Darden Could Be an Ugly Duckling

 | Feb 22, 2013 | 1:00 PM EST
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A feeble rally in Darden Restaurants (DRI) has fizzled, leaving the stock languishing 22% below its level of five months ago.

Darden's effort to spiff up its menus by offering lighter fare and some lower-priced entrees hasn't panned out so far. And yet, I like the shares of this limping food chain.

Based in Orlando, Fla., Darden operates three main restaurant chains: Olive Garden (Italian), Red Lobster (seafood) and LongHorn Steakhouse.

In the second fiscal quarter, ended Nov. 30, same-store sales were down 3.2% at Olive Garden, down 2.7% at Red Lobster and down 0.8% at LongHorn Steakhouse. That is hardly the stuff of which turnarounds are made.  

Earnings for the quarter were only $0.26 a share, down from $0.40 a year earlier and $0.53 a year before that. Of 33 analysts who follow the stock, only 10 rate it a Buy. Twenty call it a Hold, and three utter the dreaded word "Sell."

What's more, the balance sheet isn't pretty. Debt totals 115% of stockholders' equity. I very rarely buy stock of any company that has debt greater than equity.

With all these drawbacks, why do I like the shares? Here are a few reasons.

The three main brands have excellent name recognition. If management keeps experimenting, I believe it will find a way to increase traffic and improve same-store sales. Each of the three chains has a band of loyal customers.

One prominent insider has bought the shares lately. William M. Lewis Jr., a director, bought 11,000 shares on the open market in January, spending about $494,000. Lewis is co-chairman of investment banking at Lazard Ltd. in Bermuda, and he is a former managing director at Morgan Stanley.

Darden's valuation is also appealing. The stock trades at about 14x earnings and 0.7x revenue.

Just yesterday, Darden announced plans to push into Latin America by opening more than 50 restaurants, many of them in Brazil, one of the region's most dynamic economies.

Finally, the dividend is pleasant. The yield currently is 4.5%, and the dividend seems reasonably secure to me. Earnings the past 12 months were about twice the dividend. Since 2005 Darden has increased its dividend six times, and the five-year dividend growth rate is close to 22%.

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