An Undervalued Restaurant Stock With Strong Earnings Set To Double Its Dividend In 5 Years

Jul.16.12 | About: Darden Restaurants, (DRI)

It's easy to forget about stocks that don't get the majority of the attention of most investors and talking heads. While stocks such as Apple (NASDAQ:AAPL), McDonald's (NYSE:MCD), and Phillip Morris International (NYSE:PM), often get the majority of the media coverage in today's press, less known companies with strong earnings are often overlooked.

Today, while the restaurant industry in the U.S. is fairly diverse, stocks such as McDonald's (MCD), YUM (NYSE:YUM), and Chipotle (NYSE:CMG), seem to get most if not all of the attention of the press.

Indeed, well each of these stocks has been strong performers over the last decade, less known companies, such as Darden Restaurants (NYSE:DRI), has also significantly outperformed McDonald's and most of its restaurant peers over the last several months.


To be sure, McDonald's has significantly outperformed Darden Restaurants over the last decade. Still, today, Darden Restaurants trades at around 14x trailing earnings and just 11x forward earnings estimates, while McDonald's trades at 17x trailing earnings and nearly 15x forward earnings estimates.

Darden Restaurants has also consistently outperformed the S&P 500 (NYSEARCA:SPY), and its tracking exchange traded fund, SPY (SPY), by a fairly wide margin.


While, certainly, higher growth companies in the restaurant industry such as McDonald's have consistently grown in the low double digits over the last several years, while Darden Industries has grown in the high single digits, there are strong signs today that Darden industries should have accelerating growth while McDonald's, YUM, and other internationally focused companies will likely face increasingly significant headwinds.

Darden Restaurants is a nearly $6 billion dollar company does the vast majority of its business in North America, with the company having just 25 Red Lobster restaurants in Japan. The company's three major franchises are Olive Garden, Red Lobster, and Longhorn Steakhouse. While Olive Garden and Red Lobster offer value, with Olive Garden targeting slightly higher income consumers, Longhorn Steakhouse offers a more affordable luxury product, pricing the company's steaks in the $25-$30 range.

Darden Restaurants' focus on value has enabled the company to perform very well during the last several years, and the company has consistently taken market share in the North American market while growing its free cash flow by around 30% a year and raising its dividend by 25% each of the last two years, and 16% just past June. The company has never cut its dividend.

While Darden Restaurants' Olive Garden franchise has experienced slowing growth trends lately, the company's Red Lobster franchise has had double-digit same-store sales growth of late, and Longhorn Steakhouse has also had strong same-store sales growth of 2%-3% in recent quarters as well.

While more internationally focused restaurant chains such as McDonald's and YUM have benefited significant from a weak dollar and strong demand in emerging markets, Darden was hit hard over the past year by rising agricultural costs, with the company's costs up nearly 18% in 2011.

Today the economic data in Europe and most emerging markets continues to weaken, and the dollar is at the highest levels it has been against most major currencies since 2010. With a rising dollar and falling energy and agricultural commodity prices, Darden Restaurants should see its costs fall significantly this year. Also, Since Darden Restaurants' core franchises, Red Lobster and Olive Garden, cater to a medium-to-lower-income consumer, the company should also benefit significantly from falling fuel prices as well.

To conclude, while the largest and fastest growing companies in any industry often get the most attention from the mainstream press, the best value often requires more research. With leading emerging market economies such as Brazil and China facing significant headwinds, and the economic data continuing to weaken in Europe, U.S.-centered companies with strong organic growth should be able to expand margins as costs continue to fall.

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