Down 13% over the last year, the S&P 500 index has fared poorly in recent months. Given the uncertainty surrounding elevated inflation and surging interest rates, this shouldn't be surprising.
But some stocks performed much worse than this, while others performed much better. The restaurant holding company Darden Restaurants (DRI 0.46%) fits into the latter category, up 17% in the last 12 months.
After such a vast outperformance versus the broader markets, should income investors still buy shares of Darden? Let's dive into the company's fundamentals and valuation to find out.
Sales and earnings are trending upward
With eight brands including LongHorn Steakhouse and Cheddar's Scratch Kitchen serving 1 million-plus guests every day, Darden Restaurants is a leading restaurant company. The company's diverse brand portfolio means that at least one of its restaurants typically appeals to any type of customer.
This strategy has been a recipe for success in recent years: The company's total sales increased by 34.3% from 2017 to 2022, while diluted earnings per share (EPS) soared 93.2% during that time.
| Q2 2022 Restaurant Count | Q2 2023 Restaurant Count | Percentage Increase |
|---|---|---|
| 1,855 | 1,890 | 1.9% |
The Florida-based business kept its impressive growth going in the third quarter ended Feb. 26. Darden's total sales surged 13.8% higher year over year to $2.8 billion during the quarter.
The company's top-line growth was largely driven by an 11.7% rise over the year-ago period in same-restaurant sales for the third quarter. For context, this was significantly better than the industry average same-restaurant sales growth rate of 7.2% in the quarter.
This performance is proof that Darden's value proposition for the quality of service that its restaurants provide is too much for customers to resist, even in an environment where consumer sentiment is increasingly negative. Coupled with new restaurant openings, this explains the company's strong sales growth during the quarter.
| Q2 2022 Net Margin | Q2 2023 Net Margin |
|---|---|
| 10.1% | 10.3% |
Darden's diluted EPS increased 21.2% year over year to $2.34 for the third quarter. Because operating expenses grew at a slower rate than total sales in the quarter, the company's net margin edged higher by nearly 20 basis points. Along with a 4.4% reduction in Darden's diluted share count from share buybacks, this is how its diluted EPS growth outpaced total sales growth during the quarter.
Darden should have little issue expanding its restaurant count well beyond its current mark. That's why analysts believe the company's diluted EPS will compound at 9.3% annually through the next five years.
Image source: Getty Images.
A payout with room to run higher
With a 3.2% dividend yield that is nearly twice the S&P 500 index's 1.7% yield, Darden's payout should be capable of satisfying most income investors' appetites. And outside of the suspension of its dividend for a few quarters during the COVID-19 pandemic to conserve cash, the company has been a reliable dividend grower: Darden's quarterly dividend per share has climbed 142% higher over the last 10 years to $1.21.
DRI Dividend data by YCharts
The company's dividend payout ratio is poised to clock in at around 61% for the current fiscal year ending in a couple of months. This allows Darden to retain enough capital for new restaurant openings, debt repayment, and share buybacks. That's why I anticipate at least high-single-digit annual dividend growth over the next several years.
The stock appears to be undervalued
Darden is a fundamentally robust business. And even with the recent rally, the stock looks like it is a good value. Darden's forward price-to-earnings (P/E) ratio of 17.4 is considerably less than the restaurant industry average forward P/E ratio of 23.3. This is why the stock could be a buy for income investors.
