Darden Restaurants’ Challenges Are Investment Opportunities

Darden Restaurants NYSE:DRI Operational quality drove solid business in the third quarter, setting the stock up to continue its upward trend. The opportunity today is that the results were largely in line with expectations and provided no catalyst for the market. The result is a downward move within an uptrend channel that will soon result in another solid buy signal. Highlights of the report are growth, leverage, cash flow and returns on capital, all of which support the valuation.

Considering Darden’s industry-leading results, the 18X earnings valuation is light and takes advantage of the opportunity. The best of the breed Texas Roadhouse NASDAQ:TXRH trades at a 50% premium to Darden, which is rapidly improving its business. This suggests that a price multiple expansion is also at play.

Darden Restaurants grows and expands margins

The only thing wrong with Darden’s results is that the third quarter fell in line with consensus forecasts and guidance was weak. Beyond that, revenue and earnings are growing and forecasts predict the same. The company brought in $3 billion in the third quarter, up nearly 7% from last year.

The top line missed the consensus, but by only 100 basis points, offset by the wider margin. At the segment level, comps were down across most segments and offset by 2.3% growth at Long Horn Steakhouse, aided by the addition of seventy-nine company-owned Ruth’s Chris Steakhouses and 53 net new stores.

The news on margins is good. The company expanded margin in most operating segments and the one that didn’t, Olive Garden, maintained a relatively flat margin with a better-than-expected bottom line. The bottom line of $2.62 in adjusted earnings excludes $0.02 in Ruth’s Chris acquisition costs and is up 12% on 6.8% of revenue.

The guidelines represent the weakest part of the report, and in any case they are not bad. The company guided full-year results to $11.4 billion in net sales versus consensus of $12.14, weak compared to consensus but up 8.6% year-over-year. The earnings outlook is the same; is short of consensus but expects year-on-year growth. The salient detail is that earnings are sufficient to support robust capital return prospects.

Darden Restaurants increases return on capital and can sustain it

Darden Restaurants pays an attractive dividend yielding 3.0% with shares near $165. This is double the payout for great value Texas Roadhouse, and it’s a reliable payout. The distribution is less than 20% of earnings guidance and the balance sheet is a fortress, so there are no warning signs for investors. Cash flow and balance sheet health also allow for stock repurchases.

The company repurchased $33 million in the third quarter, reducing the average share count by 1.7% quarter-over-quarter and year-to-date, with further reductions expected in the current quarter and next fiscal year. The board approved a new authorization worth $1 billion or 5% of the plan’s discounted share price with no expiration.

Darden Restaurants are trending up, a buy signal is imminent

Analyst activity suggests Darden shares are fairly valued near current levels. Post-release activity includes several price target reductions that have capped the top end but continue to increase the consensus. The three revisions tracked by Marketbeat.com have the market trading between $180 and $182 versus the consensus of $180, which is 10% higher than the current action and aligns with the top of the channel. The bottom line is that Darden may fall today, but the uptrend is intact and a buy signal should come soon.

Critical support is near the 150-day EMA. This target is in line with analysts’ lower target and may provide a basis for action. If that’s the case, DRI stock could begin to rise within a few weeks, and the all-time high could be tested again before the summer. Otherwise, this stock could drop to firmer support levels near the lower end of the channel before rebounding.

Before you consider Darden restaurants, you’ll want to hear this.

MarketBeat tracks daily Wall Street’s highest-rated and best-performing research analysts and the stocks they recommend to their clients. MarketBeat identified the five stocks that top analysts are quietly whispering to their clients to buy now before the broader market takes hold… and Darden Restaurants wasn’t on the list.

While Darden Restaurants currently has a “Moderate Buy” rating among analysts, top-rated analysts believe these five stocks are better buys.

View the five stocks here