Bankruptcy Watch: 20 Riskiest Restaurant Stocks

NEW YORK (TheStreet) -- With the economy still very much in recovery mode and the jobs market stubbornly weak, consumers continue to be choosy about how they spend their limited discretionary funds. For the restaurant industry that means the competition is stiffer than ever, and some dining establishments are bound to go bust.

While a number of food chains such as McDonald's (MCD) , Chipotle Mexican Grill (CMG) and Tim Hortons (THI) have reported growth in same-store sales, also known as comps, a key industry metric that tracks sales at well-established stores, the sector as a whole continues to face environmental pressure.

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Several restaurant bankruptcies have topped headlines the last few years. Notable among them: Metromedia Restaurant Group, which filed for bankruptcy in Oct. 2008, shutting hundreds of Bennigan's, Steak and Ale, and Ponderosa Steakhouse locations; Vicorp Restaurants filed for Chapter 11 in April 2008, closing dozens of Village Inn and Bakers Square restaurants; and Pecus ARG Holding, the parent of the Black Angus Steakhouse chain, filed for Chapter 11 bankruptcy in Jan. 2009.

There were 579,416 restaurants open across the country this spring, 5,204 less than at the same time last year, the NPD Group said. Americans spent less dining out and cut their restaurant visits by 3% this year, the first decline in spending since NPD began tracking the data in 1976. And restaurant visits are forecast to grow less than 1% per year for the next 10 years.

"Forecasts are something to be worked against, and are not cast in stone," Bonnie Riggs, NPD's restaurant industry analyst, told TheStreet. She said that certain restaurant segments such as family-style dining were declining even before the recession, struggling to stay relevant. Mid-tier locations get squeezed the most because consumers tend to either trade up or trade down based on their financial situation, she added.

One way to test if a company runs the risk of filing for bankruptcy is through the Altman Z-Score, a formula developed by New York University professor Edward Altman in 1968. The Altman Z-Score measures several aspects of a company's financial health to forecast the probability of it going bankrupt within two years. Since its inception, the formula has been 72% accurate in predicting corporate bankruptcies two years prior to the filing, according to Investopedia.

On a general basis, companies with a Z-Score higher than 3 are considered safe with little danger of bankruptcy, while those with a score of 1.81 or lower are considered distressed, and are more likely to go bankrupt. Anything in between is a grey area.

While the formula, of course, isn't the only indicator of financial health -- and is by no means a guaranteed barometer of a company's bankruptcy risk -- it is a metric worth considering for those restaurants who fall below the safety zone. Those whose Z-Score is declining year-over-year may also raise a red flag.

Taking this into account, we offer the restaurant chains with a Z-Score below 3 for the trailing twelve months, according to data from I-Metrix, from the least risky to the most risky, with a little detail on what each company has been up to lately. We limited the list to companies with a stock price of at least $1.

Ruby Tuesday

Altman Z-Score, Current: 2.57

Altman Z-Score, 2009: 2.57

Ruby Tuesday (RT) is the least risky of the group, with a Z-Score of 2.57 for the last 12 months, flat from the previous year. But the casual restaurant chain remains on shaky ground.

In its recent quarterly report, Ruby Tuesday posted a decline in year-over-year revenues, booking a 1.2% drop in sales to $313.5 million, missing expectations by just under $1 million. The softening was primarily driven by the shuttering of 16 company-owned restaurants in its fiscal-fourth quarter compared with the year-earlier period.

The all-important metric of same-store sales, also known as comps, which measure sales at well-established stores open at least one year, grew just 0.3% at Ruby Tuesday-owned restaurants last quarter, while franchised locations saw same-store sales drop 0.5%.

Even so, Ruby Tuesday's profits grew by healthy percentages and earnings of $21 million, or 33 cents per share, easily beat Wall Street's expectations.

The casual restaurant chain also forecast disappointing fiscal 2011 earnings per share in a range of 76 cents to 86 cents, and cautioned that its operating margins would be down for the year as it invests more money into a higher-quality menu and new product offerings.

Red Robin Gourmet Burgers

Altman Z-Score, Current: 2.54

Altman Z-Score, 2009: 2.37

Red Robin Gourmet Burgers (RRGB) also ranked in the grey area with a Z-Score of 2.54, an improvement from 2009 when its score came in at 2.37.

Last month Red Robin posted weaker-than-expected quarterly profits and reduced its outlook, sending investors scrambling.

Comps fell 1.2% in Red Robin's fiscal-second quarter on a 2.1% drop in average guest check, partially offset by a 0.9% uptick in guest counts. In line with the restaurant chain's improving Z-Score, its quarterly comps figure was a marked improvement from year-earlier declines of 11.5%. U.S.-based comps fell 2% in the recent quarter while stores in Canada grew comps by 0.8%.

Weak results were attributed to soft sales at Red Robin's California and Arizona locations where 25% of the company's restaurants are located. Those two states have been consistently plagued by higher-than-average unemployment rates.

The Colorado-based company expects comps to be positive 0.5% for the current fiscal year, and plans to step up its national ad campaign and open 15 new restaurants.

A new CEO, Stephen Carley, a former chief executive of El Pollo Loco, will take the reigns beginning Sept. 15, replacing Dennis Mullen.

Burger King Holdings

Altman Z-Score, Current: 2.38

Altman Z-Score, 2009: 2.38

Burger King Holdings (BKC) is a well-known household name that would likely break many Whopper-loving hearts if it were to go bankrupt. The "have it your way" burger-and-fries chain's Z-Score came in at 2.38 for the trailing-12 months, flat from the previous year, indicating its standing isn't getting any worse, but it's also not getting any better.

Burger King has been in talks with private-equity firms in recent weeks about a possible sale. The status of the talks is unclear but one interested firm was 3i Group, a British private-equity firm.

Burger King, a public company since 2006, has been in the hands of private equity before. In 2002, a group led by TPG Capital, Bain Capital and Goldman Sachs (GS) Capital Partners bought Burger King for about $1.5 billion from Diageo (DEO) . The firms still own nearly 32% of Burger King, and have significant representation on the board.

Last week two analysts cut their ratings and reduced their price targets on Burger King shares, citing concerns regarding the company's full-year costs and sales.

Burger King recently posted better-than-expected fourth-quarter profits of $49 million, or 36 cents per share, though results were sharply lower than year-earlier results, likely due to stubbornly high rates of young, jobless males in the U.S. Global comps fell 0.7%, with comps at U.S. and Canadian locations down 1.5%.

UBS (UBS) analyst David Palmer said Burger King's performance in fiscal 2011 "will depend largely on the net impact of the U.S. breakfast rollout." Year-over-year comparisons will be more difficult because 2010 sales were also boosted by the launch of the $1 double cheeseburger.

Burger King plans to launch an enhanced breakfast platform this fall in U.S. and Canadian locations that will include new menu products and Seattle's Best Coffee in an effort to better compete with McDonald's (MCD) and Starbucks (SBUX) .

Benihana

Altman Z-Score, Current: 2.34

Altman Z-Score, 2009: 2.15

Japanese steakhouse and restaurant chain Benihana (BNHN) garnered a Z-Score of 2.34, an improvement from 2.15 in 2009.

Last week, the Miami-based restaurant operator said its 2011 fiscal-first-quarter net income jumped nearly 70% to $1.3 million, or 8 cents per share, while revenue grew 4.9% to $100.8 million.

Comps grew by 2.4%, including 3.3% growth at its Benihana teppanyaki restaurants and 2.4% growth at its Haru sushi locations. RA Sushi comps were flat year-over-year.

On Aug. 17, Benihana agreed to let the co-founder of Coliseum Capital Management onto its board in an effort to suppress growing shareholder unrest. Coliseum has engaged in a proxy battle by buying up chunks of Benihana's shares. At its Sept. 14 shareholder meeting, investors will decide whether to re-elect CEO Stockinger and another board member or replace them with representatives of the late Benihanana founder Rocky H. Aoki.

Carrols Restaurant Group

Altman Z-Score, Current: 2.18

Altman Z-Score, 2009: 2.3

Carrols Restaurant Group's (TAST) Z-Score declined to 2.18 in the trailing 12 months. Its score keeps the operator of Pollo Tropical and Taco Cabana restaurants in the grey area, and not necessarily headed for bankruptcy anytime soon, but its declining rating, from 2.3 in 2009, does not bode well.

To boot, Carrols is also a franchisee of Burger King restaurants, also on TheStreet's list of risky restaurant stock plays.

In its recent quarter, comps increased 6.3% at Pollo Tropical, decreased 0.1% at Taco Cabana and decreased 1.4% at its Burger King locations. Revenue edged up 0.3% to $204.5 million in the period, but Carrols' net profits plummeted 66.2% to $2.4 million, or 11 cents per share.

Carrols expects comps at Pollo Tropical to grow as much as 5% this year while same-store sale at Taco Cabana locations are likely to be flat. Its Burger King comps are expected to be negative for the year.

O'Charley's

Altman Z-Score, Current: 2.11

Altman Z-Score, 2009: 2.29

O'Charley's (CHUX) , the operator of its namesake and Ninety Nine fast-casual restaurants, got a Z-Score of 2.11, still in the less-risky-of-the-risky zone but losing steam after a score of 2.29 in 2009.

The Nashville, Tenn.-based company recently posted disappointing quarterly results. Same-store sales at O'Charley's company-operated restaurants tumbled 7.9% on a 5.7% drop in guest counts and a 2.4% decline in average check. Comps at Ninety Nine and Stoney River Legendary Steaks restaurants fell as an uptick in guest counts offset declining average checks.

Ninety Nine enjoyed its first quarter of positive guest count growth in more than four years, the company said.

O'Charley's did not offer specific guidance for 2010, attributed to limited visibility amid continued challenges in the overall economy, but did forecast current-quarter revenue between $186 million and $192 million, and a loss from operations between $1 million and $4 million. Analysts' consensus call is for a loss of $3.1 million on revenue of $186.4 million.

J. Alexander's

Altman Z-Score, Current: 1.97

Altman Z-Score, 2009: 1.68

J. Alexander's (JAX) came dangerously close to the "distressed" threshold with a Z-Score of 1.97. Still, the full-service casual dining chain got itself out of the danger zone where it was in 2009 with a score of just 1.68.

Last month J. Alexander's said it returned to profitability in the second quarter, helped by stronger overall revenue. The Nashville-based company earned $26,000, or zero cents per share, after losing $796,000, or 12 cents per share, in the year-earlier quarter. Revenue pushed up 4.6% to $36.3 million.

Average weekly same-store sales increased 4.7% year-over-year.

AFC Enterprises

Altman Z-Score, Current: 1.84

Altman Z-Score, 2009: 1.46

Of all the restaurants on our list, AFC Enterprises (AFCE) came closest to the distressed zone without actually falling into it, achieving a Z-Score of 1.84.

Its ranking was far from stellar, but certainly an improvement from its 2009 red-flag score of 1.46.

The operator of Popeyes restaurants recently posted a 6.3% jump in quarterly profits thanks to lower costs. Results beat expectations and the fast food chain raised its full-year guidance.

AFC upped its earnings outlook by two cents, and now expects to earn between 75 cents and 79 cents per year in 2010, in line with analysts' consensus call.

McCormick & Schmick's Seafood Restaurants

Altman Z-Score, Current: 1.76

Altman Z-Score, 2009: 1.73

Based on Altman Z-Score metrics, McCormick & Schmick's Seafood Restaurants (MSSR) is a distressed restaurant chain and is more likely to go bankrupt within two years.

Early last month the full-service seafood chain cut its full year earnings guidance, citing the Gulf of Mexico oil spill and its negative effects on seafood consumption and commodity prices.

McCormick & Schmick's posted an 8.3% increase in second-quarter profits as cost cuts offset lower revenue. Net income rose to $1.3 million, or 9 cents per share. Revenue fell 3.2% to $89.7 million. Results missed analysts' expectations.

The Portland, Ore.-based restaurant operator cut its earnings-per-share guidance by a nickel, expecting to earn between 35 cents and 40 cents per share this year, and reduced its sales outlook by $10 million, expecting to pull in revenue in a range of $345 million to $355 million.

Einstein Noah Restaurant Group

Altman Z-Score, Current: 1.67

Altman Z-Score, 2009: 1.34

Einstein Noah Restaurant Group (BAGL) garnered a not-so-impressive Z-Score of 1.67 in the trailing 12 months, past the metric's "distressed" threshold and a worrisome sign for the bagel purveyor, though an improvement from a score of 1.34 in 2009.

Second quarter earnings decreased 49.2% to $3.3 million as competition in the fast-casual breakfast market heated up. Chains from Jack in the Box (JACK) , Burger King and McDonald's (MCD) to Starbucks, Dunkin' Donuts and Tim Hortons (THI) all increasingly compete for breakfast sales.

The operator of Einstein Bros Bagels, Noah's New York Bagels, and Manhattan Bagel brand stores said comps fell 1.1% in the recent quarter. Overall revenue edged 0.9% lower to $103.5 million.

Management remained optimistic. Einstein expects to open as many as 12 new company-owned restaurants in 2010, between 12 and 17 new franchise restaurants, and between 35 and 45 license restaurants.

Rick's Cabaret International

Altman Z-Score, Current: 1.53

Altman Z-Score, 2009: 1.68

Rick's Cabaret International (RICK) achieved an unsexy Z-Score of 1.53 in the trailing-12 months, leading us to wonder if perhaps sex isn't recession-proof after all. Its score even declined from 1.68 in 2009.

The operator of nightclubs offering live adult entertainment, restaurant and bar operations recently booked a 5.2% decrease in quarterly revenue to $19.9 million. Hefty one-time charges involving early loan redemption and legal expenses surrounding a New York City lawsuit led quarterly profits lower by 52.4%, to $857,000.

The gentleman's club operator has shown signs of improvement. Revenue at its clubs increased 3.8% in July year-over-year, and said it was "encouraged" by reports of an uptick in August and September reservations in its Las Vegas location.

The Gentlemen's Club Expo tapped Rick's Cabaret New York City as the #1 gentlemen's club in the Northeast last week.

Ruth's Hospitality Group

Altman Z-Score, Current: 1.23

Altman Z-Score, 2009: 0.6

Ruth's Hospitality Group (RUTH) earned a worrisome Z-Score of 1.23 in the trailing-12 months, but it was a marked improvement from its 2009 score of 0.6.

The operator of the awkwardly named Ruth's Chris Steak House chain of restaurants, as well as Mitchell's Fish Market, Columbus Fish Market, Mitchell's Steakhouse and Cameron's Steakhouse restaurants, has been showing clear signs of improvement. Ruth's booked a 3% rise in second-quarter revenue to $89 million and, more impressive, a 60.9% jump in quarterly profits to $3.7 million, or 9 cents per share, despite higher beef costs.

Quarterly comps grew 2.9% at company-owned Ruth's Chris Steak House locations, its first positive sales number in three years.

Even so, Wells Fargo Securities analysts lowered its earnings expectations for Ruth's to 30 cents per share, from 35 cents, for 2010 and to 35 cents per share, from 40 cents, for 2011. The analysts also now expect Ruth's to book comps growth of 3% in the third current quarter, down from its prior estimate for comps growth of 5%.

Wendy's Arby's Group

Altman Z-Score, Current: 1.07

Altman Z-Score, 2009: 1.23

If you're "thinkin' Arby's" or looking for something "waaaay better than fast food," you may have but a couple years left to satiate your craving at the fast food chains operated by Wendy's Arby's Group (WEN) -- at least according to the Altman Z-Score metric. The Atlanta-based company got a Z-Score of 1.07 in the trailing-12 months, a decline from 1.23 in 2009.

The company said system-wide same-store sales at Wendy's restaurants decreased 1.7% in its fiscal second quarter, ended July 4, while comps at Arby's fell 7.4%.

Quarterly profits declined 28.2% to $10.7 million, or 3 cents per share, while net revenue slipped 3.9% to $877 million. Wendy's Arby's expects sales at Wendy's to be flat this year, down from its earlier forecast for growth, and continues to expect negative comps at Arby's restaurants though the roast beef sandwich maker should book a year-over-year improvement.

Still, Wendy's remains a customer favorite. It took Top Overall and Top Food honors among mega chains in Zagat's 2010 Fast Food Survey. The company also has ambitious international expansion plans with signed development agreements for 400 new international locations over the next 10 years.

Domino's Pizza

Altman Z-Score, Current: 0.89

Altman Z-Score, 2009: 0.23

Domino's Pizza (DPZ) came in with a Z-Score of 0.89, up from 0.23 in 2009. The pizza purveyor may still be on very shaky ground, but its standing is improving.

Despite comps growth of 8.8% last quarter, analysts were disappointed after having expected the key metric to climb around 10%. Still, Domino's beat Wall Street's top- and bottom-line expectations for its second quarter, growing profits by 55.9% year-over-year. Revenue grew 14.5% to $362.4 million thanks to higher volumes and improved global comps.

Concerns about whether Domino's could maintain comps growth throughout 2010 were somewhat abated when, on a conference call with investors, Domino's executives reiterated sentiments that momentum was continuing into the third quarter with repeat customers. The company said its level of sustainability should be above its historical norms of low to mid-single-digit same-store-sales trends.

Perhaps its new pizza recipe is helping.

DineEquity

Altman Z-Score, Current: 0.68

Altman Z-Score, 2009: 0.68

DineEquity (DIN) garnered a Z-Score of 0.68 in the trailing-12 months, flat year-over-year, just like the pancakes it sells at IHOP.

The operator of IHOP and Applebee's restaurant chains missed earnings expectations in its recent quarter and booked a comps decline of 1% at IHOP and 1.6% at Applebee's. Same-store sales at company-operated Applebee's fell 2.6%, even more than those run by franchisees.

The situation may not improve materially in the near-term. "It's not going to be easy to generate robust traffic trends when the unemployment has been as stubbornly high," Morgan Keegan analyst Destin Tompkins told Reuters. The analyst said DineEquity's turnaround plan, which includes a revamped menu and store renovations, seemed to be on schedule, however.

SunTrust Robinson Humphrey analyst Christopher O'Cull said DineEquity is holding on to market share and that Applebee's is outperforming rival Chili's, operated by Brinker International (EAT) .

DineEquity recently announced a $32 million deal to sell 63 company-operated Applebee's locations. It has also been actively paying down its debt, reducing it to $1.56 billion from $1.64 billion in the recent quarter.

VCG Holding

Altman Z-Score, Current: 0.47

Altman Z-Score, 2009: 0.77

Adult nightclub owner VCG Holding (VCGH) saw its Z-Score decline to 0.47 in the trailing-12 months, from 0.77 in 2009, adding to our suspicions about the resiliency of sex as a revenue driver in an economic downturn.

CEO Troy H. Lowrie would argue otherwise. He has twice offered to buy the Lakewood, Colo.-based company for $2.10 per share and take it private, and has twice been rejected for "inadequate" bids, most recently on Aug. 20. His investment entity, Lowrie Management, already owns more than 34% of VCG Holding's shares, according to an Aug. 4 filing with the SEC.

VCG said it was shopping itself around for other bids from previously interested parties. Rick's Cabaret offered to buy VCG earlier this year for $45 million, or about $2.60 per share, a deal that would have created the largest publicly traded operator of men's clubs in North America, but the deal fell through after Rick's said it couldn't agree to acquire all of VCG's outstanding shares.

VCG's second quarter revenue rose 2.4% to $14.29 billion, but the firm swung to a loss of $1.28 billion, from earnings of $763,000 in the year-earlier period, mostly attributed to higher legal expenses.

Granite City Food & Brewery

Altman Z-Score, Current: -0.11

Altman Z-Score, 2009: -0.42

Granite City Food & Brewery (GCFB) earned a Z-Score of -0.11 in the trailing months. Clearly still in danger of bankruptcy, the casual restaurant and brewery chain did show improvement from a score of -0.42 in 2009.

The operator of 26 restaurants in 11 Midwestern states, Granite City dramatically narrowed its second-quarter losses to $600,000, or 8 cents loss per share, from a loss of $2.5 million, or 94 cents per share, in the year-earlier period. Revenue grew 5.1% to $23.2 million in the period, with comps up 5.3%.

Granite City's costs continued to fall after it renegotiated its lease with some of its landlords for around $1 million in permanent annual lease reductions.

Kona Grill

Altman Z-Score, Current: -0.28

Altman Z-Score, 2009: -0.59

Kona Grill (KONA) got a trailing-12 month Z-Score of just -0.28, but results improved from -0.59 in 2009.

Kona recently returned to year-over-year profitability with second quarter earnings of $262,000, or 3 cents per share, reversing a year-earlier loss of $214,000. It was Kona's first profitable quarter in almost three years. Revenue increased 5.6% in the period to $22.7 million.

Resentment and frustration may be brewing among Kona Grill investors over a buyout offer from Mill Road that was rejected, according to Small Cap Network.

Morton's Restaurant Group

Altman Z-Score, Current: -0.33

Altman Z-Score, 2009: -0.44

Morton's Restaurant Group (MRT) earned an improved Z-Score of -0.33 in the trailing-12 months, up from -0.44 in 2009. Still, a negative score is as tough to chew on as a well-done steak.

The operator of Morton's The Steakhouse, Trevi and Bertolini's Authentic Trattorias restaurant chains missed analysts' consensus call with a quarterly net loss of $663,000, or 3 cents loss per share. The bottom-line numbers did manage to improve dramatically from year-earlier losses of $6.5 million, or 41 cents loss per share.

The return of business travel -- and with it, corporate expense cards -- has led a slow-but-upward-trending rebound for Morton's. The Chicago-based restaurateur generates about 80% of its revenue from corporate card transactions.

Same-store sales grew 7.1% in the second quarter, beating expectations, and comps were up 3% in July.

Morton's closed more underperforming restaurants than rival Ruth's Chris as restaurant sales plummeted during the recession, and its sales figures outpaced in kind.

Denny's

Altman Z-Score, Current: -0.45

Altman Z-Score, 2009: -0.38

Denny's (DENN) took the top spot -- or is it the bottom -- in TheStreet's ranking of restaurant stocks most likely to go bankrupt within two years. It earned a pitiful Z-Score of just -0.45 in the trailing-12 months, worse even than a score of -0.38 it earned in 2009.

Famous for its Moons Over My Hammy and Grand Slam offerings, the all-day breakfast chain said comps in the recent quarter decreased 6.2% at company-owned stores and 5.9% at franchised locations as the casual family-style restaurant segment continued to lose steam.

Revenue fell 13.3% to $135.1 million, and profits fell 40.9% to $5.5 million, or 5 cents per share.

Denny's, a well-known household name, is not done yet. Guest traffic did increase sequentially in each month of its recent quarter, representing its strongest guest count performance since the first quarter of 2009. It generated $3.3 million in cash proceeds from asset sales and reduced its outstanding debt by $10.0 million.

Denny's temporarily replaced CEO Nelson Marchioli with Debra Smithart-Oglesby in June after investors pushed to oust him, and this week tapped Robert Rodriguez, formerly COO of Pick Up Stix, as the new COO.

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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