How to spot the best growth stock picks in the U.S. restaurant industry

The U.S. restaurant industry has faced tough challenges over the past 18 months. That’s because the economic downturn has prompted more consumers to eat at home, or to spend less when they dine out.

The best U.S. restaurants have done a good job of cutting costs during the slowdown. Some have improved their menus by introducing new items and focusing on value-priced meals. And a few have taken advantage of the slowdown to expand into new markets with strong growth potential. That has helped these restaurants report improved results. It also puts them in a good position to profit as the global economy continues to improve.

In light of the improvement in the U.S. restaurant industry, we’ve updated our buy/sell/hold advice on two U.S. restaurant growth stock picks, Ruby Tuesday (symbol RT on New York), and Chipotle Mexican Grill (symbol CMG on New York), in the current issue of Stock Pickers Digest, our newsletter for more aggressive investors.

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Chipotle and Ruby Tuesday: 2 growth stock picks that could have gains ahead

Chipotle (pronounced chi-POAT lay) provides an example of a restaurant that’s expanding, despite the weak economy. Chipotle is a Denver-based Mexican-restaurant chain.

Founded in 1993, Chipotle charges slightly higher prices than fast-food chains, but offers higher-quality food, including naturally raised meat, and better decor and service. McDonald’s (symbol MCD on New York), one of the growth stock picks we cover in our Wall Street Stock Forecaster newsletter, once owned a majority interest in Chipotle. However, the company divested its stake in 2006, when it allowed shareholders to exchange their McDonald’s common shares for Chipotle class B shares.

Chipotle has continued to expand during the slowdown. The company now has 956 restaurants, including its first outside of the U.S., in Toronto. In April, Chipotle plans to open a restaurant in London, England. The company opened 121 new restaurants in 2009, and plans to open 120 to 130 more outlets in 2010.

Chipotle’s revenue and earnings have continued to rise, despite the downturn. That’s partly because of the new restaurants. But same-restaurant revenue was up 2% in the latest quarter, mainly because Chipotle raised its prices. That’s a good sign for its longer-term prospects.

Ruby Tuesday offers casual American dining. The company owns 670 restaurants in the U.S. Franchisees run another 171 American outlets, and international franchisees operate 55 restaurants in Canada, Chile, Dubai, Egypt, Guam, Greece, Hawaii, Honduras, Hong Kong, Iceland, India, Jordan, Kuwait, Romania, Saudi Arabia and Trinidad.

Ruby Tuesday saw its earnings drop sharply during the downturn. To attract more customers and increase sales, the company has been focusing on improving its menu and upgrading its service: Its menu now includes a wide variety of appetizers, handcrafted burgers (including beef, bison, turkey, chicken and crab), a 46-item salad bar, fish, ribs and steaks.

Cost cuts and lower debt help Ruby Tuesday’s prospects

Ruby Tuesday has done a good job of cutting its costs and lowering its debt. It is also spending less on building and refurbishing restaurants.

The company has also been closing unprofitable restaurants during the past year: it closed 43 outlets in 2009, and will close 12 or 13 when their leases expire in 2010.

The closures weighed on the company’s latest quarterly revenue, but the lower costs should free up cash for further debt repayments. Moreover, same-restaurant sales showed a significant improvement over the year-earlier quarter, and we think they could go higher as the U.S. economy continues to recover.

For our latest buy/sell/hold advice on Chipotle, Ruby Tuesday and 17 other stocks that would be suitable for the part of your portfolio you devote to aggressive investing, you should consult the latest Stock Pickers Digest. What’s more, you can get this issue absolutely free. Click here to learn how.