Darden Restaurants (DRI) – Should You Put Money Where Your Mouth Is?

 

Kurtis Hemmerling writes about investing topics on Money Crashers and it’s his goal to help demystify the world of personal finance and stock investments.

Inspiration for an investing idea can come from almost anywhere – from a new trend that school kids are buzzing about to rule-based stock screening. Many famous investors recommend buying what you know, use, and consume.

For example, I enjoy eating out, and I especially enjoy Red Lobster and the Olive Garden, where I can get a mountain of good food for a very good price. These two restaurants, as well as LongHorn Steakhouse and others, are owned by Darden Restaurants (NYSE: DRI).

I know it and I like it, so should I invest in it? Well, before committing to any investment, it’s always a good idea to first do a little research as part of your investment risk management strategy.

Overview of Darden Restaurants

Darden Restaurants can trace its roots to humble beginnings. Back in 1938, 19-year-old Bill Darden opened up a small luncheonette with seating for 25 called The Green Frog. But since then, it has grown far beyond what the entrepreneurial teenager likely dreamed of.

Darden is by no means a small “mom and pop” operation. With roughly 1,900 restaurants in North America and 180,000 employees, Darden properties serve more than 400 million meals annually and has the fifth-largest market cap at 5.8 billion, just below Tim Hortons.

 

4 Factors to Consider

With Darden, as with any investment, it pays to go “behind the scenes” to examine the numbers that support the food and image we’re familiar with.

1. Growth
Growth is usually the first place an investment inspector will investigate. The following numbers were derived specifically for Darden’s from Stock Investor Pro.

• Earnings growth from continuing operations over the past one, three, and five years is slightly better than the industry average.
• Sales growth over the past one, three, five, and seven years are also modestly above the industry average.

2. Profit Margin
Another vital aspect to evaluate a restaurant is to inspect their profit margin, or how much of every dollar generated in revenue they keep as profit. The food service industry is a cutthroat business that typically operates on thin margins. Difficult economic conditions may turn consumers away from restaurants, so to survive these times, we want to see Darden Restaurants running a fiscally efficient operation, especially as compared to its competitors.

• Gross profit margin is in the bottom third of the restaurant industry, and has been for a long time. Darden has, however, kept this number stable for many years, which ranges from 22% to 24%.
• More important is the net profit margin. This is two to three times higher than the industry average, as it fluctuates between 5% and 7%.

3. Liquidity
The one financial number in regards to Darden Restaurants that gives me pause is liquidity. Two measures of liquidity, the current ratio and the quick ratio, are both about half of the industry average. This means Darden’s has more debt relative to cash than most of its competitors. Moreover, I generally prefer to see a current ratio of one, which means that liquid assets equal company liabilities, and Darden’s is half of that.

Another aspect to consider is that Darden’s long-term debt-to-equity ratio is about twice the industry average, another indicator that debt could be a problem. That said, they have been reducing this ratio by paying down debt and increasing equity over the past few years. But it’s still a bit high for these economic conditions, in my opinion. After all, you need money to make money, and Darden is hardly rolling in the dough, so to speak.

4. Value Stock With a Great Yield
If Darden was being offered as a value meal, how would it compare against the competition? Is it expensive for what you get, or it is cheaper than the food next door?

• The price-to-earnings ratio of 14 shows it’s a decent value.
• The PEG ratio, which is the price/earnings to growth, is roughly one. This is decent as well.
• Other metrics, such as price-to-book and price-to-sales, show Darden to be a bit more expensive than the industry average.

There is some value in Darden Restaurants, but the most interesting numbers about this company are the yield and dividend payout ratio. Why does this matter? The Tweedy Browne paper, The High Dividend Yield Advantage, reveals that the higher yielding stocks with the lowest payout ratios have historically been top capital gain performers. In this regard, Darden comes out on top.

The yield of 3.7% is currently the third-highest in the restaurant category, and the payout ratio is at 40%. When you compare this to the two higher yielding companies, Ark Restaurants (which is currently paying out twice as much in dividends as they earn) and Einstein Noah Restaurant Group (with a 60% payout ratio), we see that Darden Restaurants is earning far more relative to what it pays out.

Investors seeking high yield also like to see dividend growth on an annual basis. Since 2005, Darden’s dividends have been growing every single year for a seven-year average of 48.6% and a three-year average of 21.1%. These aggressive numbers cannot continue indefinitely, but it gives us a well-fed feeling for now.

Final Thoughts

I do have some reservations about restaurant investments in a troubled economy. And Darden Restaurants is no exception, especially since it carries a high amount of debt relative to its liquidity. However, there are promising aspects to this company that may well make up for its drawbacks. For the value investor that likes growth, Darden Restaurants could present an appetizing opportunity.

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