Darden Restaurants - Hard Not To Like Management, Share Value More Ambiguous

| About: Darden Restaurants, (DRI)

Summary

Results continue to be solid at Darden as it pumps out better-than-average sales growth.

The business brands are valuable and execution is going well.

Economic weakness may enable a better entry point.

Q4 results released at the end of June showed that Darden (NYSE:DRI) produced 2.2% same-restaurant sales growth. Total sales for the entire year grew by 2.5%, making no adjustment for the extra week in FY 2015.

On a same-restaurant basis, the group as a whole saw sales increase by 1.7%.

Darden employees 150,000 people across seven brands: Olive Garden, Longhorn Steakhouse, Bahama Breeze, Seasons 52, The Capital Grille, Eddie V's and Yard House.

Olive Garden, the Italian-style restaurant is the key driver, having achieved sales of $3.8 billion in FY 2015 across 846 units. Second in size is Longhorn Steakhouse, at $1.5 billion of sales across 480 units.

The good news is that Olive Garden just had a "great" quarter to finish 2016 and served more than 220 million guests for the year.

The restaurant industry as a whole has been finding times more difficult, but Olive Garden's outperformance for the quarter was more than 440 basis points superior to the competition.

Three key drivers are given: simplification of processes, culinary innovation, and the OG to Go platform whose sales were up 19% year-on-year.

Besides Olive Garden, LongHorn Steakhouse was also resilient, sales up by 2.2% on a like-for-like basis.

Darden's other five businesses are referred to as their "specialty restaurants". Results there were described as "solid" in light of positive sales growth at each of them.

Earnings are benefiting from a broad range of positive factors: the sales growth achieved, lower commodity prices, efficiency savings and Darden's own real estate management.

The above helped to generate net earnings in Q4 of $1.10 per share, an increase of 8.9% on adjusted earnings for Q4 2015 (adjusting for the 53-week year in 2015).

Trends in profit margins across Darden's various business groups are mixed, which should be expected given the outperforming sales performance compared to the rest of the industry. It would be strange if there had been no compromise on margins.

Last November, Darden spun off its real estate interests into a new entity, Four Corners Property Trust (NYSE:FCPT).

Four Corners is currently capitalized at $1.26 billion in its own right and its share price has risen steadily since listing.

The unusual value opportunities in spin-offs are well understood thanks to the writings of Joel Greenblatt and others, but it remains the case that there are positive signs to be read into management teams who are willing to do the right thing for their shareholders, even if it means a temporary reduction in their own power.

Spinning off real-estate assets was likely the correct move for Darden, whose fiscal position was somewhat stretched prior. The almost $6 billion balance sheet last year was funded by some $3.7 billion of total liabilities: reasonable in some industries, perhaps, but overly risky for a group of restaurant chains.

Sale-and-leaseback transactions don't necessarily ensure financial stability, of course, as the rent payments on leased property must still be paid. But still, it almost certainly makes sense for shareholders to have the choice about whether they want to own a restaurant business, a real estate business, or both.

Overall, I am warm to Darden. For one thing, I like the dividend track record. Darden paid a rising dividend all throughout the global financial crisis. I like the principle behind the real estate transaction, which appears to have been executed successfully. I like what this signals about management's attitude to risk and to their shareholders. And I like the way the company is exploiting the logistics revolution to encourage takeaway sales at Olive Gardens.

I also like the mid-to-high single-digit operating margins which Darden has historically generated. Some would say that this is not super-high quality, but it is about as good as it gets in the restaurant world. Similarly, return on capital employed clocked in last year at a solid if unspectacular 15.2%.

The market cap of $7.9 billion ($62 share price) generates a forecast PE of 16x using mid-forecast earnings for FY 2017. I personally would wait for weaker sentiment, perhaps accompanied by a weaker economic backdrop, to enable a better entry point. But there is nothing in recent company-specific news to suggest that long-term holders should be in any particular hurry to sell Darden.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.