Dear Mr. Berko:

My broker just recommended that I buy 75 shares of Darden Restaurants for my Individual Retirement Account and for my wife’s IRA. He thinks that Darden is one of the better restaurant chains around and that the stock can give us good growth over the coming four to six years. What do you think of this stock?

F.L., Fort Walton Beach, Fla.

Dear F.L.:

Because I eat most of my meals out four to seven days a week, I’m sort of a casual dining aficionado. Among my favorite choices are Smokey Bones, a swell rib restaurant, the Olive Garden, a delightful Italian eatery that makes a delectable all-you-can-eat salad, and Red Lobster, where the menu features a grand selection of succulent seafood. I like these venues for six reasons:

1. The food quality is consistent and much better than at other casual restaurants.

2. The portions are filling and moderately generous.

3. The service is usually friendly, good and quick.

4. The restaurants are always clean, comfortable and attractive.

5. The prices are affordable and fair.

6. I don’t have to pay a $5 nuisance fee to a valet to park my car so he can ding my fenders and rifle my glove compartment.

These restaurants (plus a few others) are owned by Darden Restaurants Inc. (DRI-$30.65), which was spun off from General Mills in 1995.

Restaurant stocks have performed well over the past few years in spite of the challenges of higher fuel prices, the popularity of low-carbohydrate diets, higher food expenses, the modest increase in labor costs and mad cow disease. Though Darden raised menu prices, revenues, which were $4.6 billion in 2003, rose to $5 billion in 2004 and are expected to rise to $5.3 billion this year and $5.8 billion in 2006. Per-share income also has increased each year; it was $1.31 in 2003, $1.50 in 2004, and it’s expected to hit $1.77 this year and $2 in 2006.

Darden is a superbly managed restaurant company with a great balance sheet (less than $350 million in long-term debt), 156 million shares out, a consistently growing cash flow of $3.20 per share and an annually increasing book value of $8.50. Revenues have grown 70 percent since 1997, while net income has risen more than fivefold, increasing to $280 million this year from $54 million. Management greatly improved operating margins to 13 percent from 7.2 percent, and net profit margins surged to a superb 5.3 percent from 1.7 percent. In the coming three to four years, management believes it can increase those net profit margins to 6.4 percent. That’s mighty impressive.

Darden traded in the high $50s when it split 2-for-1 in 2002, and in the coming four to five years, many suits on the Street believe DRI can move up to the low $60s and perhaps split 2-for-1 once again.

The shares trade at 17.3 times 2005 earnings and 15.3 times 2006 earnings vs. the Standard & Poor’s 500 index’s price-earnings ratio of 22.4 percent. DRI trades at 9.6 times cash flow vs. 14.6 for the S&P, and its price-to-sales ratio is 1.1 vs. 2.9 for the S&P 500 index. Those are compelling numbers.

Darden doesn’t franchise, and its strategy of owning all its restaurants (679 Red Lobsters, 563 Olive Gardens, 104 Smokey Bones plus 35 other themes) gives management complete quality control of its food and service. Meanwhile, Olive Garden and Red Lobster both have achieved impressive brand recognition, which permits management to build both themes on a single piece of property without diluting brand equity. Putting two restaurant units on a single site reduces costs and improves efficiency. Heck, I suspect, with the amazing success of Smokey Bones Bar-B-Q, that Darden may soon place three restaurants on one piece of property. And the large increase of people in their 50s and 60s (most of whom are casual diners) is a positive demographic shift for Darden.

Red Lobster owns 50 percent of the U.S. seafood market and Olive Garden has 30 percent of the Italian dining market. This is no mean feat, considering the competition. DRI’s seafood buying power is phenomenal, and its hugely profitable wine selections appeal to the tastes of diners and resulted in record sales of Italian wines last year.

And management won’t rest on its successes. The company keeps customers coming back by maintaining a bright, wholesome and fresh restaurant ambience and a fantastic menu of choices. Unlike most of its competitors, Darden remodels its units every seven years.

Give your broker a gold star for his Darden recommendation. Raymond James has an “outperform” opinion on the stock and Bank of America recently upgraded DRI to a “buy.” Without question, I’d purchase 75 shares as a long-term investment for your IRA.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net.

© Copley News Service