Is Darden Restaurants Stock a Buy?

Restaurants have been some of the businesses hardest hit by the economic effects of COVID-19. It's already a hyper-competitive and low-profit margin industry, and the lockdown has hastened changes in consumer behavior and is forcing many restaurant chains to update their operations to meet new demands. Not all are in position to make a graceful pivot, but Darden Restaurants (DRI 0.46%) -- parent organization of Olive Garden -- is faring much better than many of its peers.

A long road to full recovery

For the casual dining segment of the restaurant industry, the economic lockdown and social distancing orders that started the second half of March were disastrous. For Darden, its stable of brands was no exception. Things got ugly during the final three months of its 2020 fiscal year (the period ended May 31, 2020). Darden reported the following comparable store sales (or comps, a blend of foot traffic and average guest ticket size) declines for its various chains compared to the year-ago period.

Data source: Darden Restaurants.

The bad news is that almost a month into its 2021 fiscal year, Darden's comps across all of its stores remained down nearly a third from a year ago. The good news? A recovery is in fact being made, led by the two marquee brands Olive Garden and LongHorn Steakhouse. The company also said it has returned to positive operating cash flow territory (money left over after cash operating expenses are paid).  

Darden will most certainly benefit as its dining rooms continue to reopen and mandated limited capacity restrictions on those rooms are gradually lifted. In the meantime, off-premises sales (to-go and delivery) are doing the heavy lifting. For just those stores with open dining rooms, Darden said to-go orders were 40% and 28% of total sales at Olive Garden and LongHorn respectively the week ended June 21.  

It's further proof that consumers are increasingly demanding mobile ordering and flexible options even as the economy starts to reopen, with a dining room becoming a much less important feature than it was in the past. While adapting is a painful process, Darden is in decent shape to roll with the punches.

Image source: Getty Images.

Not the world's ugliest balance sheet

During the worst of the lockdown, Darden had drawn down $750 million of its revolving credit facility to help it manage the crunch. But by early May, business had improved enough that the restaurant operator decided to repay the short-term loan. And at the end of May, Darden reported having $763 million in cash and equivalents on its balance sheet. Put simply, this restaurant stock is far from going bust.  

However, it isn't liability-free. Debt at the end of May still totaled $1.2 billion. Among the liabilities is debt Darden took out following its acquisition of Cheddar's Scratch Kitchen for $780 million in 2017. Since then, Cheddar's has been weighing down an otherwise positive run for Olive Garden and LongHorn, and as part of the "other businesses" segment, the casual dining chain doesn't appear to be headed for a return to the good times anytime soon.

High debt paired with what was already a fairly low-margin business (Darden historically runs at a high single-digit to low teens operating profit margin) and a fast-evolving restaurant industry keep me from saying this stock is a buy. In the past, a dividend payment helped sweeten the deal, but that has been axed from the equation for now to preserve the company's financial well-being. Perhaps slimming down its stable of restaurant brands would help make the core Olive Garden and LongHorn businesses more valuable, but any move in that direction is just me talking.

Put simply, Darden Restaurants looks well-positioned as a potential rebound story in the years ahead, but the path forward will be a rocky one. I personally prefer smaller restaurant outfits that sport a net cash balance (rather than net debt), like Texas Roadhouse (TXRH -0.07%) and Shake Shack (SHAK -0.45%), as a new era dawns for the industry.