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Bottom of the Barrel: A Rare Chance in the Restaurant Business

If you're hungry to invest in the restaurant sector, you might want to consider this rare opportunity.

Atlanta-based Rare Hospitality (RARE) serves up steak -- and plenty of it. With a trio of steakhouse chains under its roof, this restaurant company continues to expand from its Southeast roots. Over the past five years, it has grown restaurant revenue by more than 15% annually.

A Beefy Trio

Rare Hospitality sports three restaurant concepts: its flagship LongHorn Steakhouse, a chain of 152 midpriced steakhouses primarily in the Southeast and mid-Atlantic; Bugaboo Creek, a chain of 19 midpriced steakhouses in the Northeast; and The Capital Grille, 15 high-end steakhouses in the eastern half of the U.S.

LongHorn is the workhorse of Rare's stable, providing nearly 70% of its sales. Modeled after a prototype Texan steakhouse, LongHorn serves choice beef with a full-service bar. Fourth-quarter revenue at LongHorn grew 12.8%, driven by the opening of 19 new restaurants in 2001 and 1.8% growth in same-store sales . Rare plans to open 17 to 20 new LongHorn restaurants in 2002 and anticipates same-store sales will grow 1% to 2% in 2002.

Bugaboo restaurants, which contribute about 13% of Rare Hospitality's sales, bring the flavor of a Canadian Rockies lodge to New England. In the fourth quarter, Bugaboo posted a 10% increase in fourth-quarter revenue, including a record 10th consecutive quarter of same-store-sales growth. The company expects Bugaboo's same-store sales to grow 1% to 2% in 2002 and plans to open three new Bugaboo restaurants in 2002.

At a Glance
Rare Hospitality International (RARE:Nasdaq)
Current Price $25.46
52-week Range $32.00 - $14.50
P/E Ratio* 17.6
Market Cap $536.6 million
Avg. Daily Volume 265,590
Inst. Ownership 94%
Dividend Yield N/A
Beta 0.6
Company Web site www.rarehospitality.com
*Based on 2002 Estimates Source: Market Guide, Zacks, Company Reports

The Capital Grille restaurants under the Rare banner account for about 15% of the company's sales. The Capital Grille is an upscale steakhouse and seafood restaurant, often compared to Smith & Wollensky (SWRG). Its revenue increased nearly 30% in the fourth quarter, thanks to three additional restaurants opening over the past year and a 1.6% increase in same-store sales.

Even as all three concepts have performed well, especially in a challenging economic environment, one analyst thinks the chains can weather a longer downturn and grow as the economy accelerates.

"An economic recovery should benefit all of the company's concepts in the way of increased traffic and potential price increases," notes restaurant analyst Matthew DiFrisco of SunTrust Robinson Humphrey. "Already the company's concepts are well-positioned in terms of pricing: LongHorn has a lower average ticket than Outback Steakhouse; Capital Grille has a lower average ticket than Smith & Wollensky. Not only does more competitive pricing make the company's concepts more attractive in a slow economy, but it provides for more pricing opportunity, given an uptick in the economy."

DiFrisco gives Rare Hospitality an outperform rating, and his firm has not provided banking services for the company.

Prudent Management

Rare has been conservative with its growth plans, its revenue and earnings estimates and its managed costs, hallmarks of successful restaurant operators.

A combination of that discipline and a successful growth strategy gives DiFrisco reason to think Rare Hospitality may surprise investors in 2002. Management has offered guidance for this year's earnings estimates of $1.38 to $1.43 a share.

"We see upside to management's 2002 guidance because the company continues to be a strong operator and is now amid a very attractive cost environment," he notes. " U pside to our fourth-quarter estimate was in large part due to lower-than-expected G&A general and administrative expenses, reflecting improved management retention and prudent reductions in travel expenses and management bonuses."

G&A expenses declined to 6.1% in the fourth quarter from 6.7% in the year-ago fourth quarter.

A good example of management's conservative approach is its economic worldview. The company has budgeted growth on the basis of a slow economy for the entire year, while most pundits think growth will accelerate in the second half of the year. That focus on cost control and margin support should allow Rare to meet its 2002 earnings guidance. That represents 11% growth in a weak economy. If the economy perks up, same-store sales growth will fuel faster earnings growth, potentially as high as 15% more than 2001 levels.

Toughing It Out

Although the outlook for the year is bright, the first quarter will be challenging. The company estimates it will earn 40 cents to 42 cents for the period, compared with 43 cents in the year-ago first quarter. Rare management says same-store sales could decline as much as 1% at the LongHorn and Bugaboo chains and 2% at the upscale Capital Grille outlets in the first quarter of the year.


Food for Thought
Rare Hospitality's growth is well-done
Year Revenue (in millions) Earnings per Share
1999 $382.5 $0.83
2000 464.0 1.23
2001 533.2 1.29
2002* 599.9 1.42
2003* 683.3 1.65
*Estimates. Source: First Call, Company Reports, TSC Research

Continued economic weakness will keep pressuring sales and margins, something the company realizes and has warned investors about. "We remain focused on growing sales by providing each guest in our restaurants a superior dining experience," said Rare Hospitality Chairman and CEO Philip Hickey Jr. in the company's fourth-quarter earnings release. "We believe that by continuing to add value through high-quality service and outstanding food, we will emerge from this current environment positioned to again extend our record of consistent, profitable growth."

Rare Hospitality combines solid management with realistic expectations, a rare blend in the restaurant business. A flailing economy might pressure the stock in the near term, but the restaurant sector is typically a good place to invest in the early stages of an economic recovery. Rare Hospitality is a good name to chew on. I give it 2 1/2 barrels.

For an explanation of our barrel rating system, see our recent description .

Playing Defense

Small-caps were not spared in last week's general market malaise. The best performer among those I like was my most recent pick, Alexandria Real Estate Equities (ARE), which gained more than 3.5%.


Conservative Barrel Stocks Hold Their Own
But aggressive names are lagging behind
Original Barrel Rating Current Outlook Company/Ticker Date of Mention Current Price Mention Price* Price Last Week % Change From Mention % Change Weekly
Positive Outlook
3 Positive NetBank (NTBK:Nasdaq) Feb. 6, 2002 $13.79 $13.45 $14.81 2.53% -6.89%
2 Positive (ENDO:Nasdaq) Jan. 23, 2002 13.49 18.21 14.91 -25.92% -9.52%
2.5 Positive SurModics (SRDX:Nasdaq) Dec. 19, 2001 33.91 34.60 33.79 -1.99% 0.36%
2.5 Positive VitalWorks (VWKS:Nasdaq) Nov. 21, 2001 4.55 4.30 4.85 5.81% -6.19%
2 Positive FPIC Insurance (FPIC:Nasdaq) Nov. 14, 2001 13.32 12.83 13.60 3.82% -2.06%
3 Positive Witness Systems (WITS:Nasdaq) Oct. 31, 2001 12.75 8.06 12.60 58.19% 1.19%
Market Outlook
2.5 Market Coastal Bancorp (CBSA:Nasdaq) Dec. 12, 2001 30.40 27.84 30.44 9.20% -0.13%
2.5 Market Coinstar (CSTR:Nasdaq) Nov. 7, 2001 27.80 19.96 28.03 39.28% -0.82%
2.5 Market Hibbett Sporting Goods (HIBB:Nasdaq) Oct. 24, 2001 32.05 30.33 32.15 5.67% -0.31%
2.5 Market Quixote (QUIX:Nasdaq) Oct. 3, 2001 17.73 21.44 18.00 -17.30% -1.50%
Special Situation
3 Special Situation Quanta Systems (PWR:NYSE) Jan. 9, 2002 15.09 16.05 15.10 -5.98% -0.07%
Avoid
2 Avoid Actrade (ACRT:Nasdaq) Jan. 30, 2002 13.26 $20.65 $16.30 -35.79% -18.65%
0.5 Avoid Goody's Family Clothing (GDYS:Nasdaq) Nov. 28, 2001 4.05 4.50 4.20 -10.00% -3.57%
1 Avoid Bridgford Foods (BRID:Nasdaq) Oct. 10, 2001 10.75 13.18 10.75 -18.44% 0.00%
Income Portfolio
Yield
2.5 6.04 Empire District Electric (EDE:NYSE) Jan. 16, 2002 20.53 21.23 20.98 -3.30% -2.14%
2.5 2.43 Met-Pro (MPR:NYSE) Oct. 17, 2001 14.35 11.16 14.00 28.58% 2.50%
2.5 4.62 Integra Bancorp (IBNK:Nasdaq) Jan. 2, 2002 19.75 20.75 20.60 -4.82% -4.13%
3 4.49 Alexandria Real Estate (ARE:NYSE) Feb. 13, 2002 41.67 40.25 40.25 3.53% 3.53%
*Average price on date of mention. Source: TSC Research

Actrade (ACRT) continues to lack support after talk of accounting and management issues last week. I'd still avoid the stock, even though it's down nearly 50% in the past two weeks.

After Tuesday's close, Endocare (ENDO) announced a per-share loss of 1 cent, well ahead of consensus estimates of a 6-cent loss and a 92% improvement over last year's 23-cent loss.

Market malaise is never good for small-cap names, like those in the Barrel portfolio. Good news is rarely rewarded, and bad news is almost always punished. Hence, it's hard to trade small-caps in this environment, but for longer-term investors, it's a good time to think about building positions.


Do you have candidates for Bottom of the Barrel? If so, shoot me an email with the company's name, why you think it qualifies and your full name and hometown. If I profile your suggestion, I'll send you a TSC gift to commemorate your pick.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to Chris Edmonds.

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