Olive Garden Can Thrive In A Recession. Buy Darden Stock.

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At a time when economic concerns have become luxuries, Olive Garden is a tempting place to dine on breadsticks and a big plate of fettuccine Alfredo, and Darden's restaurant offerings may be more palatable.

It's not a good time for a restaurant company like Darden (Ticker: DRI ), which owns eight chains, including Olive Garden, Longhorn Steakhouse, Cheddar's, Capital Grille and Bahama Breeze. Although inflation has been declining for decades, it has reduced consumer spending and increased material and labor costs. At the same time, the Federal Reserve is actively trying to slow the economy, and the prospect of a recession could leave consumers feeling like they can't afford to eat.

However, Darden should be able to withstand that wind. A company that manages to keep inflation below inflation by keeping a close eye on costs, the combination of affordable food and strong brand awareness should keep customers coming. With a strong quarter expected next week, Darden looks like a quality bet while other restaurant brands struggle.

"They have very strong brands in casual dining," said Raymond James analyst Brian Vaccaro. "Also, I think they are versatile players with strong economic rates and strong balance sheets."

These advantages have shown up for Darden in both bad and good years. The stock fell 8.2% in 2022, ending a nine-year winning streak and posting its worst decline since 2007. Still, the stock outperformed the S&P 500, which fell 19.4% over the same period, and won again: Dard shares are up 6.7% this year, while the S&P 500 is up 2.1%.

Darden's strength in financial results for the second year ended Nov. 27: Earnings of $1.52 per share and sales of $2.5 billion beat Wall Street expectations. Same-store sales rose 7.3 percent, and the company opened 35 new restaurants a year ago. Darden raised prices slower than inflation, but managed to beat estimates. It said overall price growth was around 6.5%, 1.5% less than the 8% increase in the consumer price index.

In a recent conference call, Darden CEO Ricardo Cardenas attributed this to "a competitive pricing strategy, below-inflation pricing and other cost savings to offset this and our customers." I do not need a promotional email to participate.

That's not to say that companies don't use promotions to get people in the door. For example, Olive Garden has an "endless pasta dish" that offers customers unlimited pasta and sauces for one payment. The price of this promotion was $3 more in 2022 than in 2019, which helped improve the discount margin, but it was still a "sale" for customers. By keeping costs low — for example, marketing costs dropped from 3% of sales before the Covid-19 pandemic to 1% of sales — Darden has been able to maintain profit margins on the nearly 20 olive groves it covers. 10% of Sales Half of Revenue. . %

"The goal is to standardize, understand logistics, reduce costs and do the same thing," said Stephen Zagor, a professor at Columbia Business School and an adjunct fellow at New York University's Steinhardt School. "And if you look at companies like Darden, there are very few that do better than them."

Now Darden will try again. The company is due to report third-quarter earnings on March 23, and analysts expect earnings of $2.23 per share on sales of $2.7 million. Citigroup analyst John Tower expects Darden to adjust its full-year earnings guidance to an upward range of $7.60 to $8 a share, citing continued consumer spending and recognition of future risks.

"We expect a repeat of the last few quarters," said Darden, who revised his buy price target to $165, up 12 percent from Wednesday's $147.58. "Barring F24's early comments on a very conservative top line and/or further raising the commodity bar, we expect a strong quarter to be enough to provide equity comfort."

Dard fund is not cheap, but for some reason it has a high price. Shares trade at 17.8 times annual earnings estimates, close to the historical average, but higher than Applebee's and iHope owner Din Brands Global ( DIN ) and Profits and Bloomin' Brands ( BLMN ) at 9.7 times. It owns Outback Steakhouse and has 8.5 times earnings. But Darden's strong margins, strong balance sheet and growing market share warrant a high valuation.

Guggenheim analyst Gregory Frankfurt says the best comparisons are Coca-Cola ( KO ) and other consumer brands like PepsiCo ( PEP ) or TJX Cos. ( TJX ) and Tractor Supply ( TSCO ), all for 20 times earnings or more.

"We think it's fair to compare [Darden] to high-end consumer goods companies or the S&P 500 because the price is cheap, so the growth profile should be faster over the next few years. That has a purpose."

And what's more fun than a basket of green olive bread?

Email Angela Palumbo at angela.palumbo@dowjones.com