6 Stocks Offering Growth at a Bargain

Restaurants have served up unsavory returns of late. The average of 53 eatery stocks in SmartMoney's database has lost more than half its value in a year. Bennigan's, a bar and grill chain, drove owner Metromedia Co. to bankruptcy in July. Starting a year ago, this column has repeatedly cautioned readers to avoid Ruby Tuesday (RT) stock. It's down 87%.

Blame a spike in food and fuel costs, a crumbling of stock and house wealth and a souring of consumer mood. In the case of Bennigan's and Ruby Tuesday, blame a failure of management to distinguish the brands from the competition. But also blame an industry that, in good times and bad, produces a regular pace of big financial flops. Recall Roadhouse Grill (bankruptcy filing: October 2007), Ground Round (February 2004), Boston Market (October 1998), Sizzler (June 1996) and Popeye's Chicken (April 1991).

Denny's (DENN) perhaps deserves double mention. It filed Chapter 11 in July 1997, due in part to a $54 million settlement of a class-action suit alleging racial bias against black customers. Since emerging from bankruptcy protection in early 1998, the company has made fine progress in minority relations, retraining employees and recruiting black supervisors, suppliers and franchisees. Shareholder relations are another matter. Through Tuesday the stock had lost 87% of its value since its January 1998 debut.

Denny's sub-$2 stock price bespeaks financial difficulty. Sales in the company's third quarter ended Sept. 24 fell 22% from a year ago. Debt totals more than $2 for each $1 in Denny's stock market value. Interest payments this year have been half again as large as profit. A new menu offering designed to lure cost-conscious breakfasters on weekdays seems like a good enough deal to make stock investors shudder. The Weekday Express Slam comes with eggs, pancakes and either sausage or bacon and costs just $4.

Loss-weary shareholders can take small comfort in some promising signs, though. While guest traffic is weak, Denny's in its third quarter turned 8.7 cents of each sales dollar into operating profit, its best margin in seven years, thanks to careful cost controls. A recent plunge in oil prices promises to ease ingredient costs. Analysts reckon Denny's will add a penny per sales dollar to its operating profit next year. Debt is sizable, but shrinking, thanks to an ongoing effort to unload company-owned restaurants onto franchisees. Scarce credit has slowed this Franchise Growth Initiative, as management calls it, but only slightly. During the third quarter Denny's sold 21 restaurants for a total of 62 this year and 192 since the program's start in early 2007. It now has 332 company restaurants and 1,206 franchised ones.

Denny's shares jumped 20% Wednesday after Merriman Curhan Ford, a San Francisco investment bank, sweetened its recommendation on the stock to Buy from Neutral. "We see more potential for earnings upside than downside risk from current levels," noted analyst Eric Wold. He has a point. Shares go for only about six times this year's earnings forecast. I'm not sure a $4 table-service meal is the key to Denny's survival. More promising, perhaps, is a new takeaway container the company says will keep pancakes fluffy and hash browns crisp. Also, a revamped, late-night "Rockstar" menu emphasizing cheesecake-flavored milkshakes and bacon-burger fries should keep drunken revelers in attendance.

This column generally searches for promising stocks to hold for the long term. There's not nearly enough evidence to suggest that Denny's is one of those. Moreover, the low stock price and substantial debt mean investors ought to consider the likelihood of a future delisting or dilutive stock offering. That said, the company looks too cheap at today's price, and profits are seen jumping both this year and next, despite slow sales. Investors with the stomach for fast fare might consider a short-term trade.

Denny's turned up recently with five other companies on a screen for stock valuations that seem modest in relation to forecast profit growth. Run the search anytime you like using SmartMoney's stock screener and the full list of search criteria.