Bankruptcy Watch: 14 Risky Restaurant Stocks

(Bankruptcy Watch: 14 Risky Restaurant Stocks report updated with Sonic's quarterly earnings results.)
NEW YORK (TheStreet) -- Amid concern over a possible double-dip recession -- or at least some stall in the recovery -- in the midst of rising gasoline and food prices, bankruptcy is a real concern for any company, and the restaurant sector is certainly not immune.

American diners spent 40.5% of their food budgets eating away from home in 2010, down just slightly from 41% in 2006, according to data from the Bureau of Economic Analysis.

Chains such as McDonald's ( MCD), Chipotle Mexican Grill ( CMG) and Starbucks ( SBUX) continue to grow. But even so, a number of restaurant operators have filed for Chapter 11 bankruptcy protection in recent months.


Notably, Sbarro, the famously mediocre Italian chain, went bankrupt in April. The Perkins and Marie Callender's restaurant chains filed for bankruptcy in early June, with plans to close 65 of their 600 locations and cut 2,500 jobs. Even celebrity-backed restaurants have fallen: Eva Longoria's Las Vegas restaurant Beso filed for bankruptcy in January, and Michael Jordan's The Steakhouse NYC, which overlooks the renowned lobby of the Grand Central Terminal, went under in November of last year.

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 -- including working capital, total assets, total liabilities, market capitalization, sales, retained earnings and earnings before interest & taxes (EBIT) -- 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 that fall below the safety zone. Those with a declining Z-Score 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 12 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 our analysis to companies with a market capitalization of at least $100 million, but you can click through to the last slide for a complete chart of the 20 Riskiest Restaurant Stocks.

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Red Robin Gourmet Burgers ( RRGB)

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Altman Z-Score, Trailing 12 Months: 2.91

Altman Z-Score, Last Fiscal Year: 2.57

Red Robin Gourmet Burgers ( RRGB)

Red Robin is the least risky of the group, ranking just below the safety zone with a Z-Score of 2.91, an improvement from 2010 when its core came in at 2.57. This shows that the casual dining burger chain is working to improve its operations.

The stock is up around 75% over the past year. And in the first quarter, Red Robin beat quarterly profit expectations by 34 cents. The strong earnings were fueled by the success of a television advertising campaign.

TheStreet Ratings Research Manager Chris Stuart recently reported that, according to Bank of America-Merrill Lynch research, Red Robin's stock has the "potential for very substantial near-term EPS growth, from a combination of sales-driving initiatives such as a new loyalty program and better-timed ad spend as well as cost-savings plans."


TheStreet Ratings' model recently upgraded Red Robin to buy from hold with a $42 price target, representing 20% upside from recent trading prices. TheStreet's model upgraded the shares because of the 75% EPS improvement in the most recent quarter.

At a P/E of 19 times 2012 earnings, the stock is trading at a slight premium to the rest of the casual-dining group, Stuart noted. It's a premium that's warranted, according to Bank of America, "given that Red Robin's turnaround is just starting and has potential to drive EPS substantially higher."

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Sonic ( SONC)

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Altman Z-Score, Trailing 12 Months: 2.9

Altman Z-Score, Last Fiscal Year: 2.58

Sonic ( SONC)

Sonic's Z-Score improved since last year, and at a reading of 2.9, it's nearly beyond a risk of bankruptcy.

RealMoney.com contributor Alan Farley asserted that Sonic treads the same demographic waters as chronically underperforming Wendy's/Arby's ( WEN), with high market saturation and slowing growth. The stock's been a poor performer in the last few years from a technical standpoint, he said, dropping into an ascending triangle pattern that's been in place since September 2008.

TheStreet analyst Jake Lynch noted that the quick-service restaurant chain, which sells burgers, fries and shakes at some 3,000 drive-in locations, has steadily improved its business in the past few quarters. It's also cheap on the basis of earnings and cash flow, he said, reporting that Morningstar values the equity at $13, suggesting a potential return of 44% as fundamentals strengthen.


Even so, Sonic's stock has been a perennial laggard since the recession, falling from a high of $25.09 in 2007 to less than $9 earlier this year. Lynch put that performance into context, noting that shareholders have endured an annualized decline of 25% since 2008. Sales and net income dropped 12% and 25% annually, on average, over that span.

Morningstar, seeing value in the depressed equity, upgraded it to five stars, the researcher's highest rating, on Dec. 31, Lynch reported. Stressing margin buoyancy and uniqueness of format, Sonic is Morningstar's preferred play in the QSR, or quick-service restaurant, space.

On June 22, Sonic posted a fiscal third-quarter loss of $4.7 million, or 8 cents loss per share. On an adjusted basis however, excluding costs associated with the early extinguishment of debt, earnings came in at 21 cents per share. Revenue rose 4.2% year-over-year to $152.1 million in the May-ended quarter.

The average estimate of analysts polled by Thomson Reuters was for earnings of 18 cents a share on revenue of $151.4 million.

Systemwide same-store sales increased 3.9%, including a 3.6% uptick at franchised drive-in locations and 6.5% at company-owned restaurants.

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Ruby Tuesday ( RT)

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Altman Z-Score, Trailing 12 Months: 2.57

Altman Z-Score, Last Fiscal Year: 2.57

Ruby Tuesday ( RT)

Ruby Tuesday's Z-Score has held steady at 2.57 for several years now, indicating the casual restaurant chain remains on stable-yet-shaky ground, unable to move the needle higher.

Casual chains like Ruby Tuesday, along with Cheesecake Factory ( CAKE) and Cracker Barrel Old Country Store ( CBRL), stand to benefit as business travel picks up following the so-called Great Recession, Keybanc analysts recently noted. That means Ruby Tuesday could be poised to improve its outlook.

Even so, in its recently quarterly report Ruby Tuesday missed profit expectations and offered a weaker-than-expected outlook. The company blamed tough winter weather for the shortfall, saying it was hit harder than most other chains because the majority of its locations are in the Eastern region of the United States, where snow fell at record levels in some areas.

The Maryville, Tenn.-based company reported earnings of $16 million, or 25 cents per share, for the three months ended March 1 on revenue of $319.1 million. Same-store sales -- or sales at stores open at least one year, a closely watched metric in the restaurant industry -- were down 1.2% in the quarter. That performance was down from last year's net income of $17.8 million, or 28 cents per share.

Ruby Tuesday's full-year outlook was markedly below analysts' consensus view. The company forecast a profit ranging from 74 to 82 cents per share, compared with the average analysts' estimate of 90 cents per share.

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Carrols Restaurant Group ( TAST)

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Altman Z-Score, Trailing 12 Months: 2.34

Altman Z-Score, Last Fiscal Year: 2.26

Carrols Restaurant Group ( TAST)

Carrols Restaurant Group saw its Z-Score improve in the trailing 12 months. Its score keeps the operator of Pollo Tropical and Taco Cabana restaurants in the gray area, and not necessarily headed for bankruptcy anytime soon.

Carrols, which is also a franchisee of Burger King restaurants, has been looking for franchisees of its own to expand its Pollo Tropical chain in the United Kingdom, banking on brand recognition from the large number of British tourists who travel to the Caribbean-inspired restaurant concept's home state of Florida.

In its recent quarter, Carrols beat profit expectations, boosted by double-digit same-store sales growth at Pollo Tropical restaurants.

Still rising costs for a roster of ingredients led Carrols to say it would raise menu prices at all of its brands to help maintain margins and offset higher inflation.

Carrols earned $2.2 million, or 10 cents per share, in the quarter, down from $2.3 million, or 11 cents per share, in the year-earlier period. Excluding items, earnings came in at 14 cents per share, topping expectations by 2 cents.

Revenue rose 1.1% to $197.2 million. Same-store sales jumped 13.5% at Pollo Tropical.

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Einstein Noah Restaurant Group ( BAGL)

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Altman Z-Score, Trailing 12 Months: 2.3

Altman Z-Score, Last Fiscal Year: 2.1

Einstein Noah Restaurant Group ( BAGL)

Einstein Noah improved its Z-Score since last fiscal year but remains in lukewarm territory below the safety zone.

In its recent quarter, the bagel purveyor more than doubled its profits year-over-year but poor weather conditions led to 173 days of store closures, double the amount in the company's year-earlier period, negatively impacting sales.

Einstein Noah's net earnings came in at $1.2 million, or 7 cents per share, up from $570,000, or 3 cents per share, a year ago. Revenue inched up 0.4% to $101.2 million, while same-store sales fell 0.8%.

The results came up short of expectations for earnings of 12 cents per share on revenue of $103.5 million.

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O'Charley's ( CHUX)

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Altman Z-Score, Trailing 12 Months: 2.12

Altman Z-Score, Last Fiscal Year: 2.12

O'Charley's ( CHUX)

O'Charley's saw its Z-Score hold steady at 2.12 in the trailing 12 months, indicating that the casual dining chain has been able to maintain operations amid rising costs but has struggled to improve efficiency.

Still, O'Charley's, which operates restaurants under its namesake, Ninety Nine Restaurant and Stoney River Legendary Steaks brands, recently returned to profitability after posting six consecutive quarters of losses, thanks to higher guest traffic at all three brands.

Total sales fell 0.8% to $265 million while same-store sales increased 1.5%.

The company also forecast second quarter revenue between $190 million and $195 million, higher than the $188.2 million analysts had been expecting. It expects operating results to range from a loss of $1 million to earnings of $2 million.

O'Charley's had to close 16 underperforming stores to help contain costs.

At its remaining restaurants, the company pushed lower-priced entrees and value items in an effort to keep guests coming in the door despite a still-weak consumer environment.

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Ruth's Hospitality Group ( RUTH)

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Altman Z-Score, Trailing 12 Months: 1.78

Altman Z-Score, Last Fiscal Year: 1.52

Ruth's Hospitality Group ( RUTH)

Ruth's Hospitality improved its Z-Score from last year to a reading of 1.78, but that ranking kept it just below the cutoff, meaning the operator of Ruth's Chris Steak House and Mitchell's Fish Market chains is considered distressed, and is more likely to go bankrupt.

RealMoney.com Contributor Alan Farley was fairly bullish on the stock. He reported that, "in addition to buyout speculation, this eatery has the added benefit of catering to high-end customers. These folks haven't been hurt by the economic slowdown, at least in the way that affects most pocketbook issues, so their eating and buying habits haven't changed all that much. It's the same dynamic that has made jewelry giant Tiffany ( TIF) one of the strongest performing retail stocks of 2011."


The stock remains far lower than its pre-recession levels near $20 but it has gained around 20% in the past 12 months. Even so, Ruth's overall profit fell to its lowest level in years in 2010.

But many analysts are optimistic that as the economy improves, high-end diners will return to their spending ways. The consensus is for Ruth's earnings-per-share to grow to 36 cents in 2011, and to 45 cents in 2012.

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McCormick & Schmick's Seafood Restaurants ( MSSR)

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Altman Z-Score, Trailing 12 Months: 1.68

Altman Z-Score, Last Fiscal Year: 1.81

McCormick & Schmick's Seafood Restaurants ( MSSR)

McCormick & Schmick's remained in the danger zone with a Z-Score of 1.68, decreasing from a score of 1.81 in the last fiscal year.

Clearly management knows there's a problem. McCormick & Schmick's officially put itself up for sale in early May following a rejected takeover bid in April.

McCormick & Schmick's said it was considering a sale as one option for maximizing shareholder value.

In April, Landry's Restaurants founder and CEO Tilman J. Fertitta offered to acquire McCormick & Schmick's for $137.2 million, but the seafood restaurant chain rejected the unsolicited bid, saying it undervalued the company.

At the time, Fertitta said he would pay $9.25 per share for each McCormick & Schmick's share he did not already own, a 30% premium to the target's closing price of $7.12 the day before the offer was made. Fertitta's offer was made through a unit of Landry's, which has been acquiring novelty restaurant brands such as the Bubba Gump Shrimp and Oceanaire seafood restaurants and Claim Jumper steakhouses. Landry's traded publicly until 2010 when Fertitta took it private for $1.4 billion. Fertitta already owns a 10.1% stake in McCormick & Schmick's, making him the seafood chain's third-largest shareholder.


On June 1 Landry's extended its $137.2 million offer until July 29.

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Bravo Brio Restaurant Group ( BBRG)

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Altman Z-Score, Trailing 12 Months: 1.56

Altman Z-Score, Last Fiscal Year: 0.88

Bravo Brio Restaurant Group ( BBRG)

Bravo Brio saw a marked improvement in its Z-Score to 1.56 in the trailing 12 months, and while it was a move in the right direction, the operator of 83 restaurants in 27 states remains in the danger zone for bankruptcy.

Bravo Brio, which operates Italian restaurant chains under the BRAVO! Cucina Italiana and BRIO Tuscan Grille brands, has been rumored in the past to be a possible acquisition target for Darden Restaurants ( DRI), which owns Red Lobster and Olive Garden restaurant concepts, among others.

But Bravo Brio has rejected the rumor, saying it's not interested in pursuing such a deal.

The speculation was fueled by Janney Capital Markets analyst Mark Kalinowski who, in a June 1 note, tapped Bravo Brio and several other restaurant companies as possible targets for Darden.

In March, Bravo Brio priced a secondary public offering of more than 4.2 million common shares priced at $16.25 per share, looking to raise around $67.6 million.

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Domino's Pizza

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Altman Z-Score, Trailing 12 Months: 1.47

Altman Z-Score, Last Fiscal Year: 1.21

Domino's Pizza ( DPZ)

Domino's has made strides toward improving its operations and its overall brand image -- thanks to a recently revamped pizza recipe, plus new items like pasta bowls and Cinna Stix -- but its Z-Score remains on troublesome ground at a reading of 1.47.

The pizza-delivery chain has focused much of its efforts on growing its business overseas and said it expects its international presence to outpace its 4,909 U.S. stores by the fall of 2012.

In its recent quarter, Domino's booked international same-store sales growth of 8.3%, partially offsetting a 1.4% decrease in the line item stateside. It's put a particular focus on India.

Domino's stock price is up around 85% from a year ago but remains around 29% lower than its pre-recession levels.

Domino's grew revenue by 2% last quarter to $389 million. Earnings edged up by 2 cents to 43 cents per share, beating expectations.

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DineEquity ( DIN)

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Altman Z-Score, Trailing 12 Months: 0.78

Altman Z-Score, Last Fiscal Year: 0.73

DineEquity ( DIN)

DineEquity saw its Z-Score improve slightly from last year to a reading to a 0.78, but the operator of IHOP and Applebee's Neighborhood Grill and Bar restaurants continues to find itself in unstable territory.

Even so, its profit in the first quarter this year doubled thanks to improved margins and its ability to pay down debt.

Since acquiring the Applebee's chain in 2007, DineEquity has focused on refranchising and revitalizing the brand. That strategy appears to be working, with the chain's same-store sales up 3.9% last quarter.

At IHOP, however, same-store sales fell 2.7% last quarter, which management blamed on mistiming the launch of an all-you-can-eat pancakes special in January when many customers were working to maintain New Year's resolutions of eating healthier.

DineEquity has entered a licensing agreement with Wal-Mart ( WMT) to sell IHOP-branded frozen food items in 3,000 of the discount retailer's stores in an effort to extend the brand's reach. Still, competition from Kellogg's ( K) Eggo Waffles and other popular frozen breakfast food brands may put a damper on sales.

On June 20, DineEquity said its IHOP brand signed a multirestaurant franchise agreement to expand in the Middle East with 40 new IHOP Restaurants in Kuwait, Saudi Arabia, Jordan, Lebanon, Qatar, the United Arab Emirates, Oman, Bahrain and Egypt -- the IHOP chain's first major expansion outside of North America.

In its recent quarter DineEquity booked a profit of $28.1 million, or $1.53 per share, up from $12.8 million, or 75 cents per share, in the year-earlier quarter. Results topped expectations, although revenue fell 16% year-over-year to $300 million.

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Morton's Restaurant Group ( MRT)

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Altman Z-Score, Trailing 12 Months: 0.77

Altman Z-Score, Last Fiscal Year: 0.64

Morton's Restaurant Group ( MRT)

Morton's saw its Z-Score improve to a reading of 0.77, but the steakhouse operator's ranking still puts it well in the danger zone.

Even so, the company has shown marked improvements in its financials, and forecast even stronger growth for this year.

Morton's recently beat quarterly profit expectations with earnings of 13 cents per share.

Results were buoyed by the return of business travelers, many of whom dine out on expense accounts when travelling to meet with clients and potential business partners.

Also, total revenue jumped 9.6% last quarter to $82.5 million, as comps grew 7.5% at Morton's namesake restaurants.

For fiscal 2011 Morton's expects revenue to grow around 8.4% to a range of $319 to $323 million. It forecast comps growth of 6% to 8%, and earnings-per-share to grow more than threefold to a range of 45 cents to 49 cents.

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Wendy's/Arby's ( WEN)

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Altman Z-Score, Trailing 12 Months: 0.68

Altman Z-Score, Last Fiscal Year: 1.13

Wendy's/Arby's ( WEN) saw its Z-Score go from bad to worse in the last year, falling to a reading of 0.68 in the trailing twelve months.

The company's underperforming Arby's chain has been dragging on its financials for years, a truth the company clearly knew well. On June 13 Wendy's/Arby's announced it would divest the business, selling the Arby's chain to private equity firm Roark Capital Group in deal that values the sandwich chain at $430 million.


RealMoney.com contributor Alan Farley noted that Wendy's/Arby's disclosed in January its intention to sell Arby's, triggering a strong volume surge that has, so far at least, failed to translate into higher prices.

Wendy's/Arby's is divesting Arby's so it can focus its attention on reinvigorating its namesake restaurant brand. The sale of Arby's "will allow Wendy's to focus on revitalizing their core brand," Scott Rostan, principal and founder of Training The Street, told TheStreet. Wendy's/Arby's management will no longer be "distracted with chatter regarding Arby's performance or potential sale," he added.


In its recent quarter Wendy's/Arby's narrowed its losses as revenue grew and the company plans to raise prices to help offset increasing commodity costs.

Wendy's/Arby's also lowered its 2011 guidance for earnings before interest, taxes, depreciation and amortization to a range of $330 million to $340 million, well below analysts' consensus for EBITDA of $401.7 million.

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Denny's ( DENN)

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Altman Z-Score, Trailing 12 Months: -0.39

Altman Z-Score, Last Fiscal Year: -0.44

Denny's ( DENN) rounds out the Bankruptcy Watch list with the lowest Z-Score at a reading of -0.39, though it was an ever-so-slight improvement from -0.44 in the last fiscal year.

RealMoney.com contributor Jonathan Heller wrote that the Denny's name had been "all but forgotten; then, Super Bowl advertisements offering free breakfast got my attention, I started digging, and ultimately I took a position a couple months later."

Though Denny's took a fair amount of heat for the high-priced ad campaign and giving away so much food, "I thought the ads were a brilliant way to draw consumers back," Heller said. "However, the activists who sought major changes last year did not think the ads were worthwhile. Although they lost the proxy fight, the company has made major management changes -- and, much to my disappointment, there were no Super Bowl ads this year."

Denny's has been profitable for the past four consecutive years, but in its most recent quarter the casual dining chain missed expectations with a profit of 4 cents per share on the back of declining revenue.

Comps fell 1.7% and same-store guest count slid 1.1%, attributed to the calendar shift of Easter from March to April and the absence of a 2010 Super Bowl promotion.

Still, the company remained optimistic, and outlined plans to open up to 75 new restaurants in 2011, with 63 franchised locations and 7 to 12 company-owned restaurants.

NEXT...A Complete Chart of the 20 Riskiest Restaurant Stocks

The 20 Riskiest Restaurant Stocks

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-- Written by Miriam Marcus Reimer in New York.

>To contact the writer of this article, click here: Miriam Reimer.

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