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Actionable news in DRI: DARDEN RESTAURANTS Inc,

What Isn't So Great About Darden Restaurants?

Darden Restaurants (NYSE:DRI) operates full service restaurants in the U.S.A. and Canada. In terms of same-restaurant sales growth DRI continues to be a leader in the restaurants industry and the company's strong performance in Q1 2016 has raised expectations. DRI's forward Price to Earnings ratio is nearly 28% lower than current P/E ratio, a sign that the market is expecting a noticeable increase in earnings.

My thesis is that despite the optimism, 'now' may not be the right time to own DRI's shares. Let's dig deeper into the company's financials to find out why its shares do not represent a compelling investment opportunity.

Cash generation

With FCF standing at merely ~3.7% of revenue, DRI is definitely not a 'cash cow'. In fact, since last year, DRI's cash from operations has reduced by 29%.

DRI Cash from Operations (TTM) data by YCharts

Also DRI's management has not been too successful in effectively using the company's free cash. The chart below shows that DRI's CROCI has been consistently below 12.5% and at present it stands at ~6.7%. So DRI generates around $7 for every $100 of invested capital, which is unimpressive.

DRI Cash Return on Capital Invested (CROCI) (TTM) data by YCharts

Value Creation

It's important to assess how much capital a company is using to generate its earnings or in other words the value a company is creating for its shareholders. This can be done by measuring the difference between Return on Invested Capital and Working Asset Cost of Capital (W.A.C.C.).

I have calculated DRI's WACC under the following assumptions:

  1. I have set the risk free rate of return equal to 10-Year Treasury Constant Maturity Rate of 2.26%.
  2. I have used DRI's five-year average tax rate.
  3. Market risk premium refers to the difference between expected return of the market and the risk free rate of return. In my model I have set the required market premium in the following range: 6%-7.5%.

Details of the model and calculations can be seen below:

...

Inputs Summary

Low

High

Levered Beta

0.70

0.91

Market Risk Premium

6.0%

7.5%

Risk-free Rate

2.3%

2.3%

Cost of Long-term Debt

4.0%

5.0%

Tax Rate

9.0%

9.0%

Debt % of Capital

15.0%

25.0%

Implied WACC Range*

6.0%

8.7%

Selected WACC

7.5%

*See Calculations below

Note 1: Calculations

Cost of Equity

Low

High

Notes

Levered Beta

0.70

0.91

See Unlevered Beta

(times) Market Risk Premium

6.0%

7.5%


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