Darden Restaurants: Near-Record Earnings, Attractive Dividend Increase

Darden Restaurants is listed on the NYSE as DRI.

52-week range: $13.21 (Nov. 21, 2008) - $41.21 (Apr. 22, 2009)
Dividend = $0.25 quarterly = 3.14% current yield

Company profile from MSN MoneyCentral:

Darden Restaurants, Inc. (Darden) operates in the full-service dining segment of the restaurant industry, primarily in the United States. As of May 25, 2008, the Company operated, through its subsidiaries, 1,702 restaurants in the United States and Canada. In the United States, it operated 1,667 restaurants in 49 states (the exception being Alaska), including 651 Red Lobster, 647 Olive Garden, 305 LongHorn Steakhouse, 32 The Capital Grille, 23 Bahama Breeze and seven Seasons 52 restaurants, and two specialty restaurants: Hemenway’s Seafood Grille & Oyster Bar and The Old Grist Mill Tavern. In Canada, Darden operated 35 restaurants, including 29 Red Lobster and six Olive Garden restaurants.

Despite the poor economic conditions Darden reported near-record earnings of $2.75 per share (from continuing operations) for their FY 2009 [ended May, 2009] versus FY 2008’s $2.78/share. Management conservatively guided to a range of $2.59 - $2.81 for the present FY assuming no improvement until consumer confidence picks up. Most analysts had been looking for $2.90. (See conference call transcript.)

The dividend was raised yesterday from $0.20 to $0.25 quarterly putting the current yield at a very attractive 3.14%. This marked the seventh annual increase over the past eight years. Holders of record on July 10th will be paid the higher rate on August 3rd. Excepting last fall’s panic low, this represents the best yield ever on these shares.

Here are Darden’s per share numbers as reported by Value Line:

At yesterday’s closing quote of $31.85 DRI is offered at just 11.7x trailing and about 12.2x forward low-end expectations. That’s well below its historical 10-year median of 15x.

Value Line gives DRI a financial strength rating of ‘A’ and notes that the shares have outperformed 75 percent of the 1700 stocks in their universe over the long term. They assign Darden a 95th percentile ranking for ‘earnings predictability’ (with 100th being best). Morningstar also likes Darden. They rate them 4-stars (out of 5) and figure ‘fair value’ at $48 per share.

If current year earnings only reach $2.60 (near the bottom of the company’s projected range) even a thirteen multiple would have these shares back up to $33.80.

Is that reasonable? It's quite conservative. Darden shares have hit peak prices of between $37.80 - $47.60 in each calendar year 2005-2009. They traded at $41.21 as recently as April 22 of this year.

Here’s a nice short-term play with Darden going out to January 2010:

If Darden shares merely stay above $30 (as they already are) through January 15, 2010:

The $30 calls will be exercised.

You will sell your shares for $30,000.

The $30 puts will expire worthless.

You will likely have collected $500 in dividends.

(I am assuming an early exercise next January by the option holder to capture the final dividend from you.)

You will end up with no shares and $30,500 cash for your original outlay of $22,750.

That’s a best-case scenario total return of $7,750 / $22,750 = 34% achieved in less than seven months.

You will make this return if:

• Darden shares go up.

• Darden shares drop to no less than $30. (That allows for up to a 5.8% decline.)

What’s the risk?

If Darden finishes below $30 on expiration date:

The $30 calls will expire worthless.

The $30 puts will be exercised.

You will be forced to buy another 1000 shares and to lay out an additional $30,000 in cash.

You will likely have collected $750 in dividends.

You will end up with 2000 shares of DRI and $750 cash.

What’s the break-even on the whole trade?

On the first 1000 shares it’s their $31.85 purchase price less the $5.20/share call premium = $26.65 /share.

On the ‘put’ shares it’s the $30 strike price less the$3.90/share put premium = $26.10 /share.

Your break-even is figured as follows:

$26.65 + $26.10 / 2 = $26.38 /share (ignoring dividends).

Darden shares could fall by as much as $5.47 or (-17.1%) without causing a loss on this trade.

Your net outlay for the 2000 shares would be $52,750 less the $750 received from three quarterly dividend payments. That reduces your final break-even to just $26/share or $5.85 below the trade’s inception price.

Summary:

If good-quality Darden shares go up, remain unchanged or even if they drop to as low as $30 by January 15, 2010 you will likely earn 34% in less than seven months.

You are protected against loss all the way down to $26/share giving you a better than 18% margin of safety.

Disclosure: Author is long DRI shares and short DRI options.