Expect Darden Shareholder Pressure To Intensify

Jan.24.14 | About: Darden Restaurants, (DRI)

Just this week Starboard Value asked the management of Darden Restaurants (NYSE:DRI) to halt their planned spinoff of Red Lobster. DRI operates numerous casual themed dining restaurants including Olive Garden, Red Lobster, Capital Grill, Yard House, and others. DRI Management quickly responded they remain committed to the current spinoff as the best means to boost shareholder value. We suspect DRI's management is woefully misguided and would expect shareholder pressure will only intensify.

DRI's management is perceived as well behind the curve and nearly lacking any credibility in announcing a modest strategic action in response to another hedge fund, Barrington Capital's plan released late last year. (www.barington.com/darden.html) The Barrington plan called for DRI to separate Olive Garden and Red Lobster into a mature brands company and a spate entity comprised of DRI's faster growing brands while spinning off much of their owned real estate into a third structure.

From the below metrics, obtained from Yahoo Finance, DRI appears to both operate and utilize shareholder capital inefficiently. Particularly when compared to DineEquity (NYSE:DIN) and Brinker International (NYSE:EAT), two of DRI's most relevant peers.

DRI's price to sales of 0.76 is below both DIN and EAT. However, all three EV/EBITDA ratios are very consistent raging from 9.5 to 10.2, indicating greater operating efficiency, boosting the denominator, or returns of capital to shareholder without impacting overall Enterprise Value (the numerator) would enhance shareholder value.

DRI, with operating margins in the mid single digits, lags both competitors that squeeze more margin from their customer's spend at 35.72% and 9.64%. This results in double whammy for shareholders where DRI is generating less profit per dollar of revenue but also requires more shareholder capital to generate it in the first place. Leading us to conclude DRI management has significant work to do in operational and capital efficiency.

Further, DRI has large amounts of Property Plant and Equipment (PP&E), such as real estate, on its balance sheet. Companies capable of generating high returns on equity and at the same time favoring return of capital to shareholders will often choose to lease capital equipment and fixed assets rather than tie up capital in ownership. Both DIN and EAT PP&E's investments comprise a significantly lesser portion of their Enterprise Value and demonstrate a greater reliance on debt financing evidenced Debt to Equity Ratios substantially higher than DRI. From the below comparison, we conclude DRI would benefit from a spinoff of real estate assets or similar levering of the operating entities and result in creating sizeable shareholder value.

In conclusion we see a significant opportunity to generate substantial value for DRI shareholders by more fully addressing operational and capital inefficiencies evident today. We believe management is misguided in putting forth a reactionary strategic plan that only modestly addresses the issues at hand and foregoes further opportunities to create additional shareholder value.

DRI

DIN

EAT

Price to Sales

0.76

2.45

1.17

EV/EBITDA

9.65

10.15

9.54

Debt/Equity %

139.5

445.06

700.75

PP&E ($000)

$4,521,800

$281,432

$1,056,279

Enterprise Value ($000)

$9,480,000

$2,860,000

$3,880,000

PP&E as % of EV

47.7%

9.8%

27.2%

Operating Margin

6.52%

35.72%

9.64%

Click to enlarge

Source: Yahoo Finance

Disclosure: I am long DRI, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.