Earlier in December, casual dining operator Darden Restaurants (NYSE:DRI) pre-announced disappointing second-quarter results, as its largest restaurant concept is struggling to grow sales at existing locations. Higher food costs are also denting near-term profits, but Darden's long-term growth trends remain on track and look quite impressive. Better yet, weak near-term share price performance means very little of this growth is built into the valuation.

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Second Quarter Recap
Sales increased 6.1% to $1.8 billion. Results are broken down by Darden's three main restaurant concepts and another grouping of its smaller specialty restaurants. The largest concept is Olive Garden, which competes with firms such as McCormick & Schmick's (Nasdaq:MSSR) and accounted for nearly 46% of total quarterly sales and saw the opening of 28 net new restaurants. The existing stores are struggling a bit and posted a comparable-store sales decline of 2.5%, which reduced quarterly growth to only 0.9%. Red Lobster is the next largest at nearly 33% of sales and reported strong sales growth of 8.3% on the opening of eight net new stores and impressive comps of 6.8%. Longhorn Steakhouse, which competes with the likes of Texas Roadhouse (Nasdaq:TXRH), posted a 13.7% jump in sales to make up nearly 14% of total sales. Twenty-seven net new stores were open and comps advanced 6%.

The specialty group consists of Capital Grille, which competes in the higher-end steakhouse restaurant space and counts Ruth's Hospitality (Nasdaq:RUTH), Morton's Restaurant Group (NYSE:MRT), Bahama Breeze and Seasons 52 as rivals, and it recently purchased units from Eddie V's that consist of the namesake stores and Roaring Fork stores. This unit accounted for the remaining 7% of total quarterly sales and saw sales jump 19.1% on new stores, positive comps and the acquisition.

The strong top line trends didn't translate into profit growth as higher food costs sent pre-tax profits down almost 30% to $72.5 million. Lower income taxes lessened the decline in net income a bit to 28%, as the bottom line fell to $53.7 million. Share buybacks also helped, as earnings per diluted share fell 24.5% to 40 cents. (To know more about income statements, read Understanding The Income Statement.)

Outlook
Management currently anticipates full-year sales growth between 6 and 7% and modest diluted earnings per share growth in a range of 4 and 7%. Using this growth guidance, analysts project total sales of nearly $8 billion and earnings of $3.56 per share.

Darden ended the quarter with 1,936 restaurants and expects to open between 80 and 90 during the full year. In a recent presentation to investors, it detailed ambitious growth plans to add $3 billion to $4 billion in sales and $2 to $3.50 in earnings to the existing income statement over the next five years. This works out to potential earnings between $5.49 and $6.86 per share by fiscal 2016.

The Bottom Line
Investors should be looking to use the near-term food cost pressures and subsequent hit to profits as an opportunity to pick up Darden shares at a very reasonable valuation. The forward P/E is only about 11, and baked into the valuation is modest annual free cash flow growth of only 6% over the next decade. Management is already targeting profit growth of between 10 and 15%. If it can hit the high end of that target, the stock is currently undervalued by at least 50%. If it can do that for a decade, the stock can easily double from current levels. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

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At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.



Tickers in this Article: DRI, TXRH, RUTH, MRT, MSSR

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