Description

This Time It’s Different

Ruth Chris’ is experiencing the perfect storm of bad luck  1) the Pandemic impacting directly on their core customer, 2) Skyrocketing beef prices, and 3) $150mm of revolving debt due on 2/22/22. The company just diluted shareholders with a 5.6mm share offering on May 26th at $8/share adding to the overhang and short interest has increased 125% since mid-March.

The Pandemic has obviously been a game changer for all physical customer-facing businesses. The restaurant business has been impacted dramatically however I think the market is not differentiating between the different categories of sit-down restaurants. There have been some Pandemic winners in the restaurant space with take-out oriented Chipotle (CMG) and Dominos (DPZ). While predicting the return of customers to sit-down restaurants is difficult, I think the following scenario seems most likely:

Group 1: Younger, healthier and more aggressive customers will return in droves right away as social distancing eases

Group 2 : More cautious, probably middle-agish customer who will “wait and see how it goes” before returning to dining out

Group 3 : Older and the most cautious customers who are also generally the wealthiest. With an average entrée price range of $32-$99, This is one of RUTH's target market customer. This customer won’t return until there is a vaccine and probably a credible cure to Covid-19.

Group 4: Business expense account customer. With white collar business expense account types sitting at home in sweatpants, this seems like it will be a slow comeback for this customer. Now you can just have a zoom call and call it a day.

  In normal times, the restaurant business is a leap of faith as 60 percent fail in the first year and 80% fail before the five-year mark. As social distancing winds down, restaurants will be operating at roughly 50% capacity due to additional spacing guidelines at best, and they will continue to lose money even if they operate at full capacity. Under current guidelines, sitting at the bar is not an option and the bar is an important profit center for high end restaurants. RUTH's received 23% of their 2019 revenue from liquor sales. Red wine sales for diners at the table will continue but the at-the bar revenue won’t return until we have a vaccine most likely

Beef Prices

Beef prices have increased 100% in two months due to supply chain disruption. I have no prediction on the future prices of beef however this could not have come at a worse time for Ruth’s Chris. See the excerpt from their 2019 10K.

Increases in the prices of, or reductions in the availability of, any of our core food products could reduce our operating margins and revenues.

We purchase large quantities of beef, particularly USDA Prime grade beef, which is subject to significant price fluctuations due to seasonal shifts, climate conditions, industry demand and other factors. Our beef costs represented approximately 44% of our food and beverage costs during fiscal year 2019. We typically buy our beef on the “spot” market and from time to time we will enter into longer term pricing and supply agreements.  During fiscal year 2019, we entered into contracts with beef suppliers to establish set pricing on a portion of anticipated beef purchases. During the third quarter of 2019, we entered into negotiated set pricing for approximately 75% of our tenderloin requirements from mid-August 2019 through mid-February 2020 at a price approximately 1.0% below prior year.  The market for USDA Prime grade beef is particularly volatile. If prices increase, or we are unsuccessful in our longer term pricing and supply agreements, or the supply of beef is reduced, our operating margins could be materially adversely affected.

Other Issues-Labor Costs

I’ve thought that Trump was a shoo-in to win November’s election. Now I am not so sure. Biden has pulled ahead in five important states that Trump won in 2016, (Florida, Pennsylvania, Michigan, Wisconsin and Arizona) and appears to be gaining momentum as Trump fumbles with the pandemic response. Hard to bet against the Teflon-man but Biden’s momentum is unmistakable. The debates start on September 29, 2020 and we will see if Biden can at least appear to be lucid and not senile. If Biden wins, he will try to increase corporate taxes and increase the federal minimum wage to $15 from today’s $7.25. This will be very bad for the stock market as 2019 S&P 500 earnings would be impacted by an estimated 15-20% if we return to the 35% corporate tax rate and restaurants are filled with minimum wage and near minimum wage workers.

See for Biden’s Platform:  https://www.politico.com/2020-election/candidates-views-on-the-issues/joe-biden/

Here’s an excerpt from Ruth’s 2019 10K.

 Labor shortages or increases in labor costs could slow our growth or harm our business.

In addition, we have a substantial number of hourly employees who are paid wage rates at or based on the federal or state minimum wage and who rely on tips as a large portion of their income. Governmental entities have acted to increase minimum wage rates in several jurisdictions wherein Company-owned restaurants are located. The federal minimum wage may be increased and there likely will be additional minimum wage increases implemented in other states in which we operate or seek to operate.  Likewise, changes to existing tip credit laws (which dictate the amounts an employer is permitted to assume an employee receives in tips when calculating the employee’s hourly wage for minimum wage compliance purposes) continue to be proposed and implemented at both the federal and state government levels.  As federal and/or state minimum wage rates increase and allowable tip credits decrease, we may need to increase not only the wage rates of our minimum wage employees but also the wages paid to our employees who are paid above the minimum wage, which will increase our labor costs. 

The company has been aggressive raising liquidity, fully drawing on their revolver and issuing shares on 5/26/20. I estimate they are sitting on $112mm in cash and the revolver is at $150mm and due on 2/22/22. It will be a race to see if their business can fully recover before their revolver is due. I think recovery is going to be much slower for RUTH than the company anticipates and Their product does not lend itself to take-out.

Catalyst

1) 5.6mm share offering on 5/26 creates near-term overhang

2) Earnings estimates seem way to optimistic and their business does not lend itself to take-out even though the company is heavily promoting their small pivot to take-out. Losses will ensue as the recovery for their core customers will be much slower than anticipated. At 50% capacity and diminished bar revenue, this is a money losing business.

3)As losses mount, focus will shift towards the looming revolver due date on 2/2/22 causing shareholders to bail.