Ruth's Hospitality Group (NASDAQ:RUTH) had another difficult year in 2021 due to COVID-19 headwinds but managed to eke out a 12% gain, beating out some dine-in names, but slightly underperforming the restaurant industry group. The underperformance can be attributed to the fact that dine-in names had a more difficult time growing sales in the pandemic, while brands with high digital penetration in the fast-food/fast-casual space had an easy time adapting. With a full earnings recovery expected by FY2023, I see Ruth's as a decent buy-the-dip candidate. Having said that, with the stock up ~30% off its lows, I see the best course of action is to be patient for a dip before entering new positions.
(Source: Company Presentation)
In November, Ruth's Hospitality Group ("Ruth's") released its Q3 results, reporting restaurant sales of $97.5 million and total revenue of $104.2 million. This translated to a 1% increase on a two-year basis, easily outperforming names like Red Robin (RRGB), which saw revenue decline on a two-year basis in Q3 despite menu price increases. This solid performance was driven by 7.6% comp sales growth across the system and would have been up nearly 15% if not for three markets that were hit the hardest: Boston, Hawaii, and Manhattan.
The softness in Chicago and Manhattan can be attributed to a stalled and slow return to the office, and with JPMorgan (JPM), Citigroup (C), and Goldman Sachs (GS) recently pushing back return-to-office plans, this could be a minor headwind. However, in Hawaii, the state announced it would welcome fully-vaccinated tourists back last November, which should help Q4 and Q1 sales. So, while there are offsets from the recent Omicron surge that could continue to weigh on Manhattan and Boston, investors should be excited about Hawaii re-opening.
(Source: Company Filings, Author's Chart)
As shown in the chart above, Ruth's posted 1% revenue growth on a two-year basis in Q2 2021 and Q3 2021, but Q4 is expected to be a tough quarter due to lapping record revenues in Q4 2019. Fortunately, while the Q4 results could look much uglier on a two-year basis, Ruth's is expected to return to growth vs. pre-COVID-19 levels in Q1 2022 and Q2 2022 based on estimates. In fact, if Q2 2022 revenue estimates of $116.8 million are met or beat, this would represent a record Q2 for the company. This is being helped by new openings (a new location in Short Hills, NJ opened in September, Lake Grove, NY opened in December), an expected recovery in Hawaii, Manhattan, and Boston, and menu price increases, with September pricing up 4.5%.
Looking ahead, Ruth's is ramping up unit growth, expecting to open five company-owned restaurants before year-end 2022 and two franchisee-owned restaurants. This would translate to mid-single-digit growth vs. its current restaurant base, which sits at approximately 150 restaurants. So, while the company certainly isn't immune from COVID-19 headwinds with traffic negatively impacted in key markets, it has managed better than some of its peers. This is especially true on the staffing front, which is critical to providing a great guest experience and allowing the company to run at or near capacity in its restaurants. This is the opposite of Red Robin or BJ's (BJRI), which have had to limit seating capacity in some restaurants due to staffing shortages.
(Source: Company Presentation)
During the Q3 call, Ruth's company noted that staffing levels had improved, sitting at 90% staffing levels vs. 2019, helped by efficiency changes. Meanwhile, from a margin standpoint, labor actually came in 400 basis points better than 2019 as a percentage of sales, which is certainly encouraging. It's important to note that there will be some give-back on margins as an additional manager is added back to stores. However, the company expects to retain 200 basis points of gains on labor helped by efficiencies, including a more productive menu, better labor management, and demand forecasting. This helped offset the margin headwinds due to inflationary pressures on protein, with margins actually up 80 basis points vs. 2019 in Q3.
Unfortunately, with the emergence of Omicron, we could see some impact on sales in the late Q4 and Q1 2022 results and could also impact staffing due to team member exclusions. This is due to the high positivity rate of Omicron vs. Delta, even if Omicron is believed to be less severe. The impact on sales could be pronounced in Canada, where Ruth's has six of its franchisee-owned restaurants. Importantly, three of these restaurants are located in Ontario, which has barred indoor dining due to the recent surge in Omicron cases. This includes franchisee-owned restaurants in Niagara Falls, Markham, and two restaurants in Toronto, with the potential for increasing restrictions in other provinces (Edmonton and Calgary in Alberta).
While the impact on franchisee-owned restaurants could dent sales, this is partially offset by what should be a strong recovery in Hawaii, which can pick up some of the slack. This is because while four franchisee-owned restaurants will see impacts in Q1 due to the recent ban on indoor dining in Ontario, four restaurants are now open in Hawaii, including Honolulu, Wailea, Waikiki, and Mauna Lani. Meanwhile, though it's early to call this the peak, daily COVID-19 cases look like they may have topped, though it's still early to confirm this. With this being another key market for Ruth's, this would be encouraging. Let's take a look at recent earnings estimates below:
As shown below, the pandemic put a massive dent in Ruth's earnings in FY2020, with annual EPS sliding from $1.43 to a net loss of $0.20. However, FY2021 is expected to see a solid recovery ($1.08 vs. $1.43), helped by comp sales growth in most markets, and a recovery in the hardest-hit markets in Q4. If we look ahead to FY2022 and FY2023, annual EPS is projected to come in at $1.34 and $1.57, respectively, which would be a complete recovery if these estimates are met. As noted, this is being helped by what should be better sales performance as we see a steady return to offices and mid-single-digit unit growth.
(Source: YCharts.com, Author's Chart)
Obviously, a worsening situation with Omicron or a new variant could put a dent in earnings, as could dine-in restrictions. However, President Joe Biden has stated that his plan to fight COVID-19 does not include shutdowns or lockdowns, so Ruth's should be safe in its core markets, even if traffic is a little light with some diners possibly a bit apprehensive about dining in with rapidly rising cases. Having said all that, even if Ruth's misses FY2023 estimates and comes in at $1.48, this would still represent a new all-time high for annual EPS, a respectable recovery for a dine-in name that hasn't been able to rely on an off-premise sales boost like some fast-casual peers. Based on a current share price of $21.00, Ruth's trades at less than 16x FY2022 earnings estimates, which is a reasonable valuation.
Looking at Ruth's valuation below, we can see that the stock has historically traded at 17x earnings and has traded at closer to 19x earnings over the past decade. Given the industry-wide staffing headwinds and continued inflationary pressures, I believe it makes the most sense to use the lower multiple of 17x earnings to be more conservative. After multiplying this figure with FY2023 annual EPS estimates of $1.57, Ruth's fair value comes in at $26.70. However, since we're using two-year forward estimates, I believe it's best to use a more conservative figure of $1.48 and bake in a potential miss, which translates to a fair value of $25.16.
The goal should be to buy at a meaningful margin of safety, with the ideal margin of safety for small-cap names being a minimum of 25% from fair value. After applying this discount to the 18-month target price of $25.65, I see a low-risk buy zone for Ruth's of $18.90 per share. With Ruth's currently trading above $21.00, the stock is now well outside of this buy-zone. So, while I do see upside to fair value from current levels, I don't see enough of a margin of safety yet to justify chasing this rally. Let's take a look at the technical picture:
Moving over to the technical chart, we can see that RUTH has support at $17.75 and resistance at $23.05. In my most recent update, I noted that the stock would become attractive below $17.85 per share, and the stock found immediate support in this area. However, with Ruth's rallying nearly 20% from this level and finding itself in the upper portion of its trading range, the stock is now much less attractive, with the reward/risk ratio sitting at 0.63 to 1.0. This is well outside my preferred reward/risk ratio of 4 to 1. So, while Ruth's valuation is not unreasonable, even if it misses FY2023 estimates of $1.57, the stock is well outside its low-risk buy point from a technical standpoint. With an increased risk of staffing and traffic headwinds, it makes sense to buy dips, not chase rallies.
Ruth's posted decent sales performance last year, with most of its restaurants enjoying positive comps vs. 2019 levels and revenue being dragged down by mainly six restaurants. If the underperforming portion of the system can finally bounce back in 2022, we should see a near-complete earnings recovery vs. 2019, with a high likelihood of an all-time high in annual EPS in FY2023.
Therefore, I remain optimistic about RUTH's long-term. However, with the stock nearly 20% above its low-risk buy zone, I have taken profits on my small position purchased near $17.50. If the stock pulls back into a low-risk buy zone below $18.00, I may look to start a new position in the stock.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.
Additional disclosure: Disclaimer: Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.