Unfavorable macroeconomic factors, such as elevated inflation and rising interest rates, have led financial markets to sharply sell off in 2022. The S&P 500 index has crashed 23% so far this year.
But more defensive stocks (like income stocks) with strong brands have fared better during the market downturn. Best known for its Olive Garden Italian Restaurant and LongHorn Steakhouse brands, Darden Restaurants (DRI 0.46%) has dipped just 16% year to date. But is the stock's market-beating dividend yield a buy for yield-hungry investors? Let's take a look at Darden Restaurants' fundamentals and valuation to address this question.
Decent results given the tough environment
With more than 1,850 restaurants in the United States and 180,000 employees, Darden Restaurants is the largest full-service restaurant company in the country. Thanks to the high recognition of its brands, more than 1 million guests frequent its eight restaurant brands each day.
Darden reported $2.4 billion in consolidated net sales during its fiscal first quarter, ended Aug. 28. This was good enough for a 6.1% year-over-year growth rate. So what was behind the large-cap company's respectable net sales growth for the quarter? Due to the wide variety of brands within its portfolio and its service-first philosophy, customers can't help but flock to Darden's restaurants. This explains why the company's same-restaurant sales edged 4.2% higher year over year in the first quarter. Along with 34 new restaurant openings during the quarter, this is what lifted Darden's consolidated net sales.
The company served up $1.56 in diluted earnings per share (EPS) for the first quarter, which was an 11.4% decline over the year-ago period. This was the result of an 8.7% year-over-year increase in total operating costs in the quarter, which was driven primarily by a significant rise in food and beverage and restaurant labor costs. That's why Darden's net margin dipped 220 basis points over the year-ago period to 7.9% during the quarter. This was only partially offset by a 6% year-over-year decline in the company's weighted average outstanding share count to 123.9 million, which stemmed from its share repurchases executed for the quarter.
Darden plans to continue gradually opening restaurants for the foreseeable future. Along with $912 million in remaining share repurchase authorizations (6% of its market capitalization) and the fact that inflation will eventually ease up, this is why analysts are expecting 8.8% annual diluted EPS growth through the next five years.
Image source: Getty Images.
Solid dividend growth can persist
Darden's 3.9% dividend yield is more than double that of the S&P 500 index's 1.8% yield. And the good news is that the company's dividend is sustainable with room to grow in the years ahead.
It is projected that Darden's dividend payout ratio will come in at just under 63% for its current fiscal year. This gives the company the capital necessary to hit its target of opening 55 to 60 new restaurants this year, reduce debt, and complete share buybacks at an attractive valuation. On account of its manageable payout dividend obligation, I believe that Darden's dividend can compound at a high-single-digit clip annually over the next few years.
Darden Restaurants is a deeply discounted blue chip stock
Darden is a top-notch business. And the stock appears to be undervalued relative to its industry peers.
Darden's forward price-to-earnings (P/E) ratio of 14.7 is well below the restaurant industry's average forward P/E ratio of 22.5. Even accounting for the company's 8.8% annual earnings growth being somewhat lower than the industry average growth potential of 11.1%, this makes Darden an intriguing pick for income investors.
