Description

RUTH is the owner and franchisor of two restaurants concepts: Ruth's Chris Steakhouse (131 units) and Mitchell's Fish Market (20 units).  The steakhouse is a relatively high-priced restaurant, which gets about 1/3 of its business from special occasion dining, 1/3 from corporate dining, and 1/3 from everyday dining.  The company has 64 owned stores and 67 franchised stores in the Ruth's Chris segment.  There are currently 28 franchisees across 21 states and 7 countries, operating 54 domestic and 13 international locations.  The Ruth's Chris brand has been around for 45 years.  Mitchell's Fish Market is more of an emerging upscale casual dining brand, with 20 locations in 9 states.  RUTH acquired the Mitchell's chain just prior to the recession with an eye towards expansion and franchising, although those plans have been put on hold for now due to the economy.  RUTH management believes that upscale seafood is a relatively untapped market as seafood consumption is secularly increasing, and there is less competition in this segment than in steak.

At its peak in 2008, the company had sales of $406 mm and peak EBITDA of $45 mm was realized in 2007.  2010 sales were $360 mm and estimated EBITDA was $40 mm.  Due to expense rationalization, the company is operating with good margins despite being well off peak unit productivity.  On a unit level, the opportunity looks very compelling - at peak, the average sales/unit was $5.5 million, and average sales/unit will come in at $4.2 million for 2010, which isn't that far off the trough of $4.1 million per unit in 2009.  The bulk of the recovery is therefore yet to come.

RUTH is disproportionately exposed to two of the strongest spending segments out there: corporate travel and entertainment, and affluent consumer spending.  As evidenced by the RevPAR growth and strong stock prices of hotel companies leveraged to corporate travel (e.g., MAR and HOT), it is clear that corporate traveling and dining has come back in a big way.  This segment composes about 1/3 of business at Ruth's Chris, and started to show acceleration throughout 2010, and in Q4, business spending was up 16%.  Affluent consumers have also shown the biggest acceleration of spending of all demographic groups, as evidenced by the strong comparable sales posted by high-end retailers such as JWN, SKS, and TIF, which have all outpaced sales gains at more wide-reaching, moderately priced retailers like WMT and TGT.  Increasing confidence with regards to job security, as well as the wealth effect from strong financial asset appreciation, have led to double digit gains at high-end retailers as well as high-priced, aspirational brands like RL and DECK.  Simply put, RUTH is at the crosshairs of where spending is strongest: corporate and high-end.

The improving macro environment for business spending and spending by the affluent began to show up in accelerating same store sales in the last months of the year.  Comps accelerated from +3.9% in Q3 to +9.2% in Q4.  Comps also got better from month to month within the quarter, with November and December posting much higher gains than October.  Given what the hotels say their forward bookings look like in corporate travel, as well as the continued resilience of the capital markets, it is expected that comps should remain strong into 2011.  It should be noted that so far all same store sales gains have come from traffic/guest count, as opposed to increases in check.  RUTH has not raised prices for most of its items since 2008, and while it has no short-term plans to take major price increases, as traffic improves and restaurant "occupancy" rises, this is a lever they have yet to pull.  RUTH also has the opportunity to benefit from rising checks without raising prices as the economy recovers in three different ways. First, attach rates for beverages and desserts can go up (a lot of people cut back on these extras during a recession).  Second, people can go back to ordering more extravagant wine, especially on corporate accounts.  Wine units have done well, but tradedown has impacted the average price of wine ordered.  Finally, to combat shrinking traffic during the recession, RUTH introduced fixed price menus at $39.95 and $49.95.  They continue and will continue to offer these menus to people as they believe this encourages the third of their business that are regular, non-occasion and non-corporate diners to visit, since the fixed price menus allow better transparency on what dinner is going to cost.  But as people, especially affluent people, get less budget conscious, there should be some mix shift back to a la carte from price fixed.  Currently, price fixed is running about 30% of sales.

Since all of the comp improvements are coming from traffic, as opposed to price (average check will actually be down 60-100 basis points in 2010), there will be a lot of margin leverage when check averages start to improve. 

It should be noted that the Mitchell's concept has been a drag on company same store sales, as Mitchell's comped -2.2% in Q4, which was a bit better than in Q3, but still a drag given the consolidated company posted +9.2%.  The concentration of Mitchell's units in Florida is one reason the company gives for the chain's underperformance.

After several years of focusing on defensive actions, the recent pick up in traffic is allowing RUTH to go back on the offensive in a measured manner.  They will do some TV ads this year in a few selected markets for the first time in a long time.  They are also working on menu innovation, such as testing a sushi bar in several units, which they believe is helping them pull some younger people into their restaurants.

The biggest risk to RUTH in the short-term is rising commodity costs, specifically beef, which they say is already up 6% YTD and could put between 40 and 140 basis points of pressure on their gross margins this year.  Since they do not want to compromise on quality and they do have a number of regulars at individual units as well as among business travelers who visit them across the country, they can't really reverse engineer the menu or cut portion sizes to offset rising costs.  There should be more explicit information on the impact of beef prices and their 2011 hedging programs when they report earnings on February 18.  But it is entirely possible that pressure on gross margins from increasing commodity costs push an earnings recovery from 2011 to 2012.  But the acceleration of same store sales as well as the high incremental margins on incremental sales given substantial fixed restaurant costs means that even in the face of beef and other inflation, 2011 should be an up earnings year.  Also, the fact that RUTH has been so conservative with taking price increases for 3 years now should allow them pricing power relative to some of their peers.  The only price increase they have taken was on 5 SKUs back in August 2010, for an overall menu impact of <50 basis points.  Rapidly rising beef prices, while a short-term headwind, could be a long-term benefit as some local, independent competitors could end up closing their doors if inflation becomes too tough to navigate.  For commodity inflation bulls, RUTH could be part of a pair trade in which a more expensive casual or fine dining stock with similar inflation vulnerabilities is shorted.

Valuation

RUTH currently trades at 6.6x 2010e EBITDA of $40 mm versus a restaurant average of 9x, despite most public restaurant companies being lower check and a lot closer to pre-recession productivity levels.  In terms of free cash flow, RUTH is very cheap, currently trading at around a 14% free cash flow yield.  RUTH will have generated around $25 mm in free cash flow in 2010, although as business improves and they return to opening restaurants, this number should drop, albeit it increased capex should be partially offset by improving cash flow from operations.

RUTH is currently running at a comfortable 1.6x leverage (using a net debt number of $64 mm, and excluding the preferred stock which is in the EV calculation but not in the leverage calculation), having cut debt levels in half last year through a rights offering and a preferred stock offering.

Target

At 7x 2012e EBITDA of $48 mm, RUTH would trade at $7.50.  EBITDA in this calculation treats $24 mm in preferred stock as debt and gives the company credit for $15 mm in cash accumulation and/or debt paydown in 2011 (this is a conservative estimate).  That is a one year target.  Over the long-term, RUTH has significant potential for further appreciation as restaurant unit level productivity will still be off peak in 2012, and as the economy and franchise financing environment improves, franchising deals should accelerate.  There are currently 18 units under commitment to be built by franchisees, but none of these are scheduled to open in 2011.  They will also return to opening company-owned stores in the 2012-2013 time frame.

Catalyst

Catalysts

• 1. Continuing acceleration of same store sales based on strong corporate T&E spending as well as better spending from affluent individuals, ultimately resulting in EBITDA/EPS growth
• 2. Clarity on the impact of rising beef prices should be given on the Q4 earnings call on 2/18/11

Risks

• 1. Beef and other commodity inflation constrains P&L growth in 2011
• 2. Small market capitalization and realtively low liquidity (only about $2 mm notional of stock trades daily)