RT - THE PROGRESS IS SLOWING

RT is scheduled to report fiscal first quarter 2010 results after the close tomorrow.  At the risk of sounding like a broken record, my expectations for RT are similar to what I expected out of DRI last week.  Revenues are likely to come in below expectations.  Earnings should be in line with the street’s estimate of $0.09 per share.  Full-year EPS consensus numbers could be at risk but management’s full-year EPS guidance of $0.50-$0.65 will likely remain unchanged.  RT is the second best performing casual dining stock over the past three months, up nearly 27%.  It’s unlikely that performance will continue.

 

For the last two quarters, RT’s same-stores sales growth has improved rather significantly on a sequential basis, and the company even outperformed the casual dining industry as measured by Malcolm Knapp during its last reported quarter.   Even if this outperformance continues, RT’s same-store sales growth is likely to slow sequentially in Q1 as the industry on average decelerated 150 bps during the quarter.  If investors are anticipating another quarter of sequential improvement, they are likely to be disappointed.  The street is estimating that company same-store sales will be down 3.7% versus -3.2% in Q4, which points to a slight slowdown on a 2-year average basis, but based on industry trends, I would expect that sales could come in below that number. 

 

During the last two reported quarters, RT has also delivered substantial YOY EBIT margin growth (in the 250 bps range).  Like its peers, RT has been able to offset its declining sales in the back half of FY09 by cutting costs in other parts of the P&L. Specifically, the company reduced its annualized costs by $45-$50 million, with the bulk of these cost savings implemented during 3Q.  These cost saving initiatives will continue to benefit the company on a YOY basis during the first half of 2010, but the comparisons get much more difficult beginning in fiscal 3Q.  To that end, EBIT margins should continue to improve during Q1, but I would expect this trend to reverse as early as Q2.  The magnitude of EBIT margin declines, however, will be much greater come Q3.

 

The biggest red flag for RT continues to stem from its increased discounting.  As RT’s CEO Sandy Beall stated last quarter, the company's first priority is to "get bodies in seats.”  RT’s recent same-store sales growth outperformance has been driven by traffic growth.  Although it is important to get people in the restaurant, RT’s average check and restaurant margins are coming under increased pressure.  Despite favorable YOY commodity costs, the company’s cost of sales as a percent of sales increased more than 240 bps in fiscal 4Q09.  Going forward, the company expects this trend to continue and is guiding restaurant margins down 50-150 bps as a result of RT’s value promotions and its impact on food costs.  Again, this is despite management’s expectation that actual food costs should remain favorable for the year. 

 

So, same-store sales are getting less bad and food costs are coming down.  This typically points to increased profitability for a restaurant operator.  In RT’s case, restaurant margins are still coming down.  What will happen if same-store sales growth decelerates and food costs become less favorable?  Based on what we are seeing, same-store sales could easily get worse in the near-term.  RT is locked in on 95% of its costs through the first half of 2010 and will soon extend its contracts for the remainder of the year. Although actual costs may not move higher this year, RT is training its consumers to come in for low-priced meals and food costs will eventually move higher.

 

On a more favorable note, RT will likely have continued to strengthen its balance sheet during the quarter by paying down more debt after already reducing its total debt by $112 million during fiscal 2009.  The company expects to pay down $80-$100 million of debt during fiscal 2010.  This number is easily achievable and could move higher, particularly following the company’s announcement of a common stock offering.  The company plans to use proceeds to pay down debt.

 

RT - THE PROGRESS IS SLOWING - RT EBIT 4Q10E


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