By
Dividend Monk
:
Darden Restaurants owns several brands of restaurant chains
including Olive Garden and Red Lobster.
- Seven Year Revenue Growth Rate: 6.1%
- Seven Year EPS Growth Rate: 10.4%
- Latest Dividend Increase: 16.2%
- Current Dividend Yield: 3.81%
- Balance Sheet Strength: Leveraged, Stable
The company offers a substantial dividend yield and specific
five-year plans for growth, which should be appealing to investors.
The current price in the low $50′s is fair for the long term,
assuming that the company is able to meet the low end of its 2017
goals.
Overview
Darden Restaurants Inc. (
DRI
) operates Olive Garden, Red Lobster, Longhorn Steakhouse, and
other restaurant chains throughout the United States. The company
generated nearly $8 billion in sales during fiscal year 2012 and
currently has a market cap of a bit under $7 billion. Darden was
once part of
General Mills
but was spun off in the mid-1990′s as its own company.
Olive Garden
Olive Garden is a large Italian food chain of casual restaurants.
The segment has nearly 800 locations, generates $4.7 million in
average sales per location, and generates over $3.6 billion in
total sales for Darden.
Red Lobster
Red Lobster is Darden's second largest brand, with over 700
locations, over $3.8 billion in sales per average location, and
therefore about $2.7 billion in total sales. Red Lobster is the
original brand under Darden.
Longhorn Steakhouse
In 2007, Darden Restaurants acquired Longhorn Steakhouse. The brand
currently has 400 units, $3 million in sales per location on
average, and around $1.1 billion in total sales. Longhorn is the
smallest of Darden's three core brands but is the fastest growing
one.
Specialty Group
Rounding out the three core brands for Darden is the specialty
group, which is a collection of smaller brands with 110 total
locations as of the end of fiscal year 2012.
The brands include:
- Bahama Breeze, a Caribbean-styled restaurant
- Capital Grille, a restaurant originally aimed at business
people and politicians, with a large wine selection
- Seasons 52, a grill and wine bar focusing on healthy
selections
- Eddie V's, a restaurant focusing on seafood, steaks, and live
music
- Yard House, a casual restaurant with an assortment of beer
offerings and classic rock
The specialty group has fast-growth characteristics and
generates over $0.6 billion in sales. Due to the size and slightly
higher scale or specialization of these locations, the average
annual sales figure per location is $6.4 million.
Ratios
- Price to Earnings: 14
- Price to Free Cash Flow: 27
- Price to Book: 3.6
- Return on Equity: 25%
Revenue
(click to enlarge)
(Chart Source: DividendMonk.com)
Revenue grew by 6.1% per year over this period. Part of this was
organic growth but significant portions were due to acquisitions of
LongHorn and some of their smaller brands.
Earnings and Dividends
(click to enlarge)
(Chart Source: DividendMonk.com)
Earnings grew by 10.4% per year on average over this period.
With the exception of the year 2007 when Longhorn was acquired, EPS
growth has been rather smooth.
Darden is gaining traction as a
dividend stock
with a 3.81% yield and double-digit dividend growth. Prior to 2006
the company wasn't much of a dividend stock but since that year,
the annual dividend has grown from $0.40 to $2.00 per share. The
most recent quarterly increase was from $0.43 to $0.50, and the
payout ratio is moderate at 55%.
Because the company is moderately sized and does not yet have a
multi-decade dividend growth history, I view the company has an
income-producing total return stock that may offer an above average
yield but that has not proven enough stability to be foundation of
growing passive income, or a "core holding".
Approximate historical dividend yield at beginning of each
year:
| Year |
Yield |
| Current |
3.81% |
| 2012 |
3.8% |
| 2011 |
2.7% |
| 2010 |
2.9% |
| 2009 |
2.7% |
| 2008 |
2.6% |
How Does Darden Spend Its Cash?
Over the past three years, the company generated over $930 million
in free cash flow. Roughly $540 million was spent on dividends,
while nearly $650 million was spent on net stock buybacks (value
bought back minus value issued). The share count over the last
decade has decreased from a bit under 180 million to around 130
million.
Darden spent $1+ billion to acquire LongHorn, and recently spent
$585 million to acquire Yard House.
Balance Sheet
Total debt/equity is around 110%, and around 30% of existing
equity consists of goodwill. The total debt/income ratio is over
4x, and the interest coverage ratio is only around 6.5x. While
these figures are stable, it does show that the company is using a
significant degree of leverage. Particularly with regards to the
interest coverage ratio, I generally look for a ratio of 10+ in all
but the most stable companies (utilities, landfill owners,
MLPs
, etc.)
Investment Thesis
Darden Restaurants came up in the particularly good interview
with Chuck Carnevale as part of the October issue of the strategic
dividend newsletter
as one of his picks, so I decided to take a closer look at it and
publish an analysis.
I generally view anything that aims at the middle economic range
as on inherently thin ice. The U.S. has a very polarized economic
divide, so businesses that focus on high-end experiences, and
businesses that focus on being the low cost provider of budget
experiences, have room to excel. A dangerous place is in the
middle, where a company's products or services are neither of
top-notch quality or at the cheapest price.
Unique Selling Proposition
Fortunately for Darden, their brands do have strong unique selling
propositions (USPs), which seems to be a defining characteristic of
their success. Some casual restaurants aren't particularly known
for focusing on anything, and consequently there is rarely a reason
to specifically pick them for a Friday night dinner out. Each
Darden brand has a fairly specific focus, which means rather than
competing with every restaurant in town, they're only competing
with restaurants that focus on those niches.
Olive Garden, for example, is the biggest full-service Italian
restaurant chain. Red Lobster is the biggest seafood chain.
Longhorn focuses on steaks, so rather than competing with every
restaurant in town, they compete with businesses like Outback
Steakhouse for when consumers are specifically looking to go out
for a steak dinner. Capital Grille has an extensive wine selection,
Yard House has a casual atmosphere complete with beer and classic
rock, and Bahama Breeze focuses on Caribbean offerings. Each major
brand is distinct.
Diverse Returns
The objectives of Darden are to provide solid total shareholder
returns in several ways. The dividend yield of 3.81% is above
average, and they have quickly increased the payout ratio over the
last several years to transform into a solid dividend stock.
Meanwhile, the company continually buys back its stock and reduces
the share count at reasonable valuations with the remaining free
cash flow. The company also expands existing brands and
occasionally makes acquisitions of new brands.
Specific Goals
Darden management has put forth specific five year targets in the
2012 annual report. The company plans to increase sales from $8
billion in 2012 to $11-$12.5 billion in 2017, which would mean
better than 6.5% revenue growth per year over this period. They
also plan to increase EPS from $3.58 in 2012 to $5.75-$7.25, which
would mean an EPS growth rate of 10% per year at the low end to 15%
on the high end, while paying an above average dividend yield on
top of that. The sum of dividends and share repurchases for the
period of 2013-2017 is estimated by the company to be $2.9 billion
to $3.6 billion.
The company, according to the 2012 report, is aiming to open 500
more restaurants in the next five years. Red Lobster will be
slowing down growth, Olive Garden will be aiming to open 125
locations by 2017, Longhorn will be aiming to open 200 locations by
2017, and the Specialty Group will be aiming to open up over 100
locations by 2017. So overall, Darden expects to expand from around
2,000 total locations to around 2,500, and each location on average
is expected to increase sales by 2-4% per year over that period
(which largely amounts to an index to inflation).
Risks
With a fairly substantial amount of leverage, an exclusive focus
on the United States market, an economic target of the middle
class, and a dividend growth history that is fairly short, Darden
does have risk.
Olive Garden had a 0.3% decrease in same-restaurant guest
traffic between 2010 and 2011, which accelerated to a 1.2% decrease
in same-restaurant guest traffic between 2011-2012. Increases in
prices and new Olive Garden restaurant openings, along with the
fact that Olive Garden is only one brand of several for Darden,
meant that these declines did not drastically affect Darden's
bottom line. But overall, if the company's largest brand is leaking
guests, it's a concern.
It's hard to say exactly what could be causing the decline in a
strong brand. I do think it's worth pointing out a trend.
According to Google Adwords, 2.2 million people use the search
term "Atkins" per month. In addition, 1.5 million people use the
search term "low carb". Another 1.8 million search for "paleo", and
then there is a tail of words like "cave man diet" at 60k/month.
These are various diet-types that focus on eating a low amount of
carbohydrates, and wheat is often viewed as the primary food to
avoid.
This is the change in search trends for searches in Google that
contain the word "Paleo":
Now, because search terms including "Atkins" and "Low Carb" have
decreased from their highs, to some extent it appears to be a
change in terminology. However, while those two terms have
decreased over the long term, they have remained fairly flat over
the 2010-present period during the huge spike in searches for
"Paleo". So over the last three years, the largest terms in the
category appear to have collectively increased.
The term "gluten free" has also dramatically increased, reaching
3.3 million searches per month. (Gluten is a protein in wheat.) And
the growth has been a lot more steady and long-term than that
"Paleo" search spike in recent years.
Overall, it appears that interest in these sorts of dietary
approaches has gained momentum. Probably more important is that for
every person searching Google for "Paleo" or "Low Carb" or
"Atkins", and for every person treating these sorts of approaches
as a
lifestyle
, there are others that are probably just watching their carbs a
bit.
If an additional 1-5% of the U.S. population over a given period
becomes moderately or seriously interested in reducing their carb
and specifically wheat intake, could that reduce guest traffic to
the largest full-service Italian restaurant chain in the country
(with a rather large focus on wheat-based bread and pasta) by 1% in
a year? I think it could play a role.
Depending on the longevity of this interest, Olive Garden may
continue to face headwinds. This is by no means certain; the
brand-specific guest decreases could be due to other factors. Red
Lobster, for example, had a decrease in guests between 2010 and
2011, but an increase in guests between 2011 and 2012.
Conclusion and Valuation
What it comes down to is, if Darden meets the bottom range of
their five-year plan, then an investment in the stock today will be
a good one. At a P/E of a bit over 14, management is targeting
10-15% EPS growth while offering an above average dividend yield,
so even if the fairly modest stock valuation were to slip a bit
between now and then, returns should be quite reasonable.
Furthermore, a large portion of the returns are rather
straightforward to predict and difficult to disrupt. With a
moderate dividend payout ratio and consistent share buybacks, much
of the returns will be due to internal use of cash rather than
expansion. And as far as expansion is concerned, most of that
growth is due to the plan to open 500 more locations. So the one
key variable that could offset these rather predictable uses of
cash, would be the realization of consistently poor same-location
growth. If their major brands have modest declines in the number of
customers per location, then it will modestly impact the results.
If any brands were to face major downturns in customers, then this
would substantially affect business.
The company is taking measures to improve its largest brands,
including remodeling and large Spanish advertising campaigns for
Red Lobster and an increase in Olive Garden's take-out
offerings.
Overall, with a moderate stock valuation, an above average
dividend yield, and a very specific five-year plan, Darden looks
solid at today's prices in the low $50′s.
Full Disclosure:
As of this writing, I have no position in DRI.
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