Editor's Choice

Is This Restaurant Giant Worth It?

Reuben 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) is a leader in the so-called casual dining segment of the restaurant industry. The recession and slow recovery, however, have had a negative effect on the company's operations. Is the current price weakness a buying opportunity for this 4% plus yielder?

Darden Restaurants
Darden's concepts include such ubiquitous brands as Olive Garden and Red Lobster. However, these two largely mature businesses aren't the only concepts Darden manages. Its Long Horn Steakhouse is still expanding, and its collection of higher-end specialty eateries, like The Capital Grill and recently acquired Yard House, still appear to have years of growth ahead of them.

The recession and slow recovery, however, have stifled consumers' appetites for eating out, at least eating out as frequently as before the recession. This has had a notable impact across the restaurant industry that even a best-in-class operator like Darden couldn't avoid. Thus its industry-leading margins have been under pressure. Unfortunately, the company has been working to deal with the issues it is facing with mixed results. Investors have been moving away from the shares because of the still-lingering weakness at core brand Olive Garden and the recent purchase of Yard House, which will likely result in more leverage at Darden than some might think advisable.

A little SWOT
This industry leader now yields nearly 4.5%, leading me to wonder if now is a good time to buy. When considering an investment, having a framework around your research can be very helpful. It stops you from moving from interesting fact to interesting fact without ever considering the company as a whole. A strengths, weaknesses, opportunities, and threats analysis, more frequently called a SWOT, is one of the best ways to force yourself to consider both the good and the bad about a company and its prospects.

To create a SWOT analysis, all you need to do is make a quick, but thoughtful, list of what you consider a company's strengths and weaknesses, which are both internal factors, and the opportunities and threats it faces, which are both external factors. In the end, you'll have a valuable, and more complete, picture of your investment candidate.

Strengths (Internal)

  • Best-in-class operator in the casual dining segment of the restaurant industry.
  • Massive scale provides purchasing leverage and notable distribution benefits.
  • Many of the company's brands are household names.
  • Expanding up-scale business provides an important avenue for long-term growth.
  • Size and scale to acquire and expand smaller concepts (Capital Grill and Yard House, for example).

Weaknesses (Internal)

  • Company has made pricing and advertising changes that have failed to boost results, showing that even the best-in-class operator can make notable, and expensive, mistakes.
  • Expansion efforts at core brands is set to slow, which could lead to slower growth overall as the company works to turn results around.
  • Acquisition of new brands, notably Yard House, has increased leverage at a time when core brands are experiencing weakness.
  • Lack of experience in foreign markets limits growth potential abroad.

Opportunities (External)

  • Changing consumer tastes can open up new avenues for growth.
  • The wealthy have fared better than the middle class and poor in the current period of economic weakness, providing growth opportunities for the company's smaller, but higher-end, concepts.
  • Expansion into foreign markets.

Threats (External)

  • It is largely a domestic company, leaving the vagaries of the U.S. economy as an important wild card.
  • Newly acquired concepts may not resonate with consumers leading to costly divestitures and/or closures.
  • Food cost inflation would notably affect the top and bottom line.

Everyone falls sometimes
Every company has periods in which it struggles. Darden appears to be in such a period right now. However, it likely has the ability to see itself through and prosper over the long term. Though not a lock on success, scale is probably the company's biggest asset. And a near 4.5% dividend yield for a company that has regularly increased its distribution seems like a decent price.

That said, the company is likely to muddle through for at least a few more quarters until it adjusts to the so-called new normal, so this isn't likely to be a short-term turnaround play. More conservative investors would probably be better served waiting for notable performance improvements at core brands.

An interesting pairing
For those willing to wait through the difficult times, Darden could be a good investment. However, pairing it with a purchase of McDonald's (NYSE: MCD) might be an even better bet. This would, essentially, provide investors exposure to the industry leader in the fast food space with the industry leader in the casual dining space. And, with an increasingly important high-end segment at Darden, buying both would give you exposure to every level of the eating experience. McDonald's has been having its own share of difficulties of late, too, resulting in its shares falling from a high above $100 in early 2012 to recent levels in the $90 (and below). The stock's 3.5% yield is also enticing.

This pairing would be a material bet on a recovery of the U.S. economy, despite McDonald's material foreign operations. It would also be a bet on the continuation of the trend toward eating out more often, which is likely to repeat itself abroad as middle classes expand in developing economies to which McDonald's already has exposure. Darden, still domestically focused, would seem likely to be a prime participant once foreign economies have large enough middle classes to afford its restaurant options. So this duo would be an interesting long-term bet on a maturing world economy, too.

More aggressive?
For those with a more aggressive bent, however, a company like YUM! Brands (NYSE: YUM) might be a better pairing option than McDonald's. YUM! has a broader base of concepts than McDonald's with Taco Bell, Pizza Hut, and KFC, and has been expanding more aggressively into foreign markets. While none of YUM!'s concepts has the scale of McDonald's, together they are a powerful business.

Moreover, YUM! has acquired Chinese dining concepts that could be an additional foundation for growth in one of the most vibrant economies in the world. YUM!'s yield at about 2% is notably lower than McDonald's, but its growth profile, assuming emerging markets continue to expand as expected, is probably higher. This combination of value (Darden) and growth (YUM!) might make for a good long-term investment, too, if you can stomach a likely more volatile ride.


ReubenGBrewer has no position in any stocks mentioned. The Motley Fool recommends McDonald's Corp. The Motley Fool owns shares of Darden Restaurants, Inc. and McDonald's Corp. 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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