Ruth’s Hospitality Group: ‘Steak’ Your Claim To A 13% Free Cash Flow Yield With Upside, Part 2

In part one of my analysis of Ruth’s Hospitality Group (RUTH), I showed how the company should be able to sustain a free cash flow run-rate of $30-$35 million using conservative assumptions of no growth in same store sales and units nor any improvement in operating margins. In part two, I will show that significant increases in beef prices over the last few years have masked the substantial improvement in the operating expense ratio of the company.

The good news is that the company has been able to maintain its high level of customer satisfaction and service levels while producing operating leverage to higher same store sales with relatively flat employee counts. If the company is able to increase same store sales, I expect this trend to continue. However, there will be a point where the increase in customer traffic requires additional staff in order to maintain service levels and customer satisfaction. Monitoring the company’s guest satisfaction levels can alert investors as to when this may be necessary. Finally, I will also look at unit growth potential.

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Ruth’s Hospitality Group: ‘Steak’ Your Claim To A 13% Free Cash Flow Yield With Upside

Ruth’s Hospitality Group (RUTH), a $250 million market cap restaurant company, gives long-term investors the opportunity to potentially generate returns of over 13% a year, with additional upside due to its attractiveness to potential acquirers and modest growth prospects. While the company is certainly subject to the standard macro risks of any restaurant company, such as recession and high commodity costs, I believe the company’s ability to generate minimum sustainable free cash flows of $30-$35 million a year (12%-14% free cash flow yield), combined with a growing franchise income stream and the potential for incremental unit growth to boost free cash flow makes it a reasonable investment.

As a value investor, I am always interested in looking at a company that generates substantial amounts of free cash flow as a percentage of its market cap. On Wall Street there is a saying, “Earnings are an opinion, cash is a fact.” By focusing on sustainable free cash flow, an investor begins to think like an owner and not the typical transient trader who seems to dominate “investing” these days. A company’s sustainable free cash flow calculation has to incorporate numerous factors such as changes in working capital, cash taxes and capital spending.

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