Posted: Jan 07, 2011 03:00 AM by Ryan C. Fuhrmann

Restaurant operator Ruby Tuesday (NYSE:RT) reported impressive second-quarter results on Wednesday. The firm’s near-term prospects have improved markedly, but ambitions to diversify into other restaurant concepts are fraught with uncertainty and could destroy value for shareholders. (For background reading about investing in this sector, see Sinking Your Teeth Into Restaurant Stocks.) 

Ruby Tuesday’s Q2
In the second quarter, total sales for the casual dining chain grew a very respectable 6.2% to $290.5 million, while same-store sales improved 4.2% and the company bought three stores from a franchisee in Kentucky. Management boasted that this was the “third consecutive quarter of positive same-restaurant sales, and our strongest quarterly sales percentage in almost five years”. The company also boasted that it had beaten the industry by three points over the last two years.

Total costs increased 5.4% to lag sales growth and allow for sales leverage. As a result, operating earnings jumped 44.3% to $7.8 million. Interest expense fell dramatically to offset higher income taxes and pushed net income up by nearly 10 times to $4.6 million, or 7 cents per diluted share.

Outlook for Ruby Tuesday’s
For the full year, analysts expect sales to grow a couple of percent and reach just over $1.2 billion. The company currently projects earnings between 76 cents and 86 cents per diluted share.

As consumers return to dining out, Ruby Tuesday’s is benefiting, but it is also seeing improvements due to new menu items that are focused on providing lower prices and healthier food options. Its capital expenditure levels are currently quite moderate and are allowing for impressive free cash flow generation. The company didn’t provide a cash flow statement during the quarter, but free cash flow last year was nearly $123 million, or almost $2 per diluted share. 

Management is also committed to “converting certain underperforming company-owned restaurants to other high-quality casual dining concepts.” This last strategy is the most risky but will determine whether the company can return to consistently positive sales and profit growth. Current conversion concepts mentioned during the quarter include Jim ‘N Nick’s Bar-B-Q, Truffles, an upscale café concept, and Lime Fresh Mexican Grill.

The Bottom Line
Despite the company’s improved near-term fortunes, sales have fallen steadily for three straight years and will likely be flat for the current fiscal year compared to last. The valuation is very appealing at a free cash flow multiple in the single digits, but it’s difficult to see the new concepts making a meaningful contribution to either the top or bottom line any time soon. As such, concepts that focus on a single brand, such as Chipotle (NYSE:CMG), P.F. Chang’s (Nasdaq:PFCB) or Cracker Barrel (Nasdaq:CBRL) look like safer bets right now, as do firms such as Darden (NYSE:DRI), which has a solid track record of balancing many restaurant franchises. (For related reading, also check out 3 Scrumptious Restaurant Stocks For 2011.)

http://stocks.investopedia.com/stock-analysis/2011/Ruby-Tuesdays-Dubious-Diversification-Strategy-RT-CMG-CBRL-DRI-PFCB0106.aspx