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Darden Restaurants: What We Can Expect from Tomorrow´s Earnings?

ovenerio

ovenerio

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In this article let's take a look at Darden Restaurants, Inc. (DRI), the nation's largest casual-dining restaurant company, which owns and operates more than 2,100 restaurants that generate over $8.5 billion in annual sales. Let´s try to discuss some things before its report for fiscal fourth quarter and 2014 results tomorrow (on Jun 20, 2014).

Divestitures

Despite the furious of activist investors, last December Darden has revealed plans to release its historical segment. Red Lobster, founded by William Darden in 1968, is the largest full-service dining seafood specialty restaurant operator in the United States, but is the worst performing segment. After considering several structures, a $2.1 billion deal was reached with Golden Gate. After tax and transaction costs, Darden Restaurants received almost $1.6 billion, which it plans to use for paying off outstanding debts and future share repurchases. The divestiture of the Red Lobster segment will also help it to focus on its more profitable brands like LongHorn Steakhouse and Capital Grille.

Latest Financial Data

Revenues declined by 1.1% when compared to the same quarter one year prior. This impacted the bottom line and consequently decreased earnings per share. The gross profit margin is rather low at 21.2% and it has also decreased from the same quarter the previous year.

With respect to the return on equity, it is lower than the one registered in the same quarter one year prior. The price is lower than others in its industry in relation to its current earnings. All these are a clear sign of weakness within the company and make it not attractive for investors.

Relative Valuation

In terms of valuation, the company sells at a trailing P/E of 19.7x, trading at a discount compared to the industry mean.

Ticker

Company

P/E

DRI

Darden Restaurant

19.7

BKW

Burger King

36.1

YUM

Yum Brands

31.6

WEN

Wendy´s

37.2

DPZ

Domino´s Pizza

27.5

EAT

Brinker International

20.8

This ratio indicates that the stock is relatively undervalued when compared to its peers: Burger King (BKW), Yum Brands (YUM), Wendy´s (WEN), Domino´s Pizza (DPZ) and Brinker International (EAT).

In the next graph we can see the evolution of the stock price together with EPS. The reason is that earnings often lead the stock price movement. As we can appreciate, the price performance showed an upward trend in the last five years. A long position of USD 10K five years ago today represents USD 17,456 (which means an 11.8% annual return).

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Dividend Policy

Dividends have been paid since 1995, which demonstrates their commitment to returning capital to shareholders. Darden has raised its cash dividend in the past years. In 2007, it increased the annual dividend by 56% (to $0.72). In 2008, it further increased the dividend by 11% (to $0.80), in 2009 by 25% (to $1), in 2010 by 28% (to $1.28), in 2011 by 34% (to $1.72) and in 2012 by 16% (to $2.00). Last year, it announced a 10% increase to the actual level of $2.20.

Final Comment

While it is possible that Darden could prove to be an attractive long-term investment, investors should probably watch tomorrow the earnings report (the conference call will be broadcast live over the Internet) and try to predict how likely the stock’s price will move following it to help determine the best action to take (long or short). In my opinion, despite that during the first quarter of the year, traffic at quick-serve restaurants was flat, now the worst of the winter has passed and temperatures have warmed up and we should begin to see improvement, perhaps tomorrow is the beginning for Darden.

According to Yahoo! Finance, the estimated one-year target share price is $52, so if you buy shares at current market price ($49.72), your return from price appreciation would be 4.6%. In addition, for holding the stock one year, you'll be paid a dividend of 55 cents per share each quarter, totalizing $2.2 at the end of the year or a dividend yield of 4.4%. So the total expected return for investing in Darden is 9%. We consider this is a low return and we can think in other stocks in the restaurants industry such as Red Robin Gourmet Burgers Inc. (RRGB), Chipotle Mexican Grill, Inc. (CMG) and The Kroger Co. (KR).

Hedge fund gurus have also been active in the company in the first quarter of 2014. Paul Tudor Jones (Trades, Portfolio) and David Dreman (Trades, Portfolio) have taken long positions on it.

Disclosure: Omar Venerio holds no position in any stocks mentioned.

About the author:

ovenerio
We provide independent fundamental research and hedge fund and insider trading focused investigation.

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