How to Make Money From Investing in Restaurants

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Darden Restaurants' (NYSE: DRI) promotion-driven strategy certainly gave a face lift to customers as it increased the amount of sales. The promotions have had a negative impact on the company's bottom line. Going forward, investors have to be watchful of the company's business strategy.

Earnings highlights

The company was able to grow same-restaurant sales across all of its franchises. The growth in same-restaurant sales was partially driven by the promotion-driven business model. The company reported a negative 2% to negative 4% decline in its menu mix (amount of profit generated on average across all menu items). The company believes that this drop in menu mix will improve in future quarters by no longer offering promotions.

Same-restaurant sales increased 1% to 5% across Darden Restaurants’ four major franchises. The company has also increased the total number of restaurants from 1,994 to 2,138 (year-over-year). The growth in the number of restaurants paired with increases in same-restaurant sales resulted caused  11.3% year-over-year growth in sales.

The growth in sales from promotions was temporary and was done at the loss of profits. New restaurant openings will lower profitability over the short term (restaurants take a year or two to break even). Because of this, Darden Restaurants’ expenses increased by 14%. The increase in expenses caused earnings to fall by 12% year-over-year.

The lesson of the day is not to run promotions and open new stores at the same time. Promotions boost sales over the short term but pressure net income. Promotions have no meaningful contribution to companies over the long term.

Analysts on a consensus basis anticipate earnings to decline by 11.7% for the remainder of the fiscal year. The stock has already pulled back by 13.5% from its 52-week high, so it can be assumed that the weakness in short-term performance has already been priced into the stock.

Investment thesis

Because the loss of earnings was due to promotions, the negative effect on earnings is likely to be temporary. Therefore, I anticipate the company to end its promotions, which will cause earnings to grow in future fiscal years.

That being the case, investors should invest in this stock at these lower levels. Analysts on a consensus basis anticipate the company to grow earnings by 4.4% on average over the next five years. The company also compensates investors with a 3.9% dividend yield. The growth paired with the dividend make it a compelling investment.

The stock currently trades at a 15.6 earnings multiple, which could be pricey for some. However, the company’s earnings multiple is lower than the industry average 23.3 earnings multiple. This implies that if the company can grow earnings, the stock could be cheap on a comparative basis.

I’m loving it

Investors should buy shares of McDonald’s (NYSE: MCD) because of the company’s consistency in management and operations. The company is heavily focused on improving its restaurant experience. It has been able to grow comparable-store sales in the United States by 2.4% and by 2% in Europe. We can assume that because the company grew comp sales at a rate that is above inflation (the consumer price index grew by 1.4% over the past 12 months), the growth in comparable-store sales was due to increased demand rather than just higher prices. This is a very good sign.

Analysts on a consensus basis anticipate McDonald’s to grow earnings by 8.6% on average over the next five years. The growth in earnings is likely to be sustained through a mix of comp-store sales growth, restaurant openings, and share buybacks. The company also compensates its investors with a 3.2% dividend yield.

McDonald’s currently trades at an 18.1 earnings multiple. When compared to the industry average 23.3 earnings multiple, the stock is slightly undervalued.

Real definition of luxury

Another investment opportunity is The Cheesecake Factory (NASDAQ: CAKE). The company is the most dominant American restaurant brand among teenagers, according to PiperJaffray. In my opinion, the Cheesecake Factor has some of the most amazing food on planet earth, and both Red Lobster and Olive Garden can’t even compare.

The Cheesecake Factory has been able to grow comparable-restaurant sales sales by 1.6% year-over-year in its most recent quarterly earnings report. The company grew revenue by 6.5% in the same period. The lack of growth in revenue was due to the lack of new restaurant openings. Going forward, there is a growth catalyst in the opening of more restaurants.

The company’s earnings growth is driven by modest improvements in comparable-restaurant sales paired with cost cutting. Analysts on a consensus basis anticipate this company to grow earnings by 13.8% on average over the next five years. The company trades at a 23.1 earnings multiple. The added premium on earnings is due to the high rates of growth. The company also compensates investors with a smaller dividend (1.2% dividend yield).

Conclusion

Darden Restaurants reported a decline in earnings. The reasoning was pretty simple -- rising costs associated with promotions paired with store openings. Going forward, the earnings growth should eventually stabilize.

Darden Restaurants' offers an added element of uncertainty that McDonald’s doesn’t have. Therefore, McDonald’s is a better investment opportunity from a growth and valuation standpoint. Those who want to invest into something slightly riskier should consider an investment into the Cheesecake Factory. The Cheesecake Factory will grow the fastest out of the three.

McDonald’s turned in a dismal year in 2012, underperforming the broader market by 25%. Looking ahead, can the Golden Arches reclaim its throne atop the restaurant industry, or will this unsettling trend continue? The Fool's top analyst weighs in on McDonald's future in a recent premium report on the company. Click here now to find out whether a buying opportunity has emerged for this global juggernaut.


Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends McDonald's. The Motley Fool owns shares of Darden Restaurants and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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