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Jason is a value investor who searches undervalued stocks and invests them. He is currently pursuing CFA designation.
My company:
JC33&Partners Capital
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Gold Rabbit Capital
  • Darden Restaurant Analysis (DRI) 1 comment
    Dec 19, 2012 1:19 AM | about stocks: DRI

    Darden Restaurant Analysis

    Intro:

    Most equity income investors are hoping good quality companies to distribute part of their earnings to the shareholders. There are 4 most common questions that are constantly on individual and institutional investors' minds. Here, I will answer them one by one and make a recommendation about this stock.

    Is the dividend sustainable?

    In our analysis, we believe the dividends to the shareholders will be sustainable in the future mainly because its quality earnings and management's dedication to the shareholders. That being said, we don't see dividend growth will be reaching to double-digit like it used to. The main reason behind that is the 10 years average net income growth is substantially less than the 10 years average dividend growth. This will definitely impact the growth of the dividends.

    What is the quality of the dividends?

    The current dividend payout ratio is 49% which is slightly higher than the average 46.73% percent for the restaurant industry. (Source:pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/divfund.htm) We think with the possible decreasing profit margin in the future, the net income and CF will not increase by a whole lot; this will also limit the Darden's ability to pay out quality dividends unless it raises more debts to pay out dividends.

    Potential earning growth comes from?

    We think the earnings growth will come from more US stores expansion and brand acquisitions. According to the Annual Report 2012, Darden management planned to keep up the pace as in 2011, opening up 100 restaurants per year. With strong execution, good cost control, diversified subsidiary restaurants. there are good chances for the next few years, Darden's earnings growth will poise upward.

    But the most important earning growth I would like to see and currently missing from Darden expansion plan is international expansion in emerging market such as China, Brazil and others. We believe international expansion would fully leverage its comparative advantages.

    Is the company well-managed?

    Darden Restaurants is extremely well-managed. From the profitability ratios we can see that net income growth mainly comes from well-managed COGS and expenses to keep the operating margin, net profit margin relatively stable during tough times. Not only that, efficiency ratios tell us that Darden executives' ability to utilize the company resources is well above other competitors such as Brinker International and Dine Equity.

    What is the target price?

    The target price we set for this stock is around $53. This number is calculated from utilizing Gordon Growth Model and taking 20% off of the intrinsic value as the safety margin. When we use Gordon Growth Model, we make a few assumptions. 1. Darden Restaurant earnings will grow indefinitely at 12% per year; 2. Required rate of return will be 15% for us; 3. Dividends will grow at 10% pace indefinitely.

    Recommendation and Conclusion

    This year is definitely not a good year for full-service restaurant segment, especially with recent news about economic headwind, decreasing same-store sales, and decreasing prices in its menus. As the result, we believe the profit margin will further getting squeezed. That being said, with the upcoming holiday seasons and recent encouraging unemployment rate data, revenue could increase in a single digit level and net income and operating cash flow will remain the same level as now. Therefore, we believe dividends payout ratio will remain about the same level and dividend growth will increase gradually in a single digit level. We would recommend investors buy this stock in small percentages relatively to their portfolio as satellite holdings.

    12/15/2012 by Jason Chao

    Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DRI over the next 72 hours.

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  • cjhall13
    , contributor
    Comments (3) | Send Message
     
    Very, very smart and to the point. Well done.
    19 Dec 2012, 02:25 PM Reply Like
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