In fact, even a return to growth in China probably isn’t enough, either. Investors should wait for this industry giant to pull back, noting that its efforts to test fast casual fare are nice to see but not transformational at this point.
Cutting prices
On the casual side of the business, Darden Restaurants, Inc. (NYSE:DRI) shares have been moribund since late 2010 as Olive Garden has hit a growth road block. Darden Restaurants, Inc. (NYSE:DRI) operates that brand, Red Lobster, and LongHorn Steakhouse, along with smaller, but generally upscale, concepts like Capital Grille. Olive Garden and Red Lobster, however, account for the lion’s share of its restaurants and its top and bottom lines.
The fast casual concept has been drawing customers away from these older brands. To combat this trend, Darden Restaurants, Inc. (NYSE:DRI) has been working on its value proposition, particularly at Olive Garden. It’s been dropping prices to get customers in the doors, willingly sacrificing margins to maintain market share.
And, despite the headwinds, this casual giant has managed to grow its top line in each of the last three years. Still, after a couple of years of growth, earnings fell last year, going from about $3.60 a share in 2011 to around $3.15. The profit margin falling from about 9% to around 7.5% was the main culprit. However, market share is top of mind at the management ranks, so this drop shouldn’t be a surprise and, more importantly, isn’t likely to reverse in the near term.
Although the shares trade with a P/E of about 16, around 3 points higher than its five year average, there’s still turnaround potential here. Fast casual restaurants are great, but the sector is quickly filling up and old standbys like Olive Garden and Red Lobster are likely to see their day in the sun again before too long. While waiting, income investors can collect Darden Restaurants, Inc. (NYSE:DRI)’s 4.5% dividend yield.
And, Darden Restaurants, Inc. (NYSE:DRI) is using its dominant brands to build its collection of smaller brands and to expand overseas. Both add a growth component to the company that weak sales at Olive Garden appear to be hiding. Darden isn’t a one-trick pony.
Watch out for fast movers
Yum! Brands, Inc. (NYSE:YUM) is kind of expensive today, but a good company to watch for a price dip. Darden appears to be a good value right now for long-term income investors. Chipotle Mexican Grill, Inc. (NYSE:CMG), meanwhile, might interest aggressive growth investors, but you will need to be prepared for a rocky ride. For example, the company’s shares fell around 40% in about six months in mid-2012. They have come roaring back since, but could easily see another big drop if results start to slow.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill and Darden Restaurants. Reuben is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Dealing With the Fast Casual Threat originally appeared on Fool.com is written by Reuben Brewer.
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