These Casual Restaurants Offer a Delicious Opportunity

Despite facing a number of headwinds, including higher taxes and the frustratingly slow recovery in the labor market, U.S. consumers remain optimistic.

Consumer sentiment has shown remarkable resilience in recent months, as Americans slowly feel better about their finances.

As a result, consumer discretionary stocks, or those that are reliant on robust consumer spending, stand to proper. More specifically, these casual restaurants are primed for success, given their strong brands, shareholder friendliness, and compelling valuations.

A trio of strong performers

Although consumer sentiment dipped in August, weighed down by rising mortgage rates and higher payroll taxes, July's consumer sentiment figure was the highest it's been since 2007.

Consumer hopes are being buoyed by gains in stock portfolios and home values, and as a result, Americans are still largely feeling good about their financial standing.

Resilient consumer spending is great news for casual restaurants. The largest stock of the casual restaurant category is Darden Restaurants (NYSE: DRI  ) , which operates full-service restaurants and holds a $6 billion market capitalization. Its restaurants include Red Lobster, Olive Garden, and LongHorn Steakhouse brands.

Unfortunately, Darden struggled throughout fiscal 2013, reporting a 12% drop in both fourth-quarter and full-year diluted earnings per share. Higher expenses due to Darden's acquisition of 40 Yard House restaurants were the major culprit. At the same time, though, the company saw higher traffic and nearly 7% growth in total sales from continuing operations.

Despite Darden's sluggish profit results, that didn't stop the company from raising its dividend by 10%, indicative of management's optimism over the company's future.

Meanwhile, Brinker International (NYSE: EAT  ) , the company behind the Chili's and Maggiano's brands, carries a nearly $3 billion market cap.

The company's operating results in what was a challenging fiscal year are impressive, and prove that this is a company in high-growth mode. In its fiscal third quarter, GAAP diluted EPS soared 26% and franchise comparable restaurant sales increased 1.3% year over year.

Brinker's success carried over into the fourth quarter, when the company reported 5% growth in diluted EPS.

This was reason enough for Brinker to provide shareholders with a 20% dividend increase and an additional $200 million in share repurchases after releasing its fourth-quarter results.

Moving forward, management believes the future is bright for Brinker, as the company expects another 15% to 22% growth in diluted EPS in fiscal 2014.

Promising futures ahead

Not only is resilient consumer spending a huge boost to casual restaurants, but a new management technique will also serve as a positive catalyst going forward.

Many sit-down restaurants are undergoing a transition to the franchise model employed by many of their fast-food peers. This strategy is being employed by DineEquity (NYSE: DIN  ) , the $1.3 billion operator of Applebee's and IHOP, and the potential benefits are attractive.

DineEquity is rapidly turning toward the franchise model, and higher expenses related to this have dragged down profits in recent quarters. However, this will surely be beneficial to shareholders down the road, as the franchise model is extremely lucrative for a restaurant company, and the benefits are already being felt.

DineEquity grew same-restaurant sales by 1.9% and 1.3% at IHOP and Applebee's, respectively, in its recently concluded second quarter. The turnaround, driven by the newly embraced franchise model, was evident by the fact that this quarter represented the first since 2010 that IHOP reported positive growth in both same-restaurant sales and guest traffic.

Along with the franchise model, DineEquity management has also embraced a more shareholder-friendly culture.  DineEquity reinstituted its dividend program this year for the first time since 2008, and at its current price yields 4.4%

Sit down for a heaping plate of impressive returns

Consumer spending remains resilient so far in 2013, meaning sit-down restaurants such as Brinker, Darden, and DineEquity stand to reap considerable rewards.

Not only are these stocks rewarding their investors with sales and profit growth, they're not stingy about sharing their success with shareholders. DineEquity and Darden offer dividend yields greater than 4%, and while Brinker's payout stands at 2.3%, it's growing its dividend at a very high rate.

Furthermore, these stocks are trading at attractive valuations. DineEquity and Darden exchange hands for just 11 times trailing earnings, particularly compelling because the S&P 500 Index trades for an earnings multiple in the high teens.

No matter whether you're a growth investor, an income investor, or someone in between, there's a sit-down restaurant stock to suit your preferences.

The Motley Fool's chief investment officer has selected his No. 1 stock for this year. Find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.


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