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Friday, October 11, 2013

No need to get panic about Darden...

Oh, there is too much competition. Why do we see so called red indicators in company's financials? Activist investor is demanding spinning off company's restaurants to better access share performance. All of these cause some discomfort to investors who like value investing. Restaurants like those from Darden Restaurants Inc (NYSE: DRI) who have been at the corner of our streets for longer time, are not certainly the growth candidates like Buffalo Wild Wings, Chipotle etc. Therefore, if they are growing slowly or there is no growth, it should not raise investors' eyes.

Restaurants industry faces one of the most fierce competition among other industries. It is significantly driven by consumer confidence, overall economy, weather, cost of raw food materials and diversification. Recently, NRN has released that months of September and October or overall Q4 of 2013 will be testing time for the industry because of US Government Shutdown and debt ceiling issues. Clearly, consumers are not ready to spend as much as they used to do when economy was in so called clear shape 2 months ago.

I have gone through DRI's financials, forecasts and ratios. I have created brief valuation model based on its dividends and free cash flow forecasts. And surprisingly, I have not found anything which makes me join the herd who is cautious about investing in DRI. Despite of 7% growth in revenues from 2012, operating margin squeezed by 12%. The most straight forward reasons behind this are increasing inflation in cost of raw goods and in labor rates. And that led to decrease in net income by 12% as well. ROE stands at 6.4% as compared to 8.3% in 2012.

But as I always believe, cash is the king. DRI has been able to generate $949m cash from operating activities in 2013 as compared to $762m in 2012 and $264m free cash flow to equity holders in 2013 as compared to $122m in 2012. Moreover, DRI has consistently increased distributing their earnings as dividends. It provides good source of income as part of total return. According to my model, at the end of trading day 10/11/2013, DRI's fundamental value based on dividend forecast should be $52.04-$54.89 and based on free cash flow to equity forecast should be $51.73-$56.30. In either case, it is above the closing price of 10/11/2013 which is $50.50.

Looking at my limited "working" experience in equity valuation, I may not provide insightful analysis. But since I use sensitivity analysis to derive fundamental price range, I can surely give my opinion for DRI as "Neutral-- Hold it" looking at the numbers.