For a while now, I’ve been painfully aware that my portfolio is too focused on commodity prices. I have a fat position in silver, and my two largest positions are a uranium miner and a fracking services company, respectively. While I think there’s good justification that both of those should do well in any sort of market that we might see, because of supply/demand issues and long term necessity to maintain the power grid, at some point you watch competitive coal prices disintegrate and ask “Has the world changed that much?”
Most the rest of my account is distributed to the multifamily “Death Of Home Ownership Rates” thesis, which is working splendidly and has been well documented before now.
And I have a hedge position against the euro, and generally hate everything about the EU. That position theoretically hedges the commodities, a little, but has a mind of its own most of the time.
But in between those things, there’s basically nothing. And in many respects, my strategies are open to certain…weaknesses…that can be leveraged in the wrong sort of outcome.
Watching commodity prices just crater this spring and summer, like they are today, it was clear that I needed a backup play; something that would so benefit in a deflationary vortex that it could dull the pain.
Naturally, the low margin, godless work of the restaurant industry is ripe for such a role.
I’ve spent some hours peering over numbers and feel most comfortable with Darden Restaurants (DRI). Owners of such mainstay, middle class eateries as Olive Garden, Longhorn Steakhouse, and Red Lobster, this company is big and boring, priced modestly with low expectations that, in the event of any noticeable depreciation or positive developments, it will leap over.
I added DRI today for $49.72
Consider that the stock has barely performed over the last year, but sales have grown steadily. Meanwhile cash flows have the cash balance up 16% year over year, and the company pumped over a billion dollars into acquisitions and developments in the last 9 months.
The cost for the book is a little high, but more importantly the price per earnings and sales are low. And the dividend payout stands over 4%, well supported by their high cash levels. Depreciation is very high in the restaurant business, but much of it is tied up in land and buildings, from the acquisitions, so real cash and earnings are realistically greater.
The company appears to me to be cleaning up and simplifying their operations. Financial derivatives were largely unwound over the last year.
Obviously, I am not that excited about DRI. I’m buying up a single digits margin restaurant company. I mean…come on. But, with input prices falling as fast as they are, especially gasoline and fuel, DRI should come out ahead.
31% of DRI’s sales are eaten up in the cost of food and beverage. Another 15% are absorbed in general restaurant expenses. Every 1% move lower in broad commodity prices will expand DRI’s profit margin by about half a percent. And, with gasoline costs coming down, the consumer is set to have more money to splurge on a nice evening out with the family. This will push up profit margins as less food gets thrown out.
You can see DRI’s profit margins fluctuate wildly – for example, in the February quarterly report, the margin is everywhere from as low as 4.5% to as high as 7.6%. Think about how much commodities have fallen since February, then realize that a pressure spike could (and maybe already has) jack those margins above 10%, with minimal risk.
I’ll hold DRI for a few quarters, likely, then liquidate it for whatever is left. This is a play on input costs. But long term, I hate restaurants and will burn this thing at the first sign of trouble.