How You Can Beat the Cyclicality in the Restaurant Industry

Trading at 23.6 times its earnings, Yum! seems a little overvalued. However, compelling growth prospects, strong brand names and a 1.9% dividend yield make it an attractive long-term investment.

A recovering business
Darden Restaurants is the world’s largest casual-dining restaurant as measured by market share, sales, and the number of company owned-and-operated restaurants. With a wide portfolio of recognized brands, including Red Lobster, Olive Garden, LongHorn Steakhouse, and several specialty restaurants, the company enjoys not only sales diversification but also substantial cost synergies.

Although the business has been quite slow during fiscal 2013, Darden´s fourth- quarter results show improvements in its same-store sales and revenue. This ameliorates the company’s prospects going forward and makes it an investment worth considering.

In addition, a history rewarding shareholders (both through dividends and share repurchases) regardless of economic conditions and cycles adds incentives for long-term stockholders. Currently, the dividend yield stands at 4.44% of the stock price. This, added to the substantial discount to industry average valuations at which it trades, make of this stock one to buy and hold.

Going forward, management has made some decisions that should help enhance Darden´s financial standing, which has been quite unstable lately. One of the most encouraging initiatives, in my view, is that of reducing capital expenditures by more than 10% in fiscal 2014. Savings will be achieved through reduced core brand unit growth. In addition, some of the resources will be reallocated to improving the company´s competitive positioning, particularly in the specialty restaurant chains segment.

Bottom line
As the restaurant industry recoups, refranchising and revamping initiatives, menu innovations, cost control measures, an easing in inflation in the U.S., and an improving economy (globally) bode well for the restaurant chains analyzed above.

If I were to chose, I’d go for Yum!. Its international expansion opportunities and brand equity make it the safest and most appealing option. Poised to grow in emerging markets, and paying out dividends in the meantime, this is definitely a stock to add to your long-term portfolio. However, Tim Hortons also looks well positioned to grow (and certainly has space to do so), in spite of the fact that it’s brand is not as recognized globally. Keep track of its developments and consider making space in your portfolio for this company as well.

The article How You Can Beat the Cyclicality in the Restaurant Industry originally appeared on Fool.com and is written by patricio kehoe.

patricio kehoe has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Darden Restaurants and Starbucks.

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