Even after selling its Red Lobster chain to Golden Gate Capital earlier this year, Darden Restaurants (DRI 0.46%) is still the second-largest casual dining restaurant in North America. With well-known brands like Olive Garden, Yard House, and LongHorn Steakhouse, Darden is a dominant player in the $80 billion U.S. casual dining market. Today, Darden Restaurants is using the franchise model to rapidly expand its presence in international markets. While Darden doesn't use the franchise model in the United States or Canada, the company understands that the best way to succeed in markets abroad is to partner with locals in those regions. It is in this spirit that we'll look at how Darden Restaurants stacks up as a top franchise company today.
Source: Darden Restaurants.
Start small, go big
Darden is still in the early stages of its franchise development plan, but that doesn't mean investors should doubt its potential. Franchising is a smart strategy for public companies like Darden because it helps increase profitability by offering a steady stream of revenue in the form of rent and royalty income. Darden had 37 franchise locations in Japan, the Middle East, Puerto Rico, and Mexico at the end of 2013. That is tiny compared to rivals in the space such as Dine Equity (DIN 0.31%), which currently boasts over 400 franchisees across 17 countries. Nevertheless, the company has plenty of room to grow in key markets such as Japan and Mexico where it currently has franchise partners.
The company is currently focused on franchising in international markets that have the potential for a large number of restaurants. Darden now has agreements with franchisees to open Olive Garden and LongHorn Steakhouse restaurants throughout most of the Middle East and Latin America including Brazil, Colombia, Panama, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, and Honduras.
Source: Darden Restaurants.
Looking ahead, there is also the possibility that Darden would begin franchising in the U.S. -- at least if activist investors get their way. Let me explain. Starboard Value, which owns a near 9% stake in Darden Restaurants, has laid out a plan to maximize shareholder value. This plan would include selling Darden's real estate and franchising its domestic restaurants, according to Reuters. Shareholders will vote next month on possibly turning over Darden's board of directors and electing 12 new directors of Starboard's choosing to replace them. Ultimately, if Starboard were to gain complete control, investors would certainly see dramatic changes to Darden's business and strategy.
How should investors play it?
Given the ongoing pressure from Starboard and the fact that Darden's franchise ambitions are still in their infancy, would-be franchisees should probably take a wait-and-see approach before committing to international franchise operations with Darden. Perhaps a better way to take a cut of Darden's profits would be to own the stock. Shares of Darden Restaurants are trading nearly 6% below the stock's 52-week high at around $51 today.
The stock's 4% dividend yield is perhaps more enticing. Darden pays an annual dividend of $2.20 per share and its dividend has increased at an annual compound growth rate of 19% over the past three years, which trumps the industry average of 14% during the period. Last year, Darden Restaurants paid more than $258 million to shareholders in the form of cash dividends. For these reasons, it probably makes more sense to invest in Darden Restaurants stock versus directly owning one of its franchises. Not only does the stock pay a dividend, but it also has the potential to appreciate in value without many of the risks associated with operating a franchise.
