RT - Could We Be Close?

The last time I wrote a note on RT the title of the note was The Bank of Ruby Tuesday. Unfortunately, the note did nothing to endear myself to the CEO, Sandy Beal. At the time, the numbers never added up - Ruby Tuesday's had Applebee's EBIT margins, but did not have Applebee's highly franchised business model. Things are different today! Ruby Tuesday's margins have come down (maybe due to more conservative accounting around depreciation - I don't know, it was always a mystery) and now are in line with comparable companies and the CEO seems humbled.
  • Sales TrendsSales trends are horrific - rarely do you see a restaurant company with double digit declines in same store sales. It would appear that the company's remodeling effort and new, upscale look alienated some lower-end customers. In its most recent quarter, same-store sales declined 12.7% (-12.5% in December, -14.2% in January and -11.5% in February). These declines are much more severe than the casual dining segment's average 1.8% decline for that same time period, according to Knapp-Track data. The company has completed 600 remodels in the past 12 months so despite the tough casual dining environment, I would attribute at least half of these declines to the remodels, which represent a change in strategy for the company as it attempted to enter the more upscale restaurant market (some of the company's former loyal customers have obviously not accepted these changes). However, the remodel program, despite the cost, was a must. The reimaged restaurants will take time to attract new customers; it always does in casual dining! Just ask Red Lobster
  • Margin TrendsAt Ruby Tuesday's current level of AUVs, EBIT margins should begin to stabilize in the 5-6% range. Double-digit declines in same-store sales coupled with significantly higher D&A have hurt margins and earnings. It appears that there is one more quarter of difficult comparisons, as D&A has stabilized around $80 million (if the company holds its D&A expense steady, it should be able to get some sales leverage beginning in 1Q09). Of course, the big wild card to margin trends will be whether same-store trends stabilize.
  • Capital EfficiencyRT's appetite for debt over the past three years has put the company in a precarious financial position, but it appears management has to come to terms with the banks over its debt covenants. RT ended 3Q08 with total debt-to-EBITDA, including operating leases, guarantees to franchisees and letters of credit, at 4.6x times up from 4.1x in 2Q08. The excessive leverage has forced the company to stop growing, which now plans to open only two new restaurants in fiscal 2009. Including these two restaurants, capital expenditures for fiscal 2009 will be approximately $20 million. If the company can keep EBITDA at a $150 million run rate, deleveraging will have a positive impact on the equity value. A key metric for us is the net CFFO/net income ratio, which looks at the proportion of earnings yielding cash. Unfortunately, although headed in the right direction, Ruby Tuesday's can't turn off the development schedule fast enough. This creates incremental volatility in our earnings yielding cash ratio, at least in the near-term.

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