As the economy gradually recovers from the worst financial crisis in decades, it’s reasonable to invest in cyclical sectors of the economy that do particularly well in good economic times.
One such industry is the casual restaurant industry, whose fortunes are tied closely to the health of the consumer. And, since American consumers are feeling better about their finances and spending more in recent months, wise investors should pay close attention to the sit-down restaurants that are serving up hefty portions of profits and dividends.
Profiting from the return of the consumer
Many sit-down restaurants are undergoing a transition to the franchise model employed by many of their fast-food peers. One such company is DineEquity Inc (NYSE:DIN), the $1.3 billion operator of Applebee’s and IHOP.
DineEquity Inc (NYSE:DIN) is rapidly turning toward the franchise model, and higher expenses related to this have dragged down profits in recent quarters. However, this will surely be beneficial to shareholders down the road, as the franchise model is extremely lucrative for a restaurant company, and the benefits are already being felt.
For instance, consider that although the company’s first-quarter adjusted diluted EPS fell 16%, this was due primarily to the aforementioned refranchising-related expenses. Free cash flow, on the other hand, rose 34% during the quarter.
Similar restaurant chains are also seeing firming business conditions. Recently, industry leader Darden Restaurants, Inc. (NYSE:DRI) recently reported a 12% drop in fourth-quarter diluted EPS, but 11% sales growth at the same time. Same-restaurant sales, which measures sales only at locations open at least a year, rose across the company’s chains, which include Olive Garden, Red Lobster, and Long Horn Steakhouse.
For the full year, Darden Restaurants, Inc. (NYSE:DRI)’s total sales from continuing operations were 7% higher and diluted EPS clocked in at $3.14 per share. Close competitor Brinker International, Inc. (NYSE:EAT) operates the Chili’s and Maggiano’s brands and holds a nearly $3 billion market cap.
In the company’s recently announced fiscal third quarter results, Brinker International, Inc. (NYSE:EAT) showed that it is a company in high-growth. GAAP diluted EPS soared 26% and franchise comparable restaurant sales increased 1.3% year over year.
Of course, there’s often a cost associated with higher growth, which in this case is a premium valuation. Brinker International, Inc. (NYSE:EAT) trades for more than 18 times trailing earnings, while Darden Restaurants, Inc. (NYSE:DRI) trades for 16 times EPS. DineEquity Inc (NYSE:DIN), meanwhile, is even more attractively valued, exchanging hands for only 11 times earnings.