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Darden Restaurants, Inc. (DRI) owns and operates full-service dining restaurants in the United States and Canada under brands Red Lobster, Olive Garden, LongHorn Steakhouse, The Capital Grille, Bahama Breeze, Seasons 52, Eddie V's Prime Seafood, Wildfish Seafood Grille and Yard House. It currently own owns and operates more than 2,000 restaurants. In Aug 2012, it acquired Yard House USA, Inc. for $585.0 million in cash.

Weak 2Q12 results:

  • 2Q12 sales increased 7% with negative comparable same store sales (SSS) of 2.7%. All of its segments posted negative SSS mainly due to lower traffic partially offset by higher pricing.
  • Gross Profit margins declined 29bps to 20% mainly due to higher beef costs and unfavorable menu-mix and Yard House's higher restaurant expenses.
  • SG&A Margins de-leveraged by 80bps to 11% due to higher SG&A as a result of acquisition and integration costs associated with the Yard House acquisition and higher media costs.
  • As a result, EBITDA margins declined by 100bps to 9% vs. 10% in 2Q11.

Liquidity:

  • Cash flows were mainly utilized for $355 million capital expenditure, $52 million share repurchases and $578 million Yard House acquisition.
  • Further, during 2Q13, it issued $300 million notes, received funding from a $300 million term loan and completed
    the offering of $450 million of senior notes which were used to effectively refinance the $350 million of long-term notes that it repaid at maturity during the quarter.
  • Liquidity remains low with $61 million in cash on hand and $750 million unutilized revolving credit facility (RCF). It is important to note that the cash on hand (including unutilized RCF) does not sufficiently cover its debt of $2.9 billion.
  • Due to lower EBITDA, its Debt/EBITDA ratio declined to 2.6x vs. 2.0x at FYE12

Future Plans:

  • In an attempt to increase traffic, the Company is working on next generation restaurants which will be smaller and trendier than the existing restaurants. These new chains, which will include Capital Grille, Seasons 52, Eddie V's, Bahama Breeze and newly acquired Yard House (plans to increase to 200 stores), are aimed at attracting Millenials. According to a recent study by Boston Consulting Group, Millenials are the new driving trends for dining. According to the study, Millennials go out to eat 3.4 times a week on average, versus 2.8 times for the rest of the population, and they are more willing to pay a higher price for a better dining experience. In FY12, although these new chains accounted for only 5% of Darden's total stores it generated ~24% of its total sales growth.
  • Further, it also plans to add 40 Olive Gardens in FY14 and intends to focus on its remodeling, menu mix and change its marketing strategy.
  • However, despite all the above efforts, Darden is still struggling to gain momentum in its SSS. This is well evident by its negative SSS in 2Q13 (as mentioned above).

Competitors:

  • Darden is not the only company facing issues in the causal dining sector. Its peers are also facing lower traffic and pricing difficulties.
  • In Jan '13, Ruby Tuesday Inc (RT) posted a wider 2Q13 loss due to a handful of write downs resulting from closure of several restaurants. It missed analyst guidance as well as cut its full-year same-store sales and earnings guidance. It has now guided for EPS of 24 cents to 30 cents a share, from its previous view of 24 cents to 34 cents and SSS are expected to be flat vs. previous guidance of flat to up 2%.
  • Similarly, 1,593 unit company, Brinker International Inc (EAT) also admitted that the casual dining space is not a shining star that it used to be and it is facing increasing pressures from the fast casual sector. Chilli's (dominates Brinker's store count with about 1,550 units) experienced soft January comps and as of 02/24/13, its comps were -2.2%. Brinker too, revised its full-year guidance downward, with comp sales now at 1% vs. previous guidance of 2-3%.

Time to exit:

  • The causal dining space is facing tough times and restaurants are struggling to gain momentum. The National Retail Federation provided its 2013 economic forecast which projects retail industry sales to increase 3.4%, lower than the preliminary 4.2% growth seen in 2012. The overall rate of increase will mark the slowest growth in retailing spending since 2010.
  • Further, as seen in the adjacent chart, despite increase in sales, Darden is unable to maintain its margins. In FY13, EBIT margins declined 111bps and EBITDA margins have declined 63bps.
  • Despite strong dividend payout ratio of 53% and dividend yield of 4.25 (Brinker : 44% and 2.1%, resp.), given the above negative catalysts, I would recommend a SELL on Darden Restaurants.
Source: Darden Restaurants: Time To Exit