Darden Restaurants, Inc. (DRI, Financial) stock is trading near its 52-week high of $73.40. Although the stock price is relatively expensive to the rest of the industry, in my opinion, it is a "buy" at this current price level.
Analysis
Darden has compelling valuation metrics and strong earnings growth prospects. For 2016, the company will open new restaurants in the range of 18-22, apart from expecting sales growth between 2.0% to 2.5% from existing ones. The company uses its strong cash flow generation to return consistent value to its shareholders through share repurchases and dividends. For the 12 months ended in May, Darden spent $502.3 million buying back shares, representing an allocation of 115% of its net change in cash. Moreover, dividends have been paid since 1995, which demonstrates their commitment to returning capital to shareholders, and it has been increasing its dividend annually since 2005, currently offering a dividend yield of 3.09%. Only in 2014, the firm did not raise its dividend. Nonetheless, I consider the restaurant an attractive dividend stock.
In my opinion, Darden's stock has an impressive short-term momentum and it is a good long-term investment. In a report published last week, analysts at Deutsche Bank (DB, Financial) maintained a “buy” rating on the stock, while increasing the price target to $79 from $72, backed by a strong fourth quarter posted by Olive Garden.
The company seems to be more flexible, probably with the incorporation of the new CEO Gene Lee. He focuses on generating value each day while reducing or optimizing some processes. As a matter of fact, the company has experienced revenue growth, growth in EPS and solid cash flow from operations. When thinking about future growth, I must say that it will be much linked to Olive Garden´s performance. Also, Darden's efforts in improving cost structure should help to margin improvements.
The main risk for Darden is a weaker economic environment, where consumers dine out less. Further, a faster growth in food or labor costs could impact the company´s performance in the future. In my opinion, cost inflation always is a concern, but I think there exists an opportunity to buy this stock because sub-industry shows signs of growing, suggesting that Darden will compete for a major market share. Despite the growth in home cooking, in my opinion I see high growth prospects for Darden.
Latest quarter results and outlook
On June 23, Darden reported its fourth-quarter fiscal and fiscal 2015 financial results, which beat EPS expectations for both periods. The company showed earnings per share surprise in the last four quarters, as shown in the table below.
| Quarter | 14-Aug | 14-Nov | 15-Feb | 15-May |
| Estimate EPS | 0.31 | 0.27 | 0.84 | 0.93 |
| Actual EPS | 0.32 | 0.28 | 0.99 | 1.01 |
| Surprise | 0.01 | 0.01 | 0.15 | 0.08 |
| Surprise (%) | 3.20% | 3.70% | 17.90% | 8.60% |
Source: Yahoo Finance
Darden also provided strong earnings guidance for fiscal 2016 and announced a strategic real estate plan that would help reduce debt.
Relative valuation
Darden's stock is up 24.4% year-to-date while the SPDR S&P 500 ETF Trust (SPY, Financial) has increased only 2.1%. Despite this growth, I believe that the shares can rise further. Darden's valuation metrics are quite good, especially when looking at the trailing P/E, which stands at 13.90, lower than the industry median of 27.70 and close to a five-year low. On the other hand, the price-to-sales ratio is at 1.98 and price-to-book ratio is at 4.1, both above the industry median. Moreover, the PEG ratio of Darden is very low at 1.5. The rule is that stocks with lower PEGs are more attractive than stocks with higher PEGs. In other words, a lower PEG means that the stock is more undervalued compared to its peers.
Final comment
Darden is well positioned to improve its competitive position in markets that should be expanding. In my view, it will benefit from its strategic initiatives, like the planned separation of some company assets into a real estate investment trust (REIT), which may create value if structured properly. Further, the firm has compelling valuation metrics and strong earnings growth prospects; its PEG ratio is low which is attractive for investors. Darden will continue to use its strong cash flow generation to return value consistently to its shareholders through dividends and repurchasing shares.
All the factors outlined in the article, bring me to the conclusion that Darden's stock is an adequate investment for the long haul. The fact that hedge fund managers Steven Cohen (Trades, Portfolio) and Paul Tudor Jones (Trades, Portfolio) initiated a position in the stock in the first quarter makes me feel comfortable with my recommendation.
Disclosure: Omar Venerio holds no position in any stocks mentioned.
