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On a rather uninspiring trading day restaurant chain Darden (DRI) gets hammered after the company lowers its Q2 EPS guidance ahead of the official release on the 16th of December.

Price action

The warning took investors by surprise and the stock ended the day down 12% closing around $42, trading around the low end of the range for the year. The stock is now down 10% year-to-date after peaking at $53 over the summer.

Warning

Yesterday's announcement resulted in the following guidance changes. The sales growth range gets lowered from 6.5-7.5% range to 6-7%, hardly any change. Profits however were previously expected to grow 12-15% for the full year of 2012, this has been revised downwards to 4-7%.

The guidance change is not as bad as it looks. Sales growth expectations are essentially unchanged and revenues still grow at a healthy pace. While profit growth comes down significantly, profits are still growing and margins are not getting squeezed. Furthermore it should not have come as a complete surprise as on the 6th of September Darden already warned on downside risk for the profit growth guidance.

Attractive valuation

In 2011 the company made $3.41 per share on $7.5bn revenue. The new guidance implies a $3.70 estimated EPS on $8bn revenue, valuing the company at about 11 times earnings. On top of that shareholders receive a cool $1.28 dividend per share.

Over the last 4 years the company has been growing relatively slow with compounded annual growth of 3% over that period. Earnings per share grew 9% per annum as margins increased slightly and the company bought back 5% of its outstanding shares.

Long term growth story

Darden plans to increase its operations significantly in the coming years. Sales coming in at $8bn in 2012 should grow steadily to a level of $10.5-$11.5bn per year in 2016. All 4 branches of the chain are expected to show healthy growth including the well-known franchises “Olive Garden” and “Red Lobster”.

On top of the sales growth management expect it can increase current operating margins from 10% to 11-12%, resulting in 10-15% EPS growth per year. It this trajectory earning per share should come in at anywhere between $5.50 and $7.00 in 2016.

Fortunately for shareholders the company expects roughly half the sales growth to come from existing venues and increased synergies. New restaurant openings should account for half the revenue growth. Shareholders should not worry about dilution of their interest as the expansion could be financed from existing operation cash flows. In each of the last three years operating cash flows exceeded capital expenditures by some $300-$500mn

The company has laid out a nice growth trajectory for the coming years and shareholders punishing the company for missing a quarter earnings estimate are missing out. This short term correction offers a nice entry point for long term investors.

Source: Darden Restaurants Offers An Opportunity For Long-Term Investors