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This Restaurant Group Is Stuck in the Middle, But Still a Buy

Monday - 4/8/2013, 2:24pm  ET

The casual dining segment of the restaurant industry has been feeling the pinch of a consumer spending pull back. That, however, may signal a buying opportunity in stocks like Darden Restaurants , Brinker International , and BJ's Restaurants .

A bad six months

DRI data by YCharts

The last six months or so haven't been very good to the casual dining group. Some of the best known brands have either fallen or stagnated. The still weak economic recovery and an increased tax bite have both constrained consumers. Casual dining appears to have taken a larger hit than others, with Bloomberg siting Knapp-Track data showing a February's sales decline of 5.4% at casual-dining restaurants—the third consecutive month of declines.

Silver lining

Casual-dining restaurants are stuck in the middle of a nice meal out and fast food. More people are likely to trade down to fast food than skimp on a special meal at an expensive restaurant. This means that casual restaurants see less traffic. Competitive pressure from higher-quality fast food, like Chipotle Mexican Grill, hasn't helped.

However, the trend toward eating out more often goes beyond finances. Part of the driving force is the two-worker household. If mom and dad are both working, who's going to cook? And while eating fast food may save money, sitting down for a better quality meal and eating experience will definitely make a come back. Here are some names to consider:

Darden Restaurants

Darden is the largest player in the casual space. Its concepts include the ubiquitous Red Lobster and Olive Garden brands, and lesser known LongHorn Steakhouse. All three of these concepts have been under pressure, but remain the company's cash cows.

Interestingly, Darden has a growing collection of smaller, higher-end, brands. These include Bahama Breeze, The Capital Grille, Eddie V's, and recently acquired Yard House, among others. This is the division from which the company's future growth is likely to come. While these nameplates may not have the same expansion potential as the larger chains, taken together they offer material growth potential in a differentiated market segment.

Also notable is the company's relative lack of foreign operations. This is a second avenue of growth that Darden is working to exploit, using franchise relationships to spur the effort. Although management prefers to own its U.S. locations, franchising internationally will reduce expansion costs and risks.

A 4% or so dividend yield should particularly attract income investors.

Brinker International

Brinker owns Chili's and Maggiano’s Little Italy, and has a minority interest in Romano’s Macaroni Grill. It has more than 1,500 restaurants in over 30 countries. The Chili's concept accounts for more than 80% of the company's top line.

In the current environment, Brinker has been focusing on cost cutting, increasing use of the franchise model, and international expansion of its core brands. The Maggiano's brand, while not a second class citizen, isn't expected to be a driving force at the company. While Brinker is further along in the international space than Darden, it still has plenty of room to grow this well known and popular concept.

The shares only yield around 2%, but the relatively new dividend has been consistently increased every year for the last half decade.

BJ's Restaurants

BJ’s Restaurants is by far the smallest of the three companies. It owns 130 locations in just over 15 states. The concept is similar to Darden's Yard House in that it is a sit down restaurant with a heavy emphasis on beer. Although the company doesn't pay a dividend, it does offer investors notable growth prospects.

Indeed, expansion is the name of the game here and one of the most important metrics to watch. Management believes the U.S. market can support 425 locations, which means it has plenty of growth ahead. As long as the company opens new locations, its top and bottom lines should continue along their steady upward climb. That should bring investors back before too long.

Eating out

While the casual-dining segment may be feeling the pinch right now, investors shouldn't see this as a reason to avoid the sector. Casual dining isn't going away and contains some great companies. Now is a time to examine the space for buying opportunities.

This article was originally published as This Restaurant Group Is Stuck in the Middle, But Still a Buyon Fool.com

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