Is Darden Restaurants, Inc. (DRI) a Buy?

Darden Restaurants, Inc. (NYSE:DRI)Casual dining chains have not been left out of the current stock market rally, but their profits are likely to improve at least as much as their stock prices as the U.S. economy continues to recover. As the unemployment rate falls, foot traffic will likely pick up again — leading to higher earnings for these companies.

However, not all causal dining chains are equally appealing. Some stocks have run up higher than others, and some companies have brighter outlooks than others. One company, Darden Restaurants, Inc. (NYSE:DRI), is more attractive than its casual dining peers.

Outlasting the competition

Darden Restaurants, Inc. (NYSE:DRI) has an advantage over many of its peers due to its size. This allows it to spread out fixed costs across a larger number of units than its competition, which should lead to higher profit margins.

Upon closer inspection, however, Darden’s margins are in line with those of DineEquity Inc (NYSE:DIN) and Brinker International, Inc. (NYSE:EAT), despite Darden Restaurants, Inc. (NYSE:DRI) having a clear advantage in size. The reason that Brinker International, Inc. (NYSE:EAT) and DineEquity Inc (NYSE:DIN) are about as profitable as Darden is due to the nature of their operations.

Brinker International, Inc. (NYSE:EAT)owns the Chili’s restaurant chain. The Chili’s brand is ubiquitous in the casual dining industry, giving it an advantage over local competition. However, Chili’s does not have the same scale that Darden Restaurants, Inc. (NYSE:DRI) has with its numerous brands. Instead, Chili’s earns high margins by selling franchises.

Franchises allow Chili’s to expand without having to invest a significant amount of cash. This enables Brinker to invest in other brands and return capital to shareholders.

DineEquity, on the other hand, owns the number one casual breakfast chain in the United States — International House of Pancakes (IHOP). The company owns other well-known casual chains such as Applebee’s. Although Applebee’s has more locations than Chili’s, it earns lower returns on capital because it does not utilize a franchising strategy to the same extent as Chili’s. Therefore, DineEquity does not produce as much value for shareholders as Brinker.

Although Darden Restaurants, Inc. (NYSE:DRI) is not any more profitable than DineEquity Inc (NYSE:DIN) and Brinker, it has a much better future ahead of it than its peers. The company is investing heavily in its higher-priced brands like Eddie V’s, which earn higher margins and are not as sensitive to U.S. employment rates as casual chains like Chili’s and Applebee’s. The company’s portfolio of premium specialty chains should drive above-average growth going forward.

Investment case

Despite the run-up in its share price over the last few months, Darden Restaurants, Inc. (NYSE:DRI) still trades at a reasonable 16 times earnings. This is lower than Brinker’s earnings multiple — 18 times earnings — and higher than DineEquity’s multiple — 12 times earnings.

DineEquity does not have nearly the same scale and reliability that Darden has, so it should trade at a lower multiple of earnings. Darden is closer to Brinker in terms of earnings stability.

In addition to being as reliable as Brinker, Darden has revenue-increasing and margin expansion opportunities that give it a slightly better outlook than Brinker. As a result, Darden Restaurants, Inc. (NYSE:DRI) should trade at least as high at Brinker on a trailing earnings basis, which makes it an interesting investment in a market where few undervalued stocks are available.

The article Time to Buy This Restaurant Chain originally appeared on Fool.com and is written by Ted Cooper.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Comments
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months. Our beta is only 1.2 (don't click this link if beating the market isn't important to you).

Lists

The 10 Largest Pharmaceutical Companies In the World

The 10 Most Expensive Android Apps

The 9 Most Expensive Designer Bags in the World

The 7 Most Expensive Real Estate in the World

The 10 Most Expensive eBay Items Ever Sold

The 10 Most Expensive iPhone Apps

The 9 Most Expensive Designer Shoes in the World

The 10 Most Expensive Cigarette Brands

The 10 Most Expensive Law Schools in the US

The 10 Best Wall Street Movies

The 10 Most Expensive Golf Clubs Ever Sold

The 10 Most Expensive Golf Memberships

The 10 Best Disney Characters Ever Created

The 8 Best Foods for Gaining Weight

The 10 Most Expensive Colleges in the World

The 7 Most Memorable Ad Campaigns of All Time

The 7 Most Expensive High Schools in the World

The 10 Electric Vehicles with the Longest Range

The 10 Cities with the Worst Drivers in the World

The 10 Most Expensive Dresses Ever Created

10 Islands to Visit Before You Die

10 Famous Celebrities Who Needed Rehab

The 15 Countries with the Largest Oil Reserves

The 10 Most Overused Excuses in the World

The 5 Best iOS Apps You Can’t Get on Android

5 Companies Damaged By Social Media Blunders

The 10 Most Legendary Blues Songs

The 10 Most Lawless Places in the World

4 Reasons China is a Threat to the US

The 17 Most Sugary Drinks in the World

The 10 Most Ruthless Rulers in History

The 10 Greatest Generals in History

Top 8 Travel Destinations for 2015

The 10 Safest Dog Breeds for Children

The 10 Most Stolen Vehicles in the US

The 7 Most Expensive Celebrity Weddings

The 10 Best LoL Teams in the World

Top 10 Worst Marketing Campaigns Ever Produced

Top 5 Diets that Help You Lose Weight

The 10 Best Ways to Stay Awake

7 Artists That Switched Musical Genres

The 10 Most Expensive Cities to Live in New Jersey

The 10 Best High Schools in New York

The 10 Countries With the Least Gender Inequality

The 6 Biggest Musician-Manager Feuds

The 10 Countries with the Cheapest Gas Prices

The 7 Most Theatrical Bands of All Time

The 8 Worst Band Breakups of All Time

The 10 Most Important South American Leaders

The 7 Most Successful Casting Show Winners

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!