A Turnaround Looks to Be in Full Swing at This Restaurant Chain

Spotting a turnaround, let alone investing in one, is one of the most difficult aspects to investing. This is especially true when it comes to restaurant turnarounds. A restaurant not only has to get diners into its establishments with an appealing menu, but many times it also has to get customers back that chose to never return because of a bad experience.

One chain that has struggled over the past few years is Ruby Tuesday (NYSE: RT  ) . While Ruby Tuesday has made several missteps, a good portion of its problems have come from a very competitive environment. Ruby Tuesday faces competition for hamburgers and casual dining fare from competitors such as Applebee's, owned by DineEquity (NYSE: DIN  ) , and Chili's, which is owned by Brinker International (NYSE: EAT  ) .

Improvement in the latest quarter
Ruby Tuesday's latest results were a step in the right direction. While the company is still facing some struggles, it made progress in its third quarter. Same-restaurant sales decreased 1.9% at company-owned restaurants and 2.2% at domestic franchise restaurants compared to the prior year. While the results were still negative, they were an improvement over the 6.3% decline in the second quarter.

The results were also better than many analysts had expected. Earnings per share came in $0.01 better than expectations, and revenues were $11.33 million higher than analyst estimates.

Total sales were $11.8 million lower than last year. This is because the company had 30 fewer company-owned restaurants. Part of the company's turnaround efforts has been closing underperforming locations, which is a good move by management.

Further improvement expected
Management is expecting a further rebound in same-restaurant sales as we head into the company's fourth quarter. Same-restaurant sales are expected to be in the range of between negative 1% and positive 1%. The company plans to close six to nine more restaurants, and also expects to generate $2 million to $4 million from the sale of real estate and $3 million from a reduction in selling, general, & administrative expenses.

New menu items and advertising helping bring customers back
Ruby Tuesday has done a good job introducing new menu items and helping to create awareness about them. New menu items in the latest quarter include different flatbread choices, a combination entree of ribs and southern style chicken tenders, shrimp & grits, and baked ravioli. These new menu items came on the back of the company's new pretzel burger that it introduced last summer.

To better compete with Applebee's and Chili's specials, Ruby Tuesday launched its program of 20 meals under $10. This is a direct challenge to Chili's and Applebee's "2 for $20" programs. Ruby Tuesday also did a national advertising campaign to boost awareness. I think that this program helped to stem the same-restaurant sales decline in the third quarter. The new menu items have proven quite popular, and now account for 25% of all sales.

Ruby Tuesday faces intense competition
The biggest obstacle to Ruby Tuesday's turnaround is the vast amount of choices consumers have when it comes to dining out. Of the competition out there, Chili's and Applebee's have similar menu items, similar promotions, and target the same clientele. Both are serious competitors for Ruby Tuesday and have been outperforming the company in terms of sales. They also benefit from having strong parent companies.

Chili's owner Brinker International also owns Maggiano's Little Italy. In Brinker International's most recent quarter, comparable restaurant sales at company-owned restaurants increased 0.8%. Chili's domestic comparable restaurant sales increased 0.3%. Most of the growth was in Chili's international restaurants where comparable restaurant sales increased 1.4%, which marked the 16th consecutive quarterly increase.

For Applebee's, its owner DineEquity has seen its strong performance come from its IHOP restaurants. Applebee's has been affected by the competitive casual dining market as well, posting a domestic comparable restaurant sales decline of 0.7% in its most recent quarter. IHOP, on the other hand, saw its domestic comparable restaurant sales increase 4.5%.

Foolish assessment
It certainly helps Brinker International and DineEquity to have other restaurant concepts in their portfolios. Ruby Tuesday does as well, with its Lime Fresh Restaurants. However, there are only 28 locations of that restaurant, and that is not enough to offset the weakness from the company's 755 Ruby Tuesday locations.

Shares of Ruby Tuesday certainly look attractive. Its PEG ratio is 0.43 and shares trade at 0.34 times sales and 0.87 times book. Shares are also down over 23% in the past year, while shares of DineEquity are up over 10% and Brinker International is higher by almost 33% in the past year. Both companies also pay a dividend, while Ruby Tuesday does not.

For investors, the key is management continuing to execute and make improvements. Investing in turnarounds is not without risk, but management at Ruby Tuesday is making progress and I like both the company's food and value proposition. For investors willing to take the risk, I think that Ruby Tuesday is worth the potential reward if the turnaround continues.

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