Darden Restaurants has distinguished itself as a formidable player in the American dining industry with a broad portfolio of well-known eateries. The company has a proven strategy of delivering great value and a superior experience to its customers, which positions it well regardless of the operating environment. The question at hand is whether now is the right time to buy shares in Darden Restaurants, and that is what I will explore in this analysis.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Darden Restaurants. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in Darden Restaurants' competitors either. Thus, I have no personal stake in Darden Restaurants. If you want to purchase shares or fractional shares of Darden Restaurants, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
The Business
Darden Restaurants was founded in 1968 as Red Lobster Inns of America. The company was acquired by General Mills in 1970 and became a separate publicly traded company in 1995 when General Mills distributed all of its outstanding stock to its shareholders. Darden is a multi-brand restaurant operator and one of the largest full-service restaurant companies in the world. Its restaurant brands include Olive Garden, LongHorn Steakhouse, Cheddar's Scratch Kitchen, Yard House, The Capital Grille, Seasons 52, Bahama Breeze, Eddie V's Prime Seafood, The Capital Burger, and the recently acquired Ruth's Chris Steak House and Chuy's. Darden Restaurants operates 2.031 restaurants, primarily in the United States and Canada, and has 146 franchised restaurants globally. Darden Restaurants has four reportable segments: Olive Garden, which contributed approximately 44% of sales; LongHorn Steakhouse, which contributed approximately 25% of sales; Fine Dining (including Ruth’s Chris, The Capital Grille, and Eddie V’s), which contributed approximately 11% of sales; and Other Business (including Cheddar's Scratch Kitchen, Yard House, Bahama Breeze, Seasons 52, The Capital Burger, and results from franchise operations), which contributed approximately 20% of sales. Darden Restaurants' brands, particularly Olive Garden and LongHorn Steakhouse, are well-known in North America. These brands, combined with Darden Restaurants' commitment to quality food and service, create a strong competitive moat for the company.
Management
Rick Cardenas is the CEO of Darden Restaurants. He began his career with the company in 1988, starting as a busser at a Red Lobster. Over the years, he has taken on roles of increasing responsibility within the company, ultimately becoming CEO in 2022. He holds a bachelor's degree in Finance and Accounting from the University of Central Florida and an MBA from The Amos Tuck School of Business Administration at Dartmouth College. He is also a Certified Public Accountant and serves on the Board of Directors of Tractor Supply Company. Before becoming CEO, Rick Cardenas was the CFO of Darden Restaurants, where he worked closely with the former CEO to shape the company's strategy. This strategy includes a strong emphasis on operations and leveraging the company's scale and data advantages to drive results. As CFO, he was actively involved in numerous acquisitions, such as Cheddar's Scratch Kitchen, Yard House, and Eddie V's Prime Seafood. Recently, he made his second acquisition as CEO by acquiring Chuy's, which aligns with his emphasis on mergers and acquisitions as a means of allocating capital for long-term growth. When he was introduced as CEO, the former CEO described Rick Cardenas as one of the best strategic thinkers he had ever worked with. While it is too early to fully evaluate Rick Cardenas's performance as CEO, his extensive experience in various roles within the company clearly brings a wealth of knowledge to both Darden Restaurants and the industry. I also appreciate his deep involvement in strategizing and his focus on leveraging scale and data to drive results. Therefore, I am inclined to give Rick Cardenas the benefit of the doubt and feel confident in his leadership of Darden Restaurants moving forward.
The Numbers
The first metric we will investigate is the return on invested capital (ROIC). I prefer to see a 10-year history with all figures demonstrating growth of over 10% for each year. Darden Restaurants has consistently achieved a high ROIC, with the exception of 2020, which was impacted by the pandemic. It is very encouraging to see that Darden Restaurants has achieved a much higher ROIC in the past three years, with figures significantly exceeding those of the previous seven years. Although there was a slight decrease in ROIC in fiscal year 2024, I do not view this as a concern, as Darden Restaurants still managed to achieve a ROIC of 28%. It is also worth noting that ROIC has been significantly higher since Rick Cardenas became CEO, which gives me confidence that this high ROIC is sustainable under his leadership.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most significant of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The numbers are somewhat mixed, as there has been a decline in three of the past ten years. It is also worth noting that equity reached its peak in fiscal year 2021, which was some time ago. However, it is encouraging that equity has increased over the past two years, and there is hope that it will soon reach a new all-time high.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. It is not surprising to see that Darden Restaurants has consistently generated positive free cash flow every year for the past decade. The pandemic year of fiscal 2020 negatively impacted free cash flow, but Darden Restaurants still managed to achieve a positive result, which is encouraging. Another positive development is that Darden Restaurants has achieved significantly higher free cash flow in the past four years compared to the years before. Notably, Darden Restaurants delivered its highest free cash flow ever in fiscal year 2023, only to surpass it in fiscal year 2024. However, a less favorable development is that the free cash flow margin decreased in fiscal year 2024 and is at its lowest point since fiscal year 2018, excluding the pandemic year of 2020. Hopefully, the company will be able to increase the levered free cash flow margin moving forward. The free cash flow yield is slightly above the ten-year average, which suggests that Darden Restaurants may be trading at a reasonable valuation, but this is something we will revisit later in the analysis.
Debt
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. This can be calculated by dividing the total long-term debt by earnings. After performing this calculation for Darden Restaurants, I found that the company has 1,38 years of earnings in debt, which is well below the three-year threshold. In fact, Darden Restaurants has not had a debt-to-earnings ratio above three years in the past decade. Therefore, debt is not a concern for me when considering an investment in Darden Restaurants.
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Risks
Based on my findings thus far, I find Darden Restaurants to be an intriguing company. However, no investment is without risk, and Darden Restaurants also faces its fair share of challenges. One key risk is competition. Darden Restaurants contends with significant competition in the full-service dining sector, facing national chains, regional players, and local restaurants across multiple dimensions, such as pricing, service quality, location, and food variety. This environment requires Darden Restaurants to continually adapt and differentiate to retain customers. The company also faces threats from fast-casual and quick-service restaurants that offer similar food at lower prices, as well as from the growing convenience of home delivery services, which can reduce restaurant visits and increase costs through delivery fees. Furthermore, the convergence of the restaurant and retail sectors, with supermarkets offering "convenient meals," and the influence of online platforms further intensify the competitive landscape. With low barriers to entry in the restaurant industry and easily replicable competitive advantages, it remains challenging for Darden Restaurants to sustain long-term differentiation and maintain its market share.
Another risk is macroeconomic factors. Macroeconomic conditions pose a significant risk to Darden Restaurants, as they directly impact consumer discretionary spending, which is crucial for the business. Economic challenges such as slow recovery, geopolitical tensions, and uncertainty about growth have already negatively affected Darden Restaurants' performance and may continue to do so. Factors like weakening GDP growth, rising unemployment, and inflation make consumers, particularly those below the median household income, more cautious about spending, leading to a reduced frequency of dining out, especially in higher-priced segments. Additionally, rising costs in non-discretionary expenses like rent, utilities, childcare, and food that outpace wage growth further limit disposable income, decreasing spending on dining out. High inflation and increased interest rates can also drive consumers to opt for more affordable alternatives or favor at-home dining, which reduces traffic and sales for Darden's restaurants.
Laws and regulations pose a significant risk to Darden Restaurants due to their extensive and complex nature, affecting multiple aspects of its operations. The company must comply with a wide range of federal, state, local, and international regulations, covering areas such as environmental standards, labor laws, menu labeling, immigration requirements, and taxes. The variation in these laws across different jurisdictions requires continuous monitoring and adaptation, creating operational challenges for Darden Restaurants as a multi-state employer. Changes in regulations, such as higher minimum wages or stricter environmental standards, can directly increase operational costs and reduce efficiency, thereby negatively impacting profit margins. Additionally, failure to comply with these laws could result in fines, legal penalties, loss of licenses, and damage to the company's reputation, further harming its financial performance. Public policy changes, including new union regulations or shifts in health and safety standards, introduce another layer of uncertainty. These changes could lead to unforeseen costs or operational disruptions, making it more challenging for Darden Restaurants to maintain stable operations and profitability.
Reasons to invest
There are also numerous reasons to consider investing in Darden Restaurants. One key reason is the company's significant scale. Darden Restaurants' scale provides strategic and operational advantages that enhance its competitiveness and profitability. Firstly, Darden Restaurants' large scale enables it to build strong, long-term relationships with suppliers, securing better pricing and favorable terms for essential supplies. By sourcing directly from producers and maintaining a dedicated distribution network, Darden Restaurants reduces costs and ensures a reliable supply chain, minimizing the risk of disruptions. Secondly, these cost advantages allow Darden Restaurants to offer competitive pricing while maintaining high-quality standards, creating a favorable price-to-quality ratio that attracts customers and fosters loyalty. This is particularly crucial in the full-service dining segment, where consumers are highly sensitive to both price and value. Thirdly, Darden Restaurants leverages its scale for enhanced marketing and customer engagement. As a major player in the industry, it invests heavily in national and digital advertising campaigns, using data-driven insights to deliver targeted marketing that strengthens customer relationships and loyalty. Finally, Darden Restaurants' scale supports innovation and differentiation across its diverse brands. The company utilizes its resources, insights, and experience to help each brand reach its full potential while preserving its unique identity, making Darden Restaurants' portfolio appealing to a broad range of customers.
Opening new restaurants. Darden Restaurants' strategy of opening new restaurants is a compelling reason to invest, as it emphasizes growth, market expansion, and strengthens its competitive edge in the full-service dining sector. The company focuses on expanding successful brands like Olive Garden in markets where they already have a strong presence, catering to consumer demand for convenience by opening more locations closer to customers. Darden Restaurants' disciplined approach, which includes thorough market analysis and careful site selection based on demographics, competition, and accessibility, helps ensure that new restaurants are set up for long-term success. This reduces the risk of underperforming locations and maximizes the potential for profitable growth. In a highly fragmented industry dominated by small chains and independent operators, Darden Restaurants' continued expansion allows it to capture a larger market share. By leveraging its strong brand portfolio, operational expertise, and scale, the company is well-positioned to outperform smaller competitors and seize new growth opportunities, making it an attractive investment option.
Acquisitions. Darden Restaurants' acquisition strategy is a compelling reason to invest in the company because it focuses on adding high-potential brands that enhance its portfolio and drive long-term growth. Darden Restaurants follows a disciplined approach, acquiring brands that meet its criteria for growth potential, cultural alignment, and financial impact, as seen with the acquisition of Chuy's to enter the popular Mexican dining category. The company creates value by achieving synergies and improving operational efficiency, as demonstrated by the successful integration of Ruth's Chris Steak House, which delivered cost savings and boosted earnings. By targeting acquisitions that complement its existing strengths, Darden Restaurants expands its market presence and diversifies its offerings. With a focus on strategic, long-term investments and effective integration, Darden Restaurants strengthens its market position, reduces costs, and enhances profitability.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 8,53, which is from the fiscal year 2024. I have selected a projected future EPS growth rate of 10% (Finbox expects EPS to grow by 10,8%). Additionally, I have selected a projected future P/E ratio of 20, which is double the growth rate. This decision is based on the historical higher P/E ratio of Darden Restaurants. Lastly, our minimum acceptable rate of return is already set at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $109,38. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Darden Restaurants at a price of $54,69 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 1.612, and capital expenditures were 628. I tried to review their annual report to calculate the percentage of capital expenditures allocated for maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 440 in our calculations. The tax provision was 145. We have 118,8 outstanding shares. Hence, the calculation will be as follows: (1.612 – 440 + 145) / 118,8 x 10 = $110,86 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Darden Restaurants' free cash flow per share at $8,47 and a growth rate of 10%, if you want to recoup your investment in 8 years, the Payback Time price is $106,55.
Conclusion
I find Darden Restaurants to be an intriguing company. While there are some uncertainties regarding management due to the CEO being relatively new, Rick Cardenas has extensive experience with the company and has contributed to the current strategy, which has led to an increase in ROIC and free cash flow. Therefore, I am comfortable with Rick Cardenas leading Darden Restaurants moving forward. Competition is an ongoing risk for Darden Restaurants, as it faces pressure from national, regional, and local competitors, as well as lower-priced fast-casual options and home delivery services. This makes it challenging to maintain differentiation and market share in a crowded industry with low barriers to entry. Macroeconomic factors also pose a risk for Darden Restaurants because they directly impact consumer discretionary spending. In uncertain economic conditions characterized by rising unemployment, inflation, and increased non-discretionary costs, people may become more cautious about dining out. As disposable income shrinks, consumers may opt for more affordable options or prefer at-home dining instead. Laws and regulations present another risk for Darden Restaurants, as compliance with a wide range of complex and varying rules across jurisdictions increases operational costs and challenges. Changes in regulations or failure to comply could result in fines, legal penalties, and reputational damage. However, there are several reasons to consider investing in Darden Restaurants. The company's scale provides cost advantages through strong supplier relationships and a reliable supply chain, allowing for competitive pricing and high-quality standards that attract customers and drive loyalty. Additionally, the strategy of opening new restaurants drives growth, market expansion, and strengthens its competitive position by strategically expanding successful brands like Olive Garden in key markets. Darden Restaurants' acquisition strategy is another reason to invest, as it focuses on adding high-potential brands that enhance their portfolio, create synergies, and drive long-term growth. Personally, I am not interested in investing in the sector that Darden Restaurants operates in. However, for those willing to invest in this sector, I believe that buying shares below the Ten Cap price of $110 could be a good long-term investment.
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