Beware the False Promise of This High-Yield McGuffin
Alfred Hitchcock famously referred to any device in his films used to divert viewers' attention from the real story as a "McGuffin." For companies like Darden Restaurants (NYS: DRI) , which operates such restaurant chains as Red Lobster and Olive Garden, a rich dividend is the McGuffin that keeps investors from focusing on the weaknesses of the balance sheet and the income statement.
High dividend: good... high debt: bad
Darden Restaurants has a dividend yield of 3.70%, the biggest in the restaurant industry. That is a good thing for its shareholders... as long as the company can afford it. But Darden Restaurants is carrying a high level of debt with a high dividend payment, which is very unsavory.
If Darden Restaurants had a tasty profit margin, this would all be much more palatable. But the five-year average net profit margin is just 5.80%, with the sector average at 8.20%. Based on its gross margin, it does not appear as if Darden Restaurants has the pricing power to increase its net profits, either. The gross margin for Darden Restaurants is lower than the industry average and much lower than McDonald's (NYS: MCD) .
Net Profit Margin (TTM)
Net Profit Margin (5-yr. avg.)
Source: S&P Capital IQ. TTM = trailing 12 months.
Darden Restaurants has a debt-to-equity ratio of 1.13. That means it required $1.13 in borrowing to produce each dollar of equity. Moreover, almost one-third of the debt is short-term, lending instability to the capital structure due to its near-term demands on capital flows. By comparison, McDonald's has a dividend yield of 3.33% with a debt-to-equity ratio less than 1.
Short Term Debt-to-Equity Ratio
Dividend Payout Ratio
Look to the Golden Arches for high dividends and high earnings growth
Now, McDonald's can afford its dividend and debt load, as its earnings-per-share growth rate over the past five years is almost twice that of Darden Restaurants. While the earnings-per-share growth rate of 7% for Darden is right around the industry average, its sales growth for the most recent quarter is two-thirds lower than the industry mean.
In addition to better recent sales growth, the industry average dividend yield is only 2.70% with a debt-to-equity of only 1.10. These are not the only areas that make investors looking at Darden lose their appetite and place an order for McDonald's instead.
For McDonald's, the gross margin is 44.70%, more than one-fifth above the sector mean. A robust gross margin reveals that a company has pricing power. Obviously, the Golden Arches soar over the others in the restaurant industry with their ability to raise prices and still not lose customers.
More are dining out, just not at Darden's restaurants
More and more consumers are eating out. But based on the bland sales and earnings-per-share growth, it does not appear as if many are choosing Olive Garden, Red Lobster, or other Darden holdings to satisfy their cravings. Investors who are hungry for dividend yield should also look elsewhere to feed their appetite for income (with or without fries). While the McGuffin is not on the McDonald's menu, investors should chow down on its stock.
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The article Beware the False Promise of This High-Yield McGuffin originally appeared on Fool.com.Jonathan Yates has no positions in the stocks mentioned above. The Motley Fool owns shares of Darden Restaurants and McDonald's. Motley Fool newsletter services recommend McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.