With a highly populated income-oriented portfolio consisting of over 60 issues, there is one industry sector clearly absent from my diverse list: casual dining. Given the competitiveness and fickle nature of the restaurant business, that may not be a bad thing. But, if one buys into an improving economy and an accompanying upgrade of consumer dining habits, the sector is at least worth a look. I find the best way to explore new investing ideas and to hone my due diligence efforts is to write and submit an article to the Seeking Alpha community.
When I first looked at the casual dining space, I did so through the critical lenses of a dividend investor. That bias naturally led me first to Darden Restaurants (DRI). With a dividend yield over 4% and a steady record of dividend increases since 2005, it look like the best logical choice. The 53% payout ratio was also comforting from a sustainability standpoint. But rather than just jump in, I wanted to compare its performance to its industry peers. In this article, I will look at key metrics and comparisons of five companies that make up a large portion of the $75 Billion Casual Dining industry.
- Darden Restaurants has over 2,000 locations and best known for its Olive Garden and Red Lobster brands. As the largest player in the group, the company had revenues of $8.2 Billion in the last twelve months and a market cap of $5.8 Billion. Although they are experiencing flat and/or declining sales at their flagship brands, Olive Garden and Red Lobster, the specialty restaurant group consisting of Longhorn Steakhouse, Capital Grille, Eddie V's, and Yard House is showing promising growth.
- The Cheesecake Factory (CAKE) namesake is the bread and butter brand of its 170 operating units. With revenue of $1.8 Billion and a market cap of $1.9 Billion, it is just a quarter of the size of Darden. The company began paying an annual dividend in 2012 of $.48 for a yield of just 1.3%, with a payout ratio of 25%. The company is unique among the sector, in that it has no long term debt. Further, it has been very aggressive in buying back its own shares, reducing the number of shares outstanding from 74 Million to 55 Million during the past five years. Last year alone, the company repurchased $100 Million of its own shares. If half of that were to be allocated to a future dividend increase, the yield would jump to over 4% at the recent closing price of $36.14.
- Brinker International (EAT) is dominated by its Chili's brand which accounts for 84% of its total revenue of $2.8 Billion. Brinker's market capitalization stands at $2.2 Billion. Its $.80 dividend yields around 2.3% with a very stable payout ratio of 43%. Like The Cheesecake Factory, Brinker has been actively buying back shares during the past five years reducing the public float by some 20 percent. While the Chili's brand remains relevant, overall revenue growth has been weighted down by the scuttling of the company's On The Border Mexican concept in 2010.
- Bloomin Brands (BLMN) returned to public ownership just last year after being taken private by Bain Capital. They operate under many eclectic themes which include Outback Steakhouse, Carrabba's Italian Grill, Flemings Prime Steakhouse, and Roy's. Bloomin pays no dividend and is riddled with debt to the tune of 6.87 times equity, which is par for the course for companies moving from private to public hands.
- DineEquity, Inc.(DIN) is the operator of Applebees and IHOP Restaurants. Its market cap is $1.4 Billion. The company suspended its $1.00 dividend in 2009 while posting an 18 percent revenue decline over the past three years. However, most of the traditional restaurant metrics for measuring DineEquity's performance are virtually meaningless, as they have been in the process of converting the business to a franchise model over the last few years. More detail will be supplied later in this article.
The chart below compares some key metrics of the five companies listed above.
3- Year Rev Growth
Return on Assets
Market Cap $Mil
LT Debt $Mil
Free Cash Flow
EV/Free Cash Flow
* Enterprise Value is calculated by combining market
Overall, the casual dining business has experienced some headwinds due to the slowing economy pinching the consumer's pocketbook as well as the emergence of the "fast casual" restaurant concepts such as Chipotle, and Panera Bread. From the list discussed thus far, I have decided to take a pass on Brinker and Bloomin. That narrows it down to three - Darden, Cheesecake, and DineEquity.
Darden is clearly the industry leader, and despite a few twists in the road, they should continue to post the highest margins in the category and provide plenty of free cash flow to secure and grow their dividend. The Cheesecake Factory, with its upscale décor and extensive menu coupled with continued same store sales, increases has the potential to be a dividend star with its ample free cash flow, debt-free balance sheet, and modest payout ratio. Further, they are planning significant expansion in Latin America and the Middle East to further develop the brand.
So how did DineEquity make the cut? Based on the numbers in the comparison chart, they should have been the first to get the boot. But, there is a story developing which could change everything for this company.
First of all, after the Applebee acquisition in 2007, the plan was to eventually transition the entire business to a 99% franchise model. The remaining 1% would be retained for product and concept testing. By the end of last year, Dine reached their target of becoming 99% franchised, therefore underscoring their plan for a less capital-intensive business and one focused on creating shareholder value through strong free cash flow.
With that, the board recently instituted a $.75 a share quarterly cash dividend beginning in March of this year yielding 4.1% based on the recent closing price of $71.60. Further, the board authorized a $100 Million share repurchase. It should also be noted that long term debt was reduced by $330 Million in 2012. Since the Applebee acquisition in 2007, debt has been reduced by over $1.0 Billion.
Guidance for 2013 is $77 to $93 Million in free cash flow. At the midpoint of this projection, that would be a coverage ratio of 150% leaving room for share repurchases and/or further debt reduction.
In the company's recent earnings conference call, DineEquity's Chief Financial Officer stated:
Given that we are now 99% franchised, we will no longer consider restaurant operating margin to be a key indicator and affecting operating performance going forward.
Spoken like a true CFO. While it is true that the measuring stick will change, restaurant operating margins will still be a key to a successful franchisee, and ultimately will determine the success of the parent company.
The Darden Restaurants and Cheesecake Factory stories are pretty clear and compelling enough to convince me that these two are the closest thing to being "best of breed" in this category. The DineEquity story, while tempting, is another matter, and one that will require flawless execution. I will watch their progress for the next couple of months before I consider taking a bite out of this one.