It is safe to say that Ruby Tuesday (NYSE: RT ) has not had a good year so far. Year-to-date, the company's share price has fallen 3.5%, and it is down 23% from its 52-week high. In addition, the company has not been profitable for the last two years. However, I believe that Ruby still has plenty going for it.
For a start, a key point to note is that Ruby's losses over the past two years have been due to several non-cash goodwill impairment charges. These charges have resulted in the company reporting a three-year cumulative pre-tax loss under GAAP rules.
That said, the company is working hard to get itself back on track and return to profitability. Unfortunately, this has resulted in the operating margin falling as the company discounts and promotes heavily. During the company's fiscal fourth quarter, the restaurant's operating margin fell 2.6% year-on-year.
However, the company did note wider earnings before interest, taxes, depreciation, and amortization margins (up 3.5%) as a promotional TV advertising campaign ended. Interest costs also fell as the company paid off some of its mortgage debt. All in all, the company's year-over-year fiscal 2013 revenue fell 4.6%, and same-store sales declined 1% as Ruby Tuesday closed eight restaurants during the period.
Elsewhere, the company is in the process of completing a sale and leaseback program of its owned restaurants, aimed at reducing debt, which it is doing well. Cash rose 10% year-over-year and net book debt fell from $327 to $299, or 8.5%.
Ruby's transition is expected to continue through 2014 and management expects to generate $10 million to $15 million in cash from the sale of real estate, $6 million of which is expected to be spent on cost-saving initiatives. Management expects revenue to decline during the first quarter then begin to expand again during the second half of 2014.
Cash is king
However, what I believe the market is missing is the company's cash flow. Like many service companies, Ruby's selling costs are high, as wages consume a large portion of revenue. When it comes to the income statement, this means that depreciation charges have a much greater effect on operating income.
Moreover, Ruby's recent writedowns and goodwill revaluation charges have skewed the income statement. Nonetheless, these charges are non-cash and do not materially affect the company's financial position.
On a trailing-12-month basis, Ruby is loss-making, even on a trailing-24-month basis, which for prospective investors is not appealing. However, if we value Ruby using its cash flow, we get a different picture.
Excluding the effects of financing items on cash flow (operating cash flow-investing cash flow) over the last 12 months, Ruby has produced a cash inflow of $58 million, or roughly $0.95 per share.On trailing-12-month EBITDA of $97 million, this indicates a cash conversion ratio of slightly less than 60%.
Using this method to value Ruby Tuesday against its sector peers, we get an interesting result. Wendy's (NASDAQ: WEN ) is the largest company in the restaurant sector. During the last 12 months, the company generated $62 million in cash, excluding financing activities. On a per-share basis, this is worth around $0.16, or a price-to-cash-flow ratio of 53.5. In comparison, Ruby trades at a price-to-cash-flow per share ratio of 8.1.
Moreover, if we take Wendy's trailing-12-month EBITDA of $356 million, we find that the company's cash conversion ratio is only 17%, less than one-third of Ruby's. So, all in all on a cash-generation basis, Ruby looks cheap.
Value in an expensive sector
Ruby's recent declines mean that the stock is trading at a price-to-book valuation of around one. In addition, recent goodwill write-offs now mean the balance sheet is free of intangible assets, which can add an element of speculation to a relatively stable price-to-book value.
Take, for example, Ruby's closet competitor by market capitalization, Denny's (NASDAQ: DENN ) . At the end of the second quarter, Denny's had $301 million in assets and $299 million in liabilities, which gives indicative shareholder equity of $2 million, a book value of $0.02 per share.
However, the company has $48 million of intangible assets on its balance sheet. Remove these assets and the company has a tangible shareholder equity of -$46 million -- obviously it is not possible to arrive at a price-to-book value for this figure.
Ruby, on the other hand, has no intangible assets on its balance sheet. Additionally, overall the company has a relatively clean balance sheet with $1 billion in assets, $500 million in liabilities, and approximately $500 in shareholder equity. Overall, Ruby's has a tangible assets value of $8.4 per share and the company is currently trading below this level.
Cash generation is often the best way to value companies with high fixed costs such as service companies. Using this metric, Ruby's looks cheap when compared to its biggest peers in the sector. In addition, Ruby's is currently trading at a price-to-book ratio of around one with a relatively clean balance sheet. All in all, the company looks very attractive.
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