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Summary

  • Darden Reports very soft results on the back of weak traffic.
  • Even at its growth franchises, earnings are falling on a relative and absolute basis.
  • I continue to shun shares, as the operating performance is deteriorating, especially if the dilutive Red Lobster sale becomes a fact.

Darden Restaurants (NYSE:DRI) saw its shares fall again after reporting another weak quarterly earnings report. The underlying performance was still very soft, as management's fight with activist investors is resulting in distraction amidst a very difficult operating environment.

The rushed sale of Red Lobster appears to have occurred at a very low price, especially on an after-tax basis. The continued fighting, potential dilutive sale and difficult operating conditions leave shares vulnerable for a further setback.

Fourth Quarter Headlines

Darden reported fourth quarter revenues of $2.32 billion, up a percent compared to last year. Revenues from continuing operations rose from $1.59 billion to $1.65 billion, as sales from discontinued operations fell from $706.5 million to $666.2 million.

The company posted net earnings of $86.5 million versus $133.2 million last year. Earnings from continued operations came in at $48.4 million, down from $78.5 million reported last year.

Net earnings fell from $1.01 per share to just $0.65 per share. Part of the decline is explained by separation charges related to Red Lobster which shaved off $0.19 per share in earnings. Adjusting for this, earnings were still lower than consensus estimates at $0.94 per share.

Continued Operations - Olive Garden, LongHorn Steakhouse & Specialties

Olive Garden, the main chain of Darden from the core operations, reported a 2.7% fall in revenues which came in at $926 million. Nine new restaurant openings could not offset a 3.5% fall in same-restaurant sales. Traffic was down by 3.8%, the mix impacted revenues by 1.4%, partially offset by a 1.7% increase in pricing. Operating earnings were down on both an absolute and relative basis, although the numbers were not specified by the company.

LongHorn Steakhouse sales rose by 10.8% to $376 million, thanks to a modest 2.4% increase in comparable store sales and 34 net new restaurant openings. Traffic was down by 0.6%, offset by a 2.5% increase in pricing and a 0.4% increase in the mix. Despite the increase in topline results, operating earnings fell in absolute terms.

Specialty restaurant sales rose by 15.9% to $342 million, thanks to a solid performance at Bahama Breeze, The Capital Grille and Yard House. Seasons 52 saw a modest decline in comparable sales, while overall growth of the division was driven by new store openings.

Discontinued Operations - Red Lobster

Red Lobster revenues fell 5.6% to $664 million driven by a similar decline in comparable store sales. Average traffic numbers were outright ugly and fell by an average of 9.6% during the quarter.

The fact that revenues were down much less is thanks to a 1.6% increase in pricing and a 2.8% improvement in the menu mix.

Full year annual sales were $2.46 billion, down 6.2% compared to last year. As known by now, management has sold the business, which should result in after-tax proceeds of about $1.6 billion.

Paying Off Debt, And ¨Pleasing¨ Investors

Of the $1.6 billion in estimated proceeds resulting from the Red Lobster sale, Darden anticipates to use $1 billion to repay debt. Darden anticipates that the deal will close in the first quarter of 2015. The price tag looks light, especially compared to Darden's pro forma operations, with Red Lobster being valued at just 0.65 times annual sales and 15-16 times earnings.

The remainder of the proceeds will be used to initiate a $700 million new share repurchase program in 2015. The company aims to maintain its current quarterly dividend of $0.55 per share.

At the moment, the board has authorized the repurchase of up to 15.5 million shares, or 12% of the company's outstanding share base.

Implications For The Valuation

Darden ended the year with $98.3 million in cash and equivalents. Total debt stood at $2.70 billion, resulting in a net debt position of $2.6 billion. Following the divestitures of Red Lobster, the net debt position of the group would fall to about $1.0 billion.

Continued operations generated sales of $6.29 billion over the past year while posting earnings of $183.2 million.

At $48 per share, Darden's equity is valued at $6.4 billion, which values equity of the pro-forma operations at 1.0 times sales and 35 times annual earnings.

The company's quarterly dividend of $0.55 per share is very generous, providing investors with a 4.6% dividend yield. The total cost of $290 million is quite steep however, and not really sustainable. Dividend payouts exceed the pro-forma earnings by a large degree.

Starboard Value Is Right

Investors, including activist investor Starboard Value LP, which holds a 6.2% stake in the business, are right to complain about the company's announced sale of Red Lobster.

Red Lobster accounted for nearly 30% of total sales, while the $2.1 billion in gross proceeds account for just 25% of the enterprise value of Darden Restaurants, which is deleveraging as well as a result of the announced deal.

The fact that the net proceeds of the deal yield just $1.6 billion is very dilutive to investors as well. Investors, called it a ¨destructive transaction,¨ and Starboard will nominate new candidates before the company's annual meeting in September of this year.

Takeaway

If not for the involvement of activist investors, shares of Darden would have seen a much more disappointing performance in recent times in all likelihood. The company is not only struggling, but seems to have engaged in a panic sale of Red Lobster. On top of that, the company is suffering hard from fast-casual rivals like Chipotle Mexican Grill (NYSE:CMG), among many others.

Darden is aiming to boost sales at its restaurants through an increased focus on takeout, which makes up just 8% of sales. Faster service to become more competitive for a quick lunch experience, and a focus on smaller menu plates in the tapas style are other key areas of focus.

On the back of these initiatives, the company expects same store sales for the Olive Garden chain to remain flat or increase by a percent in the coming year. The unit will account for about 60% of sales in the new company, making up the majority of revenues. Adjusted earnings of $2.22-$2.30 per share foreseen for 2015 fall way short compared to consensus estimates at $2.79 per share.

Given the high valuation, the still leveraged position following the anticipated divestiture of Red Lobster, and the disappointing guidance for 2015, I remain skeptical. I continue to shun shares, being glad to not stand in Starboard's shoes.

Source: Darden Restaurants - The Worst Is Yet To Come