stay Underwater Forever

This was perhaps the earliest (and often most painful) call of my career. But you can only hold a balloon underwater for so long. WRC is finally being exposed for what it is. A massive over-earner.
A colleague shot me an email this morning saying “Warnaco finally pulled a Warnaco!” How true. I’m not going to waste your time or mine giving the run-down of what they said on the call, or what happened. The bottom line is that this has largely been a FX-induced margin story as the company printed too much FX benefit, and understated the impact to the Street. Check any of my past posts for the math. I won’t bore you with it now.

So what’s in the stock now? That a 10% margin is not sustainable after all without FX tailwind. 7% is closer to reality. But what happens if a new Obama Administration takes up rates in '09 and the dollar along with it? Then FX turns into a headwind, and there is no reason margins cannot go back to the low/mid single digit range. That’s when cash flow gets to a point where we need to start to look at debt covenants again.

There will come a time to buy this stock. But even with a 30% hit from yesterday – and 2/3 off its 1-year high, we’re not there yet.

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