Darden: Slim Pickings or Value Feast?
By Eric Wahlgren
Stocks of restaurant chains, including Applebee's International (APPB ) and Outback Steakhouse (OSI ), have sizzled the past year as Americans increasingly drive past fast-food outlets and stop instead at these and other "casual dining" eateries. When Americans eat out these days, they want a little less grease and a little more atmosphere.
Until recently, one stock largely left out of this rally was Orlando-based Darden Restaurants (DRI ), which owns the Olive Garden, Red Lobster, Smokey Bones BBQ, and Bahama Breeze chains. It happens to be the world's largest casual-dining outfit, but the company's oldest chain, 36-year-old Red Lobster, posted some declining sales last year, leading Wall Street to treat the name pretty much like, well, old fish.
That changed on Feb. 25, when Darden surprised the Street with news that Red Lobster in February generated sales up to 1% higher at outlets open at least 16 months (same-store sales). Combined with better-than-expected sales at Italian-themed Olive Garden restaurants, the company forecast third-quarter earnings per share could be as high as 46 cents, or up to 10 cents above consensus estimates. Since the announcement, the stock has risen about 10%, to close on Mar. 11 at $24.30, about 9% off its 52-week trading high of $25.60. The company is scheduled to report quarterly results on Mar. 17.
ROOM TO RISE?
Even after the recent run-up, several investing pros believe the stock remains modestly valued. Robert Derrington, an analyst with Morgan, Keegan & Co. in Nashville, recently raised Darden to outperform. He says the stock still trades at about 14 times calendar 2004 profits, vs. the 21.5 price-to-earnings (p-e) multiple of its peer group. Meanwhile, the benchmark Standard & Poor's 500-stock index's p-e ratio is 17.5.
"Darden, in the view of many, appears to be an attractive risk-reward scenario," says Derrington, who has no ties to Darden nor does his firm. Morgan Keegan doesn't assign target prices to stocks, but Derrington believes it has room to rise if performance continues to improve. For fiscal 2004, analysts on average forecast profits will increase 13%, to $1.48 a share, on 8% higher revenues of $5.04 billion, says earnings tracker First Call/Thomson Financial.
Mike Smith, an analyst with Oppenheimer & Co. in Kansas City, believes the stock could gain another 28%, to $31, over the next 12 months. Smith rates Darden a buy, saying, "We prefer [the stocks] that are out of favor." And like its larger peers in the casual-dining segment, Darden should be able to grow profits at a respectable annual rate of 15% by opening new restaurants and boosting same-store sales, he adds. (Neither Smith nor his firm have ties to Darden.)
"GETTING LESS BAD."
Although Smith is encouraged by the improving outlook at Red Lobster, which has 680 outlets in the U.S. and Canada, he is still keeping close tabs on the chain. Analysts have attributed recent struggles in part to promotions that failed to score with consumers. But they say the company appears to be getting its groove back. Says Smith: "I cannot imagine a Red Lobster-less United States."
Still, the flat-to-1% same-store sales gain in February was mostly the result of a 1% increase in menu prices and a 3% to 4% rise in average bill totals. The chain's guest counts still declined 3% for the month, the company said. "It's true that I would love to see traffic going up," Smith says, adding: "But it is getting less bad."
Darden bulls say they expect more positive news could help drive further gains in the stock. Among the possibilities, "new leadership could be named for Red Lobster at the end of the fiscal year," Derrington says. By Eric Wahlgren
BUCKING DR. ATKINS.
Analysts also are pleased with Olive Garden, the largest casual Italian chain with 532 restaurants in the U.S. and Canada. It's "doing well," Derrington says. The chain, which seems to be everywhere from commercial strips along interstates in the heartland to Manhattan's Times Square, saw February same-store sales rise 4% to 5%, the company said. The results suggest that the pasta-happy Olive Garden "seems to be defying the Atkins [low-carb diet] trend," Smith says. "I guess we have to give them a pat on the back."
And Darden is focused on re-energizing its Bahama Breeze concept, a chain of 37 Caribbean restaurants the company opened in 1999. Smith says these eateries, which tend to have a higher average menu price than other Darden outlets, were hurt during the economic downturn as customers opted for cheaper eats.
"Red Lobster is definitely heading in the right direction and seeing month-to-month improvement in traffic and sales, Olive Garden continues its strong performance, and we're pleased with progress at Bahama Breeze and Smokey Bones," says Jim DeSimone, a company spokesman.
The company plans to test a smaller square-footage version of Bahama Breeze using a prototype restaurant outside of Pittsburgh. And though the chain doesn't accept reservations as such, guests can now "get in line" by calling ahead. The restaurant hopes this will attract customers who might have been put off by having to wait for tables. The initiatives "will probably increase overall returns," Smith says.
Not everyone is persuaded Darden is a good bet, at least not yet. Stephens Inc. analyst Lynn Collier says she wants to see at least two more months of improving results before raising her equal-weight rating. "I want to make sure it is a sustainable trend," says Collier, who is based in Dallas.
She's more upbeat on faster-growing -- but more richly valued -- casual-dining outfits such as Cheesecake Factory (CAKE ) and P.F. Chang's China Bistro (PFCB ). P.F. Chang's profits, for instance, are expected to rise some 27% in 2004, but its p-e multiple is a lofty 38. (Neither Collier nor her firm has any ties to these companies.)
Another analyst, S&P's Dennis Milton, believes any Darden turnaround is already factored into the stock. Milton, has a hold on the shares, saying he doesn't think it's is worth more than $26. "I'm not really expecting more surprises on the upside," says Milton who has no ties to the stocks he covers, although other units of S&P may.
Milton is more bullish on steakhouse chain Rare Hospitality (RARE ). He has an accumulate rating on the name behind Longhorn and Bugaboo Creek steakhouses.
There are several faster-growing companies than Darden in the booming casual-dining biz. But as the biggest of the bunch, Darden's lower price relative to its peers certainly warrants consideration for investors looking for exposure to the casual-dining trend.
Wahlgren covers financial markets for BusinessWeek Online in New York
Edited by Beth Belton