Sometimes, leftovers taste good – when they’re leftover profits, delivered by restaurant stocks as dividends.
Consider the two highest-yielding North American restaurant stocks: Pizza Pizza Royalty Corp. (which pays an enticing 6.2-per-cent yield) and Darden Restaurants Inc. (which offers a healthy 4.7-per-cent payout).
Both are appetizing buys for investors looking for income. However, the two offer radically different menus of risk and reward.
For starters, Pizza Pizza is firmly Canadian, while Darden is based in the United States. Pizza Pizza is trading at 52-week highs because it’s producing decent sales gains and seems poised for a better 2014. Darden, by contrast, is more of a value proposition. The owner of the Red Lobster and Olive Garden chains has slumped near its lows for the year after reporting erratic and disappointing results. While it still offers the potential for attractive long-term gains, you should expect some dips along the way.
For cautious investors, the more immediately attractive of the two stocks is Pizza Pizza, which takes its name from the Ontario chain that gives the company the bulk of its 700-plus locations. It also owns the Pizza 73 chain in Alberta.
The second quarter was shaping up to be a winner for Pizza Pizza, says analyst Derek Lessard of TD Securities Inc., as new menu items, higher pricing and targeted promotions were poised to drive sales. Unfortunately, “eastern rains and western floods” dampened attendance at many big outdoor events that would ordinarily have provided customers for the chain’s restaurants.
Despite that, Pizza Pizza posted same-store sales growth (revenue at locations open at least a year) of 1.3 per cent. The Pizza Pizza-branded locations rose 0.8 per cent, while Pizza 73 posted gains of 3.9 per cent.
Mr. Lessard looks at this performance, in light of the disruptions, as well as the chain’s results during last season’s National Hockey League lockout, and sees a management team with an “ability to deliver, despite what remain difficult operating conditions.”
Same-store sales at Pizza Pizza locations will grow at a 3-per-cent clip this year, he forecasts, rising to 4 per cent in 2014. Pizza 73 will do even better, he figures, boosting same-store sales of 4.8 per cent this year and 5.3 per cent next year. On top of that, the company plans to open 20 to 25 restaurants this year.
All this bodes well for a dividend that Pizza Pizza has raised three times since May, 2012. The company pays out roughly all its earnings as dividends and Mr. Lessard says that growing profit will allow it to boost the payout this year and in 2014 and 2015.
Mr. Lessard started covering Pizza Pizza in late 2010, when the shares were below $8. Back then, he slapped a “buy” rating on the stock and laid out his case in a report that asked, “Will Pizza Pizza deliver?” With the stock now trading above $12.50, the answer has been a definite yes. His new target price of $14 suggests there are more gains ahead.
For Darden, however, the future looks more uncertain, as its flagship chains seem increasingly out of step with a food-obsessed culture.
Not that this is exactly news: Red Lobster and Olive Garden have long had an underwhelming reputation among the cultural elite. An earnestly glowing community-newspaper review of the Olive Garden in Grand Forks, N.D., went viral last year, allowing for widespread mockery of the tastes of flyover America. Similarly, the humorist Joe Queenan titled his 1998 attack on American culture Red Lobster, White Trash and the Blue Lagoon.
For years, the snobby foodies had to make their snide comments as they passed by packed parking lots at the chains. However, that has not been as true recently, as Darden’s mid-priced fare for the middle class has found fewer buyers.
The chain badly missed earnings expectations for the quarter ended in August, largely because of same-store sales declines at both Olive Garden (down 4.0 per cent) and Red Lobster (down 5.2 per cent). Analyst David Tarantino of Robert W. Baird & Co., who has a “hold” rating on the shares, said the company had mixed results with its promotions in the quarter. (While its Never Ending Pasta Bowl and Endless Shrimp performed okay, the Four-Course Seafood Feast failed to satisfy.)
Jim Yin of Standard & Poor’s Capital IQ, who also has a “hold” rating on the shares, says Darden’s attempts to rebuild its brand image have not succeeded, putting the restaurant chain in an awkward position. “We believe the company can attract more budget-conscious customers by offering more deals, but we think [the deals] would hurt gross margins.”
The investing risk is limited, however, because of the healthy dividend, which represents a payout of just about 70 per cent of net income for the last 12 months, according to Standard & Poor’s Capital IQ. And there are at least two sources of potential upside.
One is that management recognizes the company’s problem, and has started to cut costs and assess underperforming locations. Nicole Miller Regan, an analyst with Piper Jaffray, has an “outperform” rating on the shares because she – unlike others – believes Darden can hit its earnings guidance. Her price target is $54, versus recent trades around $46.
Another potential positive is that, while investors focus on Red Lobster and Olive Garden – the bulk of the company’s 2,100-plus locations – the company actually owns eight brands, including LongHorn Steakhouse, which posted same-store sales gains of 3.2 per cent in the recent quarter.
Mr. Tarantino of Baird says the company’s five smallest brands, called the Specialty Restaurant Group, accounted for about 14 per cent of the company’s sales. They have produced strong unit volumes and should record double-digit revenue gains in coming years, he says.
Something to chew on for folks who feel the company’s recent performance has left a bad taste.