I remember back in 1999, when I was in a salad bar restaurant and a little placard on every table told customers that the restaurant’s stock was trading on the Nasdaq under a certain symbol. That’s when I knew the market was about to top. And it did. Still, this restaurant did a great job, served a great product and was profitable at the time. That’s when I decided to keep my eyes open for other similar chain concepts — once the market calmed down.
This brings me to Darden Restaurants (NYSE:DRI), which owns Red Lobster, Olive Garden, LongHorn Steakhouse, The Capital Grille, Bahama Breeze and Seasons 52 restaurants. All in all, that’s 1,800 actual locations. The company has been in business more than 40 years. I’m hoping it’s extremely profitable but underfollowed, so it becomes the next Chipotle (NYSE:CMG).
There are tricks to running restaurants. They are a very low-margin business. There are tons of regulations. The owner might have to deal with unions. Customers can be fickle in their taste. In a bad economy, if the price points aren’t exactly right, an entire corporation can go under. Food service is a unique beast, and a lot of it is tied to customer service. With restaurants like Darden’s, the company must create a fine balance between keeping expenses low without delivering a product that comes off as cheap. In my experience, this company does a pretty good job.
Darden isn’t a hyper-growth story like Chipotle. It feels more like Cheesecake Factory (NASDAQ:CAKE), which has grown very slowly over its 40 years, to only 168 restaurants, taking care not to expand too aggressively in a fickle sector. Darden also has taken its time and is pegged by analysts to grow at an annualized rate over the next five years at 12.78%. Earnings for 2011 are expected to come in at $3.78 per share, an 11% year-over-year increase, and $4.28 in 2012, a 14% increase. Sales growth should be a solid 6.5%.
The difference between Darden and some of its competitors, however, is that Darden carries a lot more debt. It’s holding $1.46 billion of it, and paying about 7% interest. Cheesecake Factory and Chipotle carry none. P.F. Chang’s China Bistro (NASDAQ:PFCB) carries only $111 million. So the problem with Darden, in comparison, is that there’s about $96 million going to debt service instead of the bottom line, which is about 75 cents per share.
The company generates plenty of free cash flow — $250 million in FY 2009, $470 million in FY 2010 and $340 million in FY 2011. So it can pay down that debt and make its debt service payments. It won’t be going bankrupt. Indeed, Darden generates more free cash flow than the above competitors (which are in the mid-$100 millions).
Slow and steady wins the race. There’s nothing wrong with carrying debt, although I’d like to see Darden be more aggressive in paying it down and expanding from cash flow from operations. A 12 P/E on this year’s projected earnings of $3.78 gives a $45 price target. So it looks as though Darden is fully valued. In addition, the company pays a generous 4% dividend, which I’m not crazy about considering the debt it carries. Still, a dividend is a dividend.
Investors looking for a slow and steady brand might want to give Darden a look.
Lawrence Meyers holds no position in the stocks mentioned.