Darden's Stock Rally Masks Cash Flow Weakness and Valuation Concerns

What happened

Darden's stock has risen 14% over three months, fueled by positive sales growth and new restaurant openings as highlighted in recent articles. However, SEC filings reveal a concerning divergence: EPS increased to $2.05 in the latest quarter, but free cash flow plummeted 74% year-over-year to $146.6 million. This cash flow deterioration, coupled with inconsistent reporting and rising capital expenditures, indicates underlying margin pressures and potential financial strain despite top-line strength. The DeepValue report maintains a 'WAIT' rating, noting that the current P/E of ~20x already discounts mid-single-digit growth without a margin of safety. Investors should look beyond the optimistic sales narrative to assess the sustainability of growth given traffic erosion risks and increasing leverage.

Implication

The sharp free cash flow drop signals potential issues in working capital or increased capital intensity, which could impair dividend coverage and escalate leverage. With net-debt-to-EBITDA at 3.18, any further margin compression or traffic decline could breach investment-grade thresholds. Market optimism driven by sales growth ignores the reliance on pricing over guest counts, a key risk highlighted in filings. Given the 'WAIT' recommendation and attractive entry at $175, prudent investors might consider reducing exposure above $215 or awaiting improved cash flow metrics. Ultimately, the stock's valuation appears fully priced, demanding caution until evidence of sustainable, traffic-led growth emerges.

Thesis delta

The recent stock rally does not alter the core thesis; it reinforces the disconnect between market sentiment and underlying financial health. A shift would require consecutive quarters of positive traffic growth and restored free cash flow, which are currently absent. Thus, the investment call remains to wait for a lower price or clearer operational improvement.