Setting the Table for a Strong 2013

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Ruth's Hospitality Group (NASDAQ: RUTH) is a company that cleaned up its balance sheet in 2012 and has (compared to its peers) solid fundamentals, a well-balanced growth plan, and management that is relatively new but experienced and motivated. Due to these factors, the company's stock could increase substantially in the next several months and it might even be considered an acquisition target by a larger restaurant chain or a private equity firm. Investors looking for a small cap company with profitable and stable growth ahead should consider Ruth's.

Valuation and Fundamentals

Ruth's operations date back to 1965, when single mother Ruth Fertel mortgaged her house to purchase New Orleans-based restaurant, Chris Steak House. Today, the company has 136 restaurants (64 company owned and 72 franchised) including 19 company operated Mitchell's Fish Market restaurants and 17 franchised international restaurants. Ruth's has 35.5 million shares outstanding for a market capitalization of $267 million and an enterprise value (EV) of $325 million as the company had $65 million of long-term debt (net of cash) as of Sept. 23, 2012.

Ruth's can be compared to four other publicly traded companies in the restaurant industry, including Del Frisco's Restaurant Group (NASDAQ: DFRG), BJ's Restaurants (NASDAQ: BJRI), Ignite Restaurant Group (NASDAQ: IRG), and Famous Dave's of America (NASDAQ: DAVE). Below is a table showing several valuation metrics for each company:

<table> <tbody> <tr> <td> </td> <td> <p>RUTH</p> </td> <td> <p>DFRG</p> </td> <td> <p>BJRI</p> </td> <td> <p>IRG</p> </td> <td> <p>DAVE</p> </td> </tr> <tr> <td> <p>Market Cap*</p> </td> <td> <p>267</p> </td> <td> <p>375</p> </td> <td> <p>962</p> </td> <td> <p>333</p> </td> <td> <p>71</p> </td> </tr> <tr> <td> <p>EV*</p> </td> <td> <p>325</p> </td> <td> <p>367</p> </td> <td> <p>950</p> </td> <td> <p>358</p> </td> <td> <p>94</p> </td> </tr> <tr> <td> <p>Rest. Owned</p> </td> <td> <p>64</p> </td> <td> <p>32</p> </td> <td> <p>125</p> </td> <td> <p>145</p> </td> <td> <p>53</p> </td> </tr> <tr> <td> <p>Franchised</p> </td> <td> <p>72</p> </td> <td> <p>n/a</p> </td> <td> <p>n/a</p> </td> <td> <p>n/a</p> </td> <td> <p>134</p> </td> </tr> <tr> <td> <p>Forward P/E</p> </td> <td> <p>13.7</p> </td> <td> <p>16.7</p> </td> <td> <p>25.7</p> </td> <td> <p>17.1</p> </td> <td> <p>13.2</p> </td> </tr> <tr> <td> <p>EV/EBITDA</p> </td> <td> <p>7.6</p> </td> <td> <p>9.8</p> </td> <td> <p>11</p> </td> <td> <p>7.5</p> </td> <td> <p>7.4</p> </td> </tr> <tr> <td> <p>PEG Ratio</p> </td> <td> <p>1.3</p> </td> <td> <p>1.6</p> </td> <td> <p>1.5</p> </td> <td> <p>1</p> </td> <td> <p>0.6</p> </td> </tr> <tr> <td> <p>Price-to-sales</p> </td> <td> <p>0.7</p> </td> <td> <p>2</p> </td> <td> <p>1.4</p> </td> <td> <p>0.7</p> </td> <td> <p>0.5</p> </td> </tr> <tr> <td> <p>Price-to-CFO</p> </td> <td> <p>5.9</p> </td> <td> <p>12.2</p> </td> <td> <p>9.1</p> </td> <td> <p>7.8</p> </td> <td> <p>7</p> </td> </tr> </tbody> </table>

P/E – price-to-earnings; EBITDA – earnings before interest, taxes, depreciation, and amortization; PEG – P/E-to-growth; CFO – cash flow from operations; Source: Thomson, author's estimates, SEC filings; *In $$ millions.

It is clear from the above table that Ruth's has solid fundamentals as well as a respectable size. Only Famous Dave's valuation metrics are better than those of Ruth's in all categories except price-to-CFO. The reason is that Famous Dave's has more franchises than company owned restaurants. However, on the negative side, franchise restaurants generate a fraction of the revenues and cash flow of company owned and operated restaurants.

In addition to favorable valuation metrics and strong cash flow generation power, Ruth's balance sheet allows the company further flexibility. Following a debt reduction in 2011, in March of 2012, Ruth's retired its preferred shares that were paying 10% interest per year by using cash on hand and a senior revolving credit facility at a cost of 3.15% per year. Ruth's cash flow generation ability and relatively low debt level allow the company to grow at a reasonable price without compromising its financial soundness.

2013 Growth Initiatives

During 2013, Ruth's plans to open a new company-owned restaurant in Denver, a restaurant under a management agreement (similar to franchise) with Harrah's casino in Las Vegas, and four to five franchised restaurants. These new locations, together with an expected increase in foot traffic at Mitchell's Fish Market and higher utilization at Ruth's Chris Steakhouse (due to new promotions as discussed in the Q3 2012 conference call) should more than offset the expected higher food inflation and specifically in the price of premium beef.

Del Frisco's, BJ's, Ignite, and Famous Dave's most recent plans are to open new restaurants in 2013. Del Frisco's, with 4-5 new restaurants slated for opening in 2013, will increase the number of its restaurants by 12%-15%. BJ's plans to open 17 new restaurants in 2013 or an increase of 13.6%. Consistent with the 2012 new restaurant opening rate, Ignite should open about 12 new restaurants in 2013 or a rise of about 9%. And finally, Famous Dave's should add about 15 new restaurants (2 of which will be company owned) in 2013, an increase of about 8% from 2012.

Expected growth in these four competitors is much higher than the 5.1% increase in restaurants for Ruth's. In an environment where the economy is still recovering and disposable incomes are falling, it could be a dangerous bet to grow your restaurant base faster than 5%. This is especially true for a country already saturated with chain restaurants.

Management

Most recently Ruth's appointed Peter Beaudrault to be president and chief operating officer of Mitchell's Fish Market while keeping his predecessor on in a consulting role. This signifies that Ruth's will continue growing its seafood themed Mitchell's Fish Market. This appointment was preceded by installing a new CEO, president and chairman of the company, Michael O'Donnell, and a new CFO, Arne Haak. These three executives all joined relatively recently from other companies and they should be strongly motivated to prove themselves at their new positions.

Conclusion

Ruth's has most of the ingredients necessary for a good stock performance including solid fundamentals, reasonable growth rate, and a new but seasoned senior management. The company is well-positioned to serve both lovers of high-quality steaks/seafood and investors who like solid investments. Bon Appetit!


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