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Darden analysis: Why Barington’s valuation could be a bit high

Xun Yao Chen

Strategic analysis: Should Darden spin off its brands? (Part 21 of 25)

(Continued from Part 20)

Why analysts use EV/EBITDA

Many analysts often tout the benefits of using EV/EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization). It’s different from the PE ratio because it assumes companies’ capital structure (the mixture of debt and equity used to fund the company), interest, and tax rates are all the same. It’s also simple, quick, and easy to apply since analysts often take the average EV/EBITDA and throw it at a company to see if it’s cheaper than the industry average.

Drawbacks of enterprise value–based multiples

However, many restaurants have different mixes of capital lease, operating lease, and company-owned properties that EV/EBITDA doesn’t take into account. If a company has more buildings or capital leases, it will have higher depreciation and interest expenses. Although EV/EBIT factors in depreciation costs, it doesn’t include interest and tax. Darden Restaurants Inc. (DRI) and Bloomin’ Brands (BLMN), for example, have lower effective tax rates, as they’re taking advantage of a government program that gives out tax credit for hiring workers. Likewise, unless a company has similar capital structure and expenses such as interest and tax rate, as well as depreciation expense to the industry’s, it’s not the most accurate way to value a company.

Barington’s multiples are a bit optimistic

We believe the EV/EBITDA and EV/EBIT that Barington Capital Group had included in its letter to Darden’s board of directors is slightly too high. In particular, we see the EV/EBITDA multiple too high for the valuation assigned to Darden’s specialty brands, at 12x EV/EBITDA and 18.5 EV/EBIT. It’s true that high-growth restaurant companies are priced at a premium in the market at the moment—think Noodles Co., Chipotle, and Potbelly that trade at EV/EBITDA metrics of plus-25x. But these companies are in the fast casual business, which is experiencing same-store growth of 5% and above.

We’ve also thrown companies like Bob Evans Farms Inc. (BOBE), Chuy’s Holdings Inc. (CHUY), Cracker Barrel Old Country Store Inc. (CBRL), Ignite Restaurant Group Inc. (IRG) and Ruby Tuesday Inc. (RT) out of the valuation calculation. The reasons behind our decision include below $10 average check, negative or slim profitability and high growths that Darden’s specialty brands aren’t reaching, as these factors could inflate valuation multiples. Furthermore, Ruth Hospitality Group Inc. (RUTH) is a closer competitor to Darden’s specialty brands. The company is currently traded at last twelve months EV/EBITDA of 9.43.

Valuation for higher-growth brands may be too high

Brands under Darden’s Specialty Group aren’t seeing higher than 1.5% same-store growth over the past three quarters. Besides, the comparable companies that we’ve used so far, Bloomin’ Brands (BLMN), Cheesecake Factory (CAKE), Brinker International (EAT), and Texas Roadhouse (TXRH), aren’t too far off in terms of same-store growth.  Of course, this could change once we know more about Darden’s operations. Further strengthening Darden’s specialty brands and delivering higher growth would merit higher valuation in the future. If you didn’t get that, it’s okay. Let’s talk about Barington’s interesting real estate spin-off recommendation that could further add value.

Continue to Part 22

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