Ruby Tuesday: Sell While Momentum Is High

| About: Ruby Tuesday, (RT)

Summary

Ruby Tuesday has seen large gains this week after CEO Buettgen purchased 50,000 shares of the company.

Insider purchases can point to go things, but not always. Ruby Tuesday is expecting flat revenue, has low profit margins, a low current ratio, and isn’t effectively harnessing its market.

As the economy contracts, Ruby Tuesday will end up facing hard times. Investors would be wise to sell now while momentum is high.

Ruby Tuesday (RT) soared on Monday in the hour before market close after President and CEO JJ Buettgen purchased 50,000 shares of the company. Buettgen paid just over $6 per share for the stock. Ruby Tuesday's share price soared in response, pushing up nearly 6% to close the day at $6.41 and that movement continued into Tuesday, rising to $6.50 per share at midday.

INVESTMENT THESIS

Momentum has driven Ruby Tuesday's share price up but that doesn't necessarily mean the stock is a good investment. While it's true that a large insider deal can be a positive signal, insiders make investments for all sorts of reasons - it doesn't always mean you should follow suit.

THE GOOD

There are reasons to be encouraged about Ruby Tuesday. The company has exhibited a trend towards growth. Its fiscal Q4 ended June 3, 2014. Ruby Tuesday's net income from continuing operations is still in the red but 4Q14 was a loss of just $0.9 million compared to a loss of $27 million for the same quarter last fiscal year, including special items. This improvement trickled down to Ruby Tuesday's bottom line. The company reported a diluted loss per share of $0.01 versus a loss of $0.44 per share in the same quarter last fiscal year.

Those are solid improvements and analysts are encouraged. Ruby Tuesday is trading at $6.50 per share and consensus estimates give the company a one-year target of $7.88, with some analysts saying that number could go even higher. Telsey Advisory Group upped its price target on Ruby Tuesday to $8 from $7 on July 30. If they are right, that means someone buying in today could generate a return of 23% over the next year.

THE BAD

Of course, not all analysts are as bullish on Ruby Tuesday. UBS downgraded its price target on the company in July, setting its one year estimate at $6.50 per share, down from $7.60.

In addition, the earnings results listed above includes special items.

Removing those from the mix, "the company reported earnings of 3 cents a share, excluding items, down from 12 cents a share in the same period one year earlier. Revenue declined year over year to $307.3 million from $316.1 million. Analysts had expected earnings of 9 cents a share on revenue of $303.8 million, explains The Street. "Ruby Tuesday also said it expects first-quarter same-restaurant sales in the range of down 1% to up 1%. For the full fiscal year 2015, the company expects a range of flat to up 2%.".

THE UGLY

Ruby Tuesday has several major weaknesses. The company has a low debt to equity ratio at 0.56 but it also has a low quick ratio, of just 0.51. Ruby Tuesday's gross profit margin is only around 14.56% and its net profit margin is -0.13%. In other words, the company could have problems meeting its short term debt obligations and given such weak earnings and flat revenues, it doesn't appear that trend will change soon. The market just does not appear to be there, and it's only going to get worse.

The economy is peaking now - according to the EIU, IMF, and OECD, US GDP is going to fall off after 2015 - if Ruby Tuesday has flat revenues now, what happens when the economy is weaker?

Most troubling though is Ruby Tuesday's strategy. In the company's 4Q14 earnings call, CEO Buettgen was asked about his couponing strategy - an important question given the company's weak margins. "Interestingly the buy one get one half off does intend up being that much different in terms of what it cost us than a $5 off two launch rate, but it seems to be much better received in more compelling to our guests," said Buettgen. "So, we've offered - our discounts have been in that range for the most part although we have varied of the products we feature and kind of what we use in terms of the messaging in the coupon."

If Ruby Tuesday's customers aren't compelled by modest discounts and require "buy one get one" type deals, is it because they are extremely budget-conscious or is it that they do not see much value in Ruby Tuesday's offerings? The company may respond to this trend by adjusting the items on special to those with the highest profit margins, but it may not be enough to help the company grow going forward.

TAKEAWAY

Insider purchases can be a positive signal but in the case of Ruby Tuesday it does not appear to be indicative of big things on the horizon for the restaurant chain. Weak margins, flat revenue, and a low current ratio mean that Ruby Tuesday will be facing hard times as the economy contracts. Investors would be wise to take advantage of the recent momentum surrounding CEO Buettgen's share purchase and sell while the price is elevated.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.