Thinking About Restaurants

One of the very best industries to analyze early in your career is restaurants. The companies are generally very simple and the issues are usually clear. That does not mean it is easy to pick the best one. In fact, since individuals often have personal feelings about where they like to eat, it can often be quite difficult to pick the correct restaurant stock to invest in.

The first stock I ever analyzed in depth was McDonald’s in 1980 for a security analysis class at the University of Wisconsin.

Let’s go a little slower with these stocks than we did with the utilities.

The process will be the same. Let’s pick a “king if the hill”, and then start doing our “equity questions”.

Picking the King

I like to start with a company that has underperformed the market, and has valuation characteristics I like. I usually choose simple to understand companies with above average balance sheets. Often this leads to stocks with market caps around $1 billion dollars.

Let’s make Ruth’s Hospitality our king of the hill and try to knock it off. RUTH - $17 sells for about 14x TTM earnings and only about 12x what they earned in 2019. There is even a 3% dividend yield. The stock sells at 4x book and 1.1x sales. the market cap is $550 million. The growth strategy here is slow and steady adding 5-7 locations each year on a base of 150 locations. The US locations are company owned, and there is room for franchisees to grow outside the US. The balance sheet is reasonable and the company has been actively buying back stock. Beef prices and labor costs will be an issue. Since RUTH is a high priced restaurant, general economic conditions and corporate spending will be important.

I would make the case that RUTH could be a solid 10% grower, if economic conditions are decent.

RUTH vs McDonalds’s

There really not much of a choice here MCD - $269 sells for 34x earnings. Maybe MCD is a better choice in a terrible economy, but 34 times is silly. Starbucks is also 35x, so let’s pass there as well. Yum Brands is a seeming bargain at 29x, so let’s pass there as well. Let’s also dismiss Chipotle at 46x. In some industries we will just have to ignore the big caps. Let’s also dismiss Wingstop at over 10x sales.

RUTH vs Darden

DRI - $144 is a great operator, and I have owned this stock in the past. However, at 19x and near an all-time high I will pass.

RUTH vs Domino’s

I would really like to make a case for for DPZ or PZZA, they have done a decent job of expanding their menu’s and are great at delivery, but the stocks are just too damn expensive at over 30x

RUTH vs Jack in the Box

Now let’s do some tougher comparisons. It is ok to dismiss the “high growth, high expectations” stocks with little examination.

JACK ($70) sells for roughly the same PE multiple as RUTH. You could argue they have an above record of historical growth. I do not mind the food, and you could argue they have a more diverse menu than McDonalds’s. Maybe you could argue they have slightly better growth prospects than RUTH.

The problem is JACK also brings financial leverage. Interest coverage is about 3x. Given the stability of the business that might be ok for some, but not for me. If JACK sold for 10x earnings, maybe I would have to think harder, but for now I cannot get past the balance sheet.

You could also make the case the fast food business is less economically sensitive than RUTH’s business, but to me the bad balance sheet outweighs this potential positive.

The only other fast food company is Wendy’s (WEN - $30), at 27x and an all-time high I will pass.

RUTH vs Brinker International

EAT ($35) is a very tough competitor for king of the hill. The stock was $75 just a few years ago, and earning got near $4.00. Maybe I should bet on the rebound, but again the balance sheet scares me. Interest coverage is about 3x. The PE is about 13x on forward earnings, but might be cheaper on “earnings power”.

I used to eat at the original Chili’s on Greenville Avenue in Dallas before the company went public. I had a chance to eat lunch with Mr. Brinker shortly before his death. He was a nice man. Maybe I know this story too well. That can be a problem. Sometimes you can just get bored with an idea. Again if the balance sheet wad better i would be digging in to look further.

Reasonable folks could prefer this stock to RUTH. Expectations are fairly low with only 5 buys and 14 Hold/Sells.