Restaurant stocks are not the market's favorites right now as investors fear that rising inflation and a potential recession could hurt demand as customers skip going out to eat in order to save money. But I think a company at the top of the food chain in terms of fine dining like Ruth's Hospitality Group (RUTH) may be able to fare better than the market is giving it credit for. Here's why I think that Ruth's is well-positioned going forward. 

Staff at high end steakhouse restaurant await customer

Image source: Getty Images

Franchise player 

Ruth's Hospitality Group operates fine dining steakhouses under the name Ruth's Chris Steak House. It has 150 locations, with about half of these company-owned and the other half franchised. I like Ruth Chris' franchise-focused approach because a franchise-based business model tends to be asset-light and boast high margins. This is because most of the fixed costs are borne by the franchise owner. Ruth's collects an upfront franchise fee plus ongoing royalty payments based on about 5% of revenue. Using investors and franchisees to fund growth with new locations also allows companies like Ruth's to expand rapidly.

Ruth's management says it has "significant room for continued unit growth," and is aiming to open five to seven new restaurants annually. The company has 23 franchise-owned establishments in locales across the world, ranging from Aruba, Canada, and Mexico in North America to Singapore, Indonesia, and Taiwan in Southeast Asia. Continued expansion internationally and in Southeast Asia specifically could represent a significant growth opportunity for the company if it is successful there. 

Ruth's also seems to enjoy a good rapport with its franchisees. For example, the company waived royalty payments during the COVID pandemic until dining rooms fully reopened, a sensible gesture of goodwill that should go a long way with franchisees and prospective franchisees.

Top of the food chain 

While the company was affected by the COVID-19 pandemic as restaurant dining rooms were shut down, by the end of 2021 the company's revenue and traffic were approaching pre-pandemic levels. Ruth's is seen as one of the premier fine-dining chains in the U.S., which gives it high brand recognition and pricing power. The company's position at the top of the food chain likely gives it some resilience as consumers at the high end of the economic spectrum are less likely to need to cut spending on things like dining out in the event of a tightening economy.

Case in point, the company raised prices on certain products 3.4% in March to deal with inflation, but reports that it "[has] not seen a noticeable change in mix and traffic due to this increase." Also, since Ruth's is viewed as a premium destination, customers may still splurge and go there for a special event. 

There's also reason to believe that perhaps the consumer is stronger than generally perceived. For example, on American Express's (AXP 0.27%) earnings call on Friday, July 22nd, CEO Stephen Squeri reported that billed business was up 30% thanks to a "vigorous rebound in travel and entertainment spending." A strong consumer looking to spend on dining and entertainment certainly bodes well for Ruth's. Because of its business at the heart of commerce, American Express has a good read on the consumer, and Squeri reported that he didn't see any "significant signs of stress" in American Express' customer base. 

Where's the beef? 

While inflation has been a familiar headwind to restaurant stocks in 2022 as their input costs have risen, good news may be around the corner. Raymond James (RJF 0.10%) recently added Ruth's to its Analyst Current Favorite list, saying that it expects continued outperformance in the fine dining segment and that Ruth's should benefit from "second half commodity deflation as it laps exceptionally high Prime grade beef costs in the second half of 2021." In other words, while the outlook for many stocks is tempered by fears of rising inflation, Ruth's may have already survived through the worst of inflation, and is now on the downslope.

Lukewarm valuation, sizzling shareholder returns

Ruth's is valued at a reasonable 13 times earnings, and is even cheaper at 10 times forward earnings -- well below the market average. A price-to-earnings-growth (PEG) ratio of just under one also seems to indicate that shares are at least slightly undervalued.

In addition to this modest valuation, Ruth's also pays a dividend with a market-beating yield of 3.3%. The company suspended the dividend during the height of the pandemic in 2020 and resumed it this February at $0.12 a quarter, subsequently raising it to $0.14 in May. The company is also returning capital to shareholders via share repurchases, including $16.6 million in share buybacks in 2021, and still has $25 million left in its existing share repurchase authorization.

Is Ruth's Hospitality a buy?

With the worst of beef inflation perhaps in the rearview mirror and the company better-positioned in the event of a declining economy than one might expect at surface level, Ruth's Hospitality looks like a sensible portfolio addition. The company's asset-light, franchise-heavy business model and potential for further international growth are attractive, and investors also get paid a 3.3% dividend yield for owning shares.