Ruby Tuesday Bouncing, Not So Fast

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The casual diner chain has fallen substantially from its 2006 high of $33 per share with an April 1 closing price at $7.79. To turn the company around, J.J. Buettgen (a former Darden executive) is looking to reposition the company through a new brand and a bit of balance sheet restructuring.

The plan is simple; sell-off secondary brands and focus on developing Ruby Tuesday (NYSE: RT), reduce prices and target lower-end consumers rather than compete with quasi-luxury brands like Outback and Red Lobster, utilize sale-leasebacks of 340 properties to stimulate growth, and employ more of a franchise model. However, this plan could encounter multiple problems along the way.

While the sale leasebacks have been estimated by some to be worth as much as $500M they would only provide temporary cash inflows and long-term would ultimately be detrimental to earnings. Buettgen has made it clear his intention is to increase TV as spend; however, additional advertising dollars will only go so far for the company and it will ultimately need a competitive advantage; Buettgen’s plan, reestablish the brand for the lower end consumer.

As the company looks to reestablish the Ruby Tuesday brand to appeal to lower-end consumers it may find itself in a price war straight to the bottom. Darden Restaraunts (NYSE: DRI) has recently announced plans to restructure several of its brands including Olive Garden and Red Lobster by slowing growth in new restaurant openings and lowering prices. This is almost identical to the plan put in place by Buettgen (once again, a former Darden executive). Despite its best efforts, Ruby Tuesday may be forced to remain a quasi-luxury brand in the industry or face further margin contraction (net margins were 8% in 2012 versus 16% in 2007).

Expectations for a Ruby turnaround are so high that there is little upside left in the shares. At $7.67 the shares trade at 18x TTM EPS. Management is targeting EBITDA of $125-135M within 3 years, a 40% increase from current levels, despite cost cutting and a reduction in the footprint of the business. Additionally, even if the company can maintain its 8% net margin, this target would require revenue growth of roughly 25% from the consensus FY13E of $1.3B.

 While Buettgen’s plan looks good at face value, competition in the industry may prevent it from ultimately succeeding. I believe there are too many headwinds facing the restaurant chain for it to warrant its current valuation. While the company can certainly grow and looks poised to do so, the opportunities its facing are too heavily offset by continuing competition from Darden. Additionally, lower PE multiples in more developed competitors Brinker, Darden, and DineEquity (13.5x, 15.6x, 16.4x respectively) appear much more attractive especially considering the high dividend yields they offer (2.2%, 4.1%, and 4.3% respectively).

Zach Carvalho has no position in any stocks mentioned. The Motley Fool owns shares of Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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