I remember back in 1999, when I was in a salad bar restaurant and a little
placard on every table told customers that the restaurants stock was trading on
the Nasdaq under a certain symbol. Thats 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. Thats 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, thats 1,800 actual locations. The company has been in business more than 40
years. Im hoping its 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 arent 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 Dardens, 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 isnt 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. Its holding $1.46
billion of it, and paying about 7% interest. Cheesecake Factory and Chipotle
carry none. P.F. Changs China Bistro (NASDAQ: PFCB ) carries only $111 million.
So the problem with Darden, in comparison, is that theres 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 wont be going bankrupt. Indeed,
Darden generates more free cash flow than the above competitors (which are in
the mid-$100 millions). Conclusion Slow and steady wins the race. Theres nothing
wrong with carrying debt, although Id like to see Darden be more aggressive in
paying it down and expanding from cash flow from operations. A 12 P/E on this
years 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 Im 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.
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