Ruth's Hospitality Group: The Valuation Article
Summary
- This article will offer not one, but four different valuations depending on if you are a pessimist, realist, optimist, or chartist.
- Ruth's EPS has grown by almost 20% per year for the past eight years. Despite this fantastic performance, the company trades at a significantly discounted 7.8 TTM P/E.
- In fact, the company is so undervalued, even the pessimistic investor has an opportunity to make double digit returns. The rest of us have an opportunity to double our return.
I have spent the last three articles describing why Ruth's Hospitality Group, Inc. (RUTH) makes an exceptional investment. In my first article, I went through the company's cash position and determined the company has sufficient liquidity to make it through the year. In my second article, I explained how management has done a great job of consistently growing the business. Finally, in my third article, I did a full-on competitor comparison, which exhibited that Ruth's was the best company out of the bunch in regards to analytics, margins, and risk/reward metrics.
Now that we have determined the company is solvent, has skillful management, and is stronger than competitors, it is time to value the business. I will present three discounted cash flow models; one for the pessimist, one for the realist, and one for the optimist. Then, I will present in-depth technical analysis and a valuation using FAST Graphs charts and data.
Ruth's is a great buying opportunity for whichever category you fall under. All four types of investors have an opportunity to make a positive return.
DCF Valuation - Pessimist's View
Here is an explanation of how I set my assumptions:
- Sales: set off pessimist's/realist's/optimist's viewpoint until 2025, where sales resume normal historical rates
- CGS % Sales: set off historical rates
- SGA % Sales: set off historical rates
- Effective Tax Rate: set off the Tax Cuts and Jobs Act
- Net CA % Sales: set off historical rates
- CAPEX Growth: set off historical rates
- CAPEX (net of depreciation): set off historical rates
- Cost of capital: calculated
- Terminal Growth Rate: set to keep up with inflation
- Net Present Value: set at 7%
With that out of the way, let me quickly explain DCFs. These models project all the future cash flows of a company and discount them back into present value dollars. The value of a business is equal to all these expected future cash flows added up (along with some adjustments, which are made at the bottom). This model allows us to adjust the future as we see fit; so, in this case, let's take a pessimistic view of the future.
In 2019, Ruth's sales were $468.03 million. Let's say that in 2020, sales get cut by 65%, which is essentially saying Ruth's was closed for two thirds of the year. Furthermore, let's assume the recovery is so abysmal that it takes Ruth's another ten years just to recoup its lost sales and get back to a 2019 level of $468.03 million.
Given these assumptions and Ruth's current weighted average cost of capital of 5.63%, the business' fair value would be $15.12. This represents a 37.49% gain from current levels.
DCF Valuation - Realist's View
If you are a realist, you do not see the glass half empty or half full - you see the glass for however much liquid is inside, like it or not. Translating that mindset over, a realistic investor would likely assume that Ruth's will struggle to achieve 2019 sales of $468.03 million again for some years, but afterwards, the company should be back at that level.
This investor might assume that Ruth's will see the same large decline of 65% in 2020, but subsequently will see an increase in revenue of 70% in 2021. The following few years see strong earnings growth and by 2025, Ruth's would be earning that same $468 million in revenue. Afterwards, this investor can assume earnings will grow at their historical rate of 3.20%.
Given these assumptions and Ruth's current weighted average cost of capital of 5.63%, the business' fair value would be $20.32. This represents an 84.75% gain from current levels.
Note: While 70% sounds tremendous, keep in mind that a 70% increase after a 65% decrease is still quite low. In our case, this results in sales of $278.5 million for 2021. To put this in perspective, the last time Ruth's was anywhere near this level of sales was 2006 ($271.5 million).
DCF Valuation - Optimist's View
The optimist expects a quick bounce back. He accepts 2020 and 2021 sales will be lower, but he thinks the fears are overblown and the business is going to come roaring back.
This investor might believe that Ruth's can get back to 2019 sales of $468 million by the end of 2022. He might then assume the business will grow at its historical average rate of 3.20% after that.
Given these assumptions and Ruth's current weighted average cost of capital of 5.63%, the business' fair value would be $25.03. This represents a 127.54% gain from current levels.
Which Investor Am I?
I would classify myself as a realist. I think Ruth's, as it stands today, is offering an 84.75% return.
I think being overly pessimistic is foolish. The Dow went through WWI, The Great Depression, and WWII all within 28 years. To believe that COVID-19 is going to be the end of the stock market (and restaurant business) is, in my view, utterly preposterous.
On the other hand, being overly optimistic is foolish too. To believe there are no ramifications for real world events is to be delusional. However, these ramifications matter far more to derivative traders who gamble on the near future, where timing is of the essence. For us long-term investors, these ramifications smooth out over time and have less impact, all while providing a once in a blue moon opportunity to buy great companies.
As Warren Buffett's famous saying goes:
Be greedy when others are fearful.
FAST Graphs Technical Analysis
Starting from the left, we can see that during the period leading up and through The Great Recession, Ruth's earnings suffered. Ruth's went from earning ¢75/share to ¢30/share. For a few years, the company's earnings were stagnant and then starting in 2012, the company's earnings took off on a fantastic upward trajectory. At the end of 2019, before COVID-19 hit the United States, Ruth's was earning $1.43/share and had a fair value of $21.45 (based on a 15 P/E).
The question at this point is can Ruth's get back to earning $1.43/share? If so, the shares will be worth $21.45 each.
The answer, I believe, is yes. The past does not predict the future, but we can use the past to learn and extrapolate. Ruth's has been through numerous recessions in its 55-year history. Based on the company's perseverance and ability to adapt, I believe earnings will not only hit $1.43 again, but will be substantially higher. The balance sheet is in good enough shape, management is growing the business at a consistent pace, and Americans love steak. I think Ruth's will be earning $1.43/share again sooner than most people think.
And even if not, think of it this way: if Ruth's only manages to earn $1/share (a level it has at least earned for the past four years), its fair value would be $15/share. This represents a 36.4% upside from today's price.
Now, I am going to shorten the time frame to look at the last eight years of the company's performance. In this time period, Ruth's EPS grew by almost 20% a year. That is a tremendous rate of return, one that an investor might expect out of a growth company.
Next, we can take a look at the PEG ratio, which compares a company's P/E to its EPS growth rate to see if the valuation is justified. The lower the ratio the better, as that indicates the company is growing at a faster rate than its price can keep up (eventually it will). In general, a PEG under one is considered undervalued.
Ruth's PEG for the past eight years has been .90, indicating the price tracks earnings at about the same rate. This correlation means if Ruth's earnings double, the market price should also double.
Note: The EPS Growth Rate of 19.67% was calculated over a span of eight years from 2011-2019 with EPS ranging from ¢34/share to $1.43/share. 12/11 EPS was ¢34/share. It is cut off on the above graph.
Lastly, let's plot monthly closing stock price on the chart and see the price history for Ruth's relative to its earnings.
As we can see, the company has had three distinct periods. The first is a period of extreme overvaluation from 2004-2007, followed by significant undervaluation from 2008-2012, and ended by extreme overvaluation again from 2013-2018. Ruth's price history ends with market price/share reaching fair value in 2019.
We can learn two things from this graph:
- Prices always intersect with fair value over time.
- It is devastating to buy a great company for a lousy price.
When the company was first overvalued, it eventually fell to its fair value. Then, once the company was undervalued, it eventually rose to its fair value. Then, once the company was overvalued again, it fell to its fair value. Now, the price has fallen beneath its fair value (when we look past the anomaly of 2020).
Investors who bought Ruth's Chris in 2006 for over $23/share had to wait eleven years until 2017 to break even. On the other hand, investors who bought at the bottom of the financial crisis for ¢66/share, made 51x their money back if they sold at the peak in 2018. A $20,000 investment would have been worth $1.0 million. Even if you were not convinced in 2009, you could have waited until 2011 when the dust had settled and still made 9x your money back.
The moral of the story is you have to buy great companies at good or better prices. Investors have an opportunity to take advantage of the decline in Ruth's market price and make a handsome return in the long run.
FAST Graphs Valuation
This is one of my favorite graphs because it allows us to extrapolate historical growth rates. I picked the longest time frame available (17 years) because it provides nearly two decades of data and a low growth rate (6.02%).
Due to COVID-19, 2020 EPS will be significantly lower than the $1.52/share in this chart. So, let's be conservative and assume Ruth's can only manage to earn $1.43/share in 2025, the same as in 2019. If you recall, this aligns with my Realist DCF. In that DCF, I assumed Ruth's would have sales of $468 million, the same as in 2019.
If that is the case, Ruth's would be worth slightly over $20. Look at the small, highlighted green circle on the graph above 12/31/19. This represents what the company should be trading at today. My Realist DCF perfectly aligns with this, as in that model, the fair share price comes out to be $20.32.
The conclusion to draw is that Ruth's is not only undervalued by today's standards, but also undervalued by its future earnings based on its past seventeen-year growth rate.
Takeaway
I threw a lot of scenarios out there so I will concisely sum up all the positions based on a current price of $11.00 per share:
DCF Valuation:
- Pessimist's View: $15.12, 37.49% return
- Realist's View: $20.32, 84.75% return
- Optimist's View: $25.03, 127.54% return
FAST Graphs Valuation:
- Chartist View: $20.32, 84.75% return
Composite Average
- Multiple Method Valuation: $20.20, 83.63% return
By utilizing multiple scenarios and methodologies, we can quadruple check our accuracy. Averaging out the models, we can see there is potential to make an 83.63% return if the stock price rises to $20.20. Ruth's is a great company selling at a great price. Opportunities like these do not come along every day. I took advantage.
This article was written by
Analyst’s Disclosure: I am/we are long RUTH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Neither this article nor any comment, message, video, or interaction associated with it is to be taken as financial advice. Investors should always do their own research before executing any financial transaction. Raul Shah is not liable for any financial outcome which might occur. Investors assume full responsibility for their actions.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (12)
2) negative GDP growth for the foreseeable future
3) a broken supply chain
4) risk of inflation as the Fed continues to print money to fund their “socialism packages” — read: inflating asset prices exorbitantly above their fundamental value
5) risk of higher taxes to fund municipal/state shortfalls
6) risk of another credit/housing crisis as more people lose their homes and companies declare bankruptcies. I would expect a more realistic price target of $0.50.
Food and beverage costs: 127,597,000
Total restaurant operating expenses, for 1 year: 214,715,0002020 total lease liabilities,operating and variable(for the whole year, part of operating expenses):
37,877,000This is what basically pays the building lease and equipment rents. Some of their leases also have contingent rent provisions based on annual sales.Marketing and advertising of 15,432,000 is probably 100% cut.
So ... assuming full operation, total costs and expenses are 415 million dollars for a year. Divide by 12 and you get 34 million a month, before a single cut or allowance is made. Food and beverage is pretty variable, lets cut it by 75%So, 31,899,250 Food
General and administrative, 34,643,000, lets assume this has no changes.
Lease cost is 37,877,000, assume no cuts, nothing that may reduce rent or forbearance or anything.
Assumed remainder of non lease operating expenses ... 64,067,000(math is near bottom)Total is 168,486,000 / 12 = 14 million dollars a month burn.However, they are still doing business, which I did not account for. They closed about 29 locations that were unable to even meet fixed costs. The rest are still open, and it is safe to say that the open stores are making enough to pay fixed costs, or they would close. You likely can back out 70% of the lease cost from the burn, which probably puts the monthly burn closer to 10 million a month.The rest .... is "operating expenses". On average, labor - 30% of revenue, so 124,500,000 of operating expenses is labor. Management said they would take temporary pay cuts, and they probably laid off lots of people, so lets cut this down by 75% = 31,125,000 yearly labor cost.So, 37,877,000 + 124,500,000 = 162,377,000 .. 52,338,000 operating costs unaccounted for. Lets assume we can cut those by 50% =26,190,000This is not to mention, these guys have a pretty clean balance sheet. They have no debt besides their revolver, and very little in the way of interest costs. They would be a good candidate for a bank to loan to in a pinch, they had a healthy, profitable business before this that generated excellent FCF and would likely get an investment grade rating from an agency if they issued bonds.
