Although RT’s momentum may continue into fiscal 1Q11, the balance of the year looks less promising.
Fiscal 2010 (ending May) was a transformational year for RT. The company was able to maintain its top-line momentum from late fiscal 2009 with same-store sales declining only 1.3% for the full year versus -7.9% in FY09. Comp trends improved sequentially each quarter of the year on both a one-year and two-year average basis and turned positive in 4Q10 for the first time in 15 quarters. Despite the company’s promotional tactics, restaurant-level margin increased slightly for the year while operating margin improved about 130 bps to 6.5% (before reported closure and impairment charges). Earnings grew about 30% (again before the closure and impairment charges) after declining for three consecutive years. Free cash flow was up 44% and the company paid down $204 million in debt, leaving the company with a much healthier balance sheet at the end of fiscal 2010.
Given these sharply improved results, RT’s stock price has climbed 53% since the end of the company’s fiscal 2009. And, investor sentiment has shifted with short interest declining to just under 8% currently, from 10% in May 2009 (end of RT’s fiscal 2009) and as high as 13.5% in February 2010. Sell-side love for the name has also grown with about 50% of analysts now recommending the stock as a buy relative to only 10% at the end of the company’s FY09.
Although RT seems to be doing a lot of the right things to increase the number of people in its restaurants, I don’t think the company will be able to maintain this momentum in fiscal 2011. Given the current economic backdrop, I am expecting sales trends to slow across the industry. To that end, RT’s full-year same-store sales guidance of flat-to-plus 2%, which implies a fairly steady improvement in two-year average trends throughout the year, seems unrealistic. For now, I am modeling a 0.5% decline in same-store sales for the full year, which still implies some improvement in two-year average trends so it could prove aggressive. On an earnings basis, I am at $0.78 per share for FY11, lower than the street’s $0.84 per share estimate and at the lower end of management’s full-year EPS guidance of $0.76 to $0.86.
Getting the timing right on this name will be important, however, because despite my bearish view on RT for fiscal 2011, the first quarter could potentially show further improvement. This is how we view the set up for RT next quarter, based on my numbers right now:
- Same-store sales could improve again on one-year and two-year average year basis in 1Q11 (I am modeling +0.5%).
- Restaurant-level margin and operating margin could once again be up YOY (so potentially in Hedgeye Nirvana for the second consecutive quarter in 1Q11, as shown below).
- However, I have them missing on an EPS basis…I am at $0.14 per share versus the street at $0.16 per share.
For reference, RT held its fiscal 4Q10 earnings call on July 22 and the company’s fiscal 1Q11 ends in August so management had relatively good visibility on quarterly trends and they sounded quite bullish, which is why I would not be surprised to see the company post another quarter of positive same-store sales growth.
From there, I see momentum slowing for RT. It will get increasingly difficult for RT to continue to achieve stronger comps on a one-year basis and my full-year same-store estimate of -0.5% implies negative comps for the remainder of the year. I would also expect restaurant-level margin to come under pressure after the first quarter and decline for the balance of the year as the company laps its improvements from the prior year and food costs as a percentage of sales likely move higher in the back half of the year. I am modeling a nearly 80 bp decline in full-year restaurant-level margin relative to management’s guidance of a slight decline YOY. Based on my assumptions, which include negative same-store sales and declining YOY restaurant-level margin after the first quarter, RT could be headed for the Hedgeye Deep Hole as early as its fiscal second quarter of 2011.