It’s not often investors get the chance to buy leading businesses at significant discounts. Investors willing to look past the dip in economic activity can find great value. This firm has the cash flows and balance sheet to survive the downturn and is well positioned to grow profits during the economic recovery. Darden Restaurants (DRI: $62/share) is this week’s Long Idea.
DRI’s History of Profit Growth
DRI is down 43% year-to-date (YTD) and trades at its cheapest valuation, as measured by price-to-economic book value (PEBV), in the history of our model (dates back to 1998).
Prior to the COVID-19 outbreak, DRI had a strong history of profit growth. Since 2014, (the year DRI sold Red Lobster) DRI grew revenue by 6% compounded annually and core earnings by 30% compounded annually, per Figure 1. Longer term, DRI has grown core earnings by 5% compounded annually over the past decade. The firm increased its core earnings margin year-over-year (YoY) in four of the past five years and its core earnings margin of 8% over the trailing-twelve-months (TTM) is up from 3% in 2014.
Figure 1: DRI Core Earnings & Revenue Growth Since 2014
Sources: New Constructs, LLC and company filings
DRI’s rising profitability helps the business generate significant free cash flow (FCF). The company generated positive FCF in seven of the past 10 years and a cumulative $1.6 billion (22% of market cap) over the past five years. DRI’s $878 million in FCF over the TTM period equates to an 8% FCF yield, which is significantly higher than the Consumer Cyclicals sector average of 1%.
This article originally published on April 22, 2020.
 Our core earnings are a superior measure of profits, as demonstrated in In Core Earnings: New Data & Evidence a paper by professors at Harvard Business School (HBS) & MIT Sloan. The paper empirically shows that our data is superior to IBES “Street Earnings”, owned by Blackstone (BX) and Thomson Reuters (TRI), and “Income Before Special Items” from Compustat, owned by S&P Global (SPGI).
Disclosure: New Constructs
Disclosure: David Trainer, Kyle Guske II, Sam McBride, Andrew Gallagher, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.
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