"The reports of my death have been greatly exaggerated."
Ruby Tuesday (RT) has been wrongly maligned as a broken concept by Wall Street snobs that have never stepped foot in an actual Ruby Tuesday restaurant. Our research concludes the concept is viable and operational performance is stabilizing. The current stock price ignores the hidden value of the company-owned real estate assets (45% of locations). We estimate the net value of the real estate assets alone is worth $6.15 per share. Investors can buy the stock today at a discount to the underlying real estate value and get the operating business and brand equity for free.
A new management team was put in place by activist investor, Becker Drapkin Management, and our research suggests the turnaround they are implementing is taking root. Company insiders have been buying the stock in the open market during the past three months at prices above today's closing price. Furthermore, a potential exit strategy may be in the works; there have been reports that Goldman Sachs has been retained by RT to explore a possible sale of the company.
We see the intrinsic value of RT being $9 per share. The stock trades at 72% of tangible book value which suggests limited downside. Our estimate of potential downside risk is $5.15 per share, which equates to an asymmetric upside/downside profile of 8:1.
Ruby Tuesday operates and franchises a chain of casual dining restaurants in the United States and internationally. RT owns and operates 703 Ruby Tuesday restaurants and franchises 76 Ruby Tuesday restaurants. The company also owns and operates 21 Lime Fresh restaurants and franchises 8 Lime Fresh restaurants. The company-owned and operated restaurants are concentrated primarily in the Southeast, Northeast, Mid-Atlantic, and Midwest.
The Trail of Tears:
Ruby Tuesday was founded in 1972 in Knoxville, TN by Sandy Beall. The company grew its footprint to 16 locations before selling to Morrison Restaurants in 1982. Mr. Beall stayed on with Morrison Restaurants to steward the Ruby Tuesday business. With Morrison's financial support, Ruby Tuesday was able to embark on a rapid growth program. The success of Ruby Tuesday led to Mr. Beall becoming the CEO of Morrison Restaurants in 1992. In 1996, Morrison Restaurants was broken up into three separate companies; Ruby Tuesday, Morrison Health Care Inc., and Morrison's Fresh Cooking Inc.
RT continued its growth trajectory unabated throughout the 90's and into the early 2000's. The number of Ruby Tuesday locations (company-owned, franchised, and other concepts) peaked at 945 units in 2008. Mr. Beall was the CEO and Chairman throughout this entire time.
The success of the RT concept was impressive but it eventually led to misplaced hubris for its Founder, Mr. Beall. In 2006, Mr. Beall (who had been building RT for the past 34 years) fell victim to the "Wheel of Retail" and decided that he wanted to move RT upstream and transform it into a more expensive upscale casual restaurant. The company embarked on a massive CAPEX spending campaign to change the interiors of the restaurants. It also raised menu prices and began offering more elaborate entrees. Predictably, this shift in strategy did not sit well with RT's core customer who had become accustomed to value-based menu items over the past 34 years. To make matters worse, the United States entered the Great Recession in 2008 just when RT was at its peak store count. It was a horrific mix of bad strategy and bad timing.
The damage done to shareholders over the past 7 years has been severe. The stock currently trades at $5.60 which is down significantly from the $25-30 range prior to the upscale adventure.
The enterprise value has shrunk from over $2B to $575m currently.
The strategic misstep was bad but we think the market has greatly overreacted at this point and we see significant upside for the stock price. Consider this, the current enterprise value of $575m is only 69% of the cumulative CAPEX spent over the past 10 years.
The good news is that all of this (and more) is already priced into the stock. The management team has been completely overhauled with new executives hand-picked by the activist investment firm, Becker Drapkin Management. Mr. Beall left RT in 2012 and no longer has any influence on the company. RT has transitioned back to targeting the casual dining consumer and is in the midst of an operational turnaround. The new management team has lowered its price points and refocused on value-oriented menu offerings. Our independent research confirms the strategic turnaround is taking hold and business operations are stabilizing.
Hidden real estate assets:
We believe many investors are unaware that RT owns a considerable amount of real estate assets. At the end of Q2 2014, RT owned and operated 703 Ruby Tuesday restaurants and 21 Lime Fresh restaurants. RT owns the building and land for 45% (316 of the 703 locations) of its company-owned locations. Our research indicates these properties are worth, on average, approximately $2.18m per property based on recent sale leaseback transactions and the credit facility appraisal conducted in December 2013.
Our analysis bakes in a margin of safety and assumes a -10% discount to this $2.18m average value per location. Applying our estimate ($1.96m per location) across the real estate portfolio shows that RT owns ~$619m worth of real estate. If we net out the company's debt, equity holders are left with $6.15 per share in net real estate assets.
The current stock price is trading at 90% of the company's net real estate value and is attributing zero value to the company's operating business which has generated an average of $113m per year in cash flow from operations over the past 7 years. During this time period, the operating business has generated an average free cash flow of $61m per year (18% FCF yield based on current stock price).
The current stock price is also attributing zero value to the Ruby Tuesday and Lime Fresh brands. Furthermore, RT has $223m in state net operating loss carryforwards (NOLs) and $33m in federal NOLs. These valuable NOLs can be used to offset taxable income in the future.
Current Operations Are Stable:
Our research team surveyed RT customer traffic at several locations over the past few weeks. We interviewed employees, managers, and customers during our checks. Our research concludes that business operations have stabilized and the new menu items are gaining traction. Furthermore, increased advertising is reaching customers and getting people in the door, which had been a challenge over the past several quarters. Despite the inclement winter weather, we were surprised by how populated the restaurants were. The parking lots were mostly full on weekend nights during dinner hours and we even saw one location that had a line to be seated and a 45 minute wait.
Full parking lot:
45 minute wait:
The service was good in each location; the interiors and bathrooms were clean and in good condition. The Garden Bar offerings were fresh and fully stocked each time we visited the salad bar. Our food tasted good and the ingredients were as advertised. Clearly this isn't meant to be a food review, but we do think it's instructive to realize that RT is delivering on its strategy and value proposition to customers.
Critically, the price points are now back to a level that appeals to the value-oriented casual diner. Most entrees on the new menu are priced in the $10-15 range which is in line with direct competitors.
The business model for a restaurant has an incredible amount of operating leverage because expenses such as labor, utilities, and rent are all fixed costs. This is why generating same-restaurant sales growth is so important. Q1 and Q2 had terrible same-restaurant sales; however, guidance for Q3 and Q4 shows improvement. The stock market clearly priced in Q1 & Q2 as evidenced by the stock dropping from nearly $10 to $5.60 per share. We don't believe the market is appropriately pricing in the forthcoming improvement.
Our research suggests Q3 same-restaurant sales could come in better than expected. The wildcard will be the impact of the terrible winter weather. Absent the polar vortex and snow storms, we estimate RT would be on pace to exceed Q3 same-restaurant sales guidance. We wouldn't be surprised to see Q4 2013 guidance revised higher.
The Chairman and CEO, JJ Buettgen, has been actively buying RT shares on the open market. Mr. Buettgen recently added 50k shares on January 28th and now owns over $4m worth of stock (1.3% of the company). Todd Burrowes, Chief Operating Officer, also recently purchased 25k shares in the open market at a price of $6.16 per share. We always like to see insider buying as confirmation of an undervalued situation.
New Management Team at the Helm:
We believe the new management team at RT has the right vision and motivation for a turnaround. The old guard of Sandy Beall (former Chairman & CEO) and Margie Duffy (former CFO) was replaced at the behest of activist investor, Matt Drapkin, in late 2012. Our research indicates that both Mr. Buettgen (current CEO) and Michael Moore (current CFO) were interviewed and approved by Mr. Drapkin while he was the Lead Director at RT. Although Mr. Drapkin is no longer involved with RT, we think it's safe to assume the current CEO & CFO have no allegiance to the status quo and share the same vision for RT as Mr. Drapkin. We also think these gentlemen don't have the same emotional attachment to Ruby Tuesday as Sandy Beall, which makes an eventual sale of the company more likely.
Possible Deal in the Works:
In December, it was reported that RT had hired Goldman Sachs to explore strategic alternatives according to DebtWire. Neither RT nor Goldman Sachs has confirmed this rumor yet but it does make sense that RT could be targeted for an LBO. With the significant real estate assets, a private equity firm could borrow heavily to finance an LBO transaction. The current stock price is so undervalued that an LBO would likely offer very compelling returns for the financial sponsor.
The stock is trading at a significant discount to recent M&A transactions in the restaurant space. Notably, Darden Restaurants (DRI) and Dine Equity (DIN) have been willing to pay 9.6-12x EBITDA for acquisitions. We estimate a transaction done at a multiple comparable to the peer group below would equate to $9-10 per share.
RT looks to be significantly mispriced in our opinion. The stock is trading at a sizeable discount to tangible book value; it is even trading at a discount to the net real estate value of the company-owned locations. An investment in RT allows an investor to purchase the entire RT operating business for essentially $0. Our research indicates the new management team has stabilized business operations and we expect the company to return to profitability later this year. The stock appears to offer a highly favorable risk/reward profile with an upside/downside payout of 8:1. With significant tangible asset value, we see limited further downside.
RT is currently our largest holding in the Fund and we see fair value at $9 per share.
Additional disclosure: The author and/or employer may buy or sell shares in any company mentioned, at any time, without notice. The information contained herein is believed to be accurate as of the posting date. Readers should conduct their own verification of any information or analyses contained in this report. The author undertakes no obligation to update this report based on any future events or information. This article represents best efforts to convey a fact-based opinion. Our conclusions may be incorrect. This is not a recommendation to buy or sell any securities. This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein or of any of the affiliates of the Author.