Market Misses the Boat on Ruth's Hospitality

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Everyone's favorite steak stock reported earnings Friday. The results were savory -- and support my prior thesis about Ruth's Hospitality (Nasdaq: RUTH  ) -- but thus far have failed to impress the market.

Earnings per share, excluding one-time benefits, came in at $0.10 versus $0.08 for the quarter last year, a 25% year-over-year increase. Revenue increased a much smaller 4.75% for the quarter. Growth was driven by same-store sales growth of 5.8% in Ruth's Hospitality-owned steakhouses and 7.1% in franchisee-owned steakhouses.

The fact that earnings grew by a larger amount (25%) than revenue (4.75%) is indicative of the significant operating leverage I wrote about earlier. Further evidence is found in Ruth's restaurant operating expenses, as a percent of sales, decreasing 1.5 percentage points for the quarter. As the fixed costs of running a fancy restaurant are met with greater sales, additional revenue is falling straight to the bottom line.

Higher beef costs
However, Ruth's does have one big variable cost. And judging by the stock's performance Friday -- at one time down 7% -- Wall Street focused on this item.

Food and beverage costs increased 1.2% primarily due to beef inflation. The USDA Prime cut meat that Ruth's serves is not that easy to come by -- only 2% can make the grade -- so as demand comes back with the economy, so does higher pricing. Joy, joy.

Skittish Ruth's investors may want to diversify their holdings with Market Vectors Agribusiness ETF (NYSE: MOO  ) . The exchange-traded fund holds a basket of agribusiness stocks that should benefit from higher commodity prices. However, I don't recommend buying this unless you also think commodities are going to soar, as commodities stocks are an imperfect proxy for the extra-special beef Ruth's relies on.

I also believe Ruth's newly improved balance sheet gives the company the strength to weather fluctuating commodity prices. Shareholder equity is now at $96.3 million, supporting $240 million in total assets. Compare that with competitor Morton's Restaurant Group, which is supporting assets of $201 million with only $13 million in shareholder equity. That's like buying a house with only 6.5% down.

I know which stock I could sleep at night owning.

Still an attractive bet
The basic qualities that made Ruth's an attractive bet are still in place. Ruth's Chris is still a go-to place for steak, management is still projecting free cash flow of $21 million to $23 million, and the stock continues to trade at around 10 times that number. As things get better, they still have operating leverage to accelerate results, along with the balance sheet to withstand changes if they don't.

Fool contributor Chris Baines is a value investor. Follow him on Twitter @askchrisbainesChris's stock picks and pans have outperformed 89% of players on CAPS. Chris owns no shares of the companies mentioned. 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.

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10/21/2016 4:00 PM
RUTH $14.65 Down -0.15 -1.01%
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MOO $49.75 Down +0.00 +0.00%
Market Vectors Agr… CAPS Rating: ****