Investors Should Follow Darden Restaurants For Break-Up Value

| About: Darden Restaurants, (DRI)

Shares of Darden Restaurants Inc. (NYSE:DRI) were up over 7% on Wednesday. The jump in the company's share price came from a new ownership stake from Barrington Research and a possible push to break up the company's assets. Investors liked the move, but there is still plenty of room for the stock to run.

Reports are calling for Darden Restaurants to split its long standing, slow growing assets apart from its high growth, high expansion assets. Under this plan, Red Lobster and Olive Garden would be one company, with the company's Specialty Restaurant Group becoming a new company. What is unknown is on which side the company's Longhorn Steakhouse brand would end up. The company's Specialty Restaurant Group consists of The Capital Grille, Bahama Breeze, Eddie V's, Seasons 52, and Yard House.

The company's Red Lobster and Olive Garden chains have been suffering from negative same-store sales and declining customer counts. In the most recent quarterly earnings, the company missed on both earnings per share and revenue. Here is a look at quarterly same-store sales results:

  • Olive Garden: -4.0%
  • Red Lobster: -5.2%
  • Longhorn Steakhouse: +3.2%
  • The Capital Grille: +3.2%
  • Bahama Breeze: +2.7%
  • Eddie V's: +2.1%
  • Seasons 52: -4.4%
  • Yard House: -1.5%

In the first quarter, total sales at Darden grew 6.1% to $2.16 billion. Sales were lifted by positive same-store sales of 0.5% at Specialty Restaurant locations and a net addition of 103 units versus the previous year. Total sales at specialty locations increased 73% thanks to the addition of the Yard House brand to the company.

The brands held under the Specialty Restaurant Group are different than the company's key Olive Garden and Red Lobster brands. The operating segment, which made up 12% of fiscal 2013 revenue, recently grew by acquiring the Yard House brand. I wrote about that company in a previous article. Average sales at a Yard House restaurant are $8.4 million. Darden spent $585 for the acquisition and is hoping to grow the company, which is currently only in 13 states.

A break up of assets would be nothing new for the market. Several companies have spun off higher growing assets to unlock value. Kraft Foods (KRFT) recently spun-off Mondelez, the company's higher growing snack and international brands. Altria (NYSE:MO) spun-off Phillip Morris International, the company's high growth international assets. There are also calls for Pepsi (NYSE:PEP) to split into two companies, one controlling beverages and one controlling the faster growing snacks category.

Here is a look at the company's restaurant unit breakdown (as of 8/25/13):

  • Olive Garden: 832
  • Red Lobster: 704
  • Longhorn Steakhouse: 438
  • The Capital Grill: 50
  • Yard House: 46
  • Bahama Breeze: 36
  • Seasons 52: 31
  • Eddie V's: 12
  • Other: 6
  • Total: 2155

To me, combining Longhorn Steakhouse with the Specialty Restaurant Group would make the most sense. Both Olive Garden and Red Lobster are almost at saturation points and have seen declining sales. Longhorn has seen positive same-store sales growth. During a 2012 investor presentation, Darden stated it believed Longhorn could hold between 600 and 800 total restaurants in the United States.

The combination of Longhorn and the Specialty Restaurant Group would represent 26% of fiscal 2013 sales. Red Lobster and Olive Garden make up the other 74%. Without Longhorn Steakhouse, the Specialty Group makes up only 12% of fiscal 2013 sales. With the split, the group containing Red Lobster and Olive Garden will likely have a small price-to-earnings ratio, slower growth, and a high-yielding dividend. The Specialty Restaurant Group could command a nice premium and give long-term investors a nice way to play the company's expansion efforts.

Using peers BJ's Restaurant (NASDAQ:BJRI) and Buffalo Wild Wings (NASDAQ:BWLD), Darden's smaller group could command a price-to-earnings ratio of 24.15 times next year's sales. Both of these chains were used as they represent strong expansion and positive same-store sales growth. On the other hand, Darden's Red Lobster and Olive Garden businesses would likely command a price to earnings of around 13.85 times next year. This figure was derived from the average of peers Brinker (NYSE:EAT) and Dine Equity (NYSE:DIN).

Using these price-to-earnings multiples and the representative percentages (74%, 26%) of fiscal 2013 sales, Darden shares should climb higher than current levels. My math would give the combined company a price of $52.56 based on next year's expected earnings per share of $3.18. While this doesn't represent a great increase from Wednesday's closing price, it served only as a starting guide to where shares could quickly climb to. Remember, investors also get a high growing dividend, which is currently over 4%. If the company can hit some of its five-year growth targets and quickly expand its Specialty brands, shareholders could see a total combined value quickly approach $60.

As I wrote back in June of 2012, Darden has an exciting five-year plan. The company plans to add $3 to $4 billion in annual revenue. Darden also wanted to add $2 to $3.50 in earnings per share over the five-year period. The company also believes it will have 2425 units by 2016. With a separate Specialty Restaurant Group, the unit number could be achieved quicker and possibly be forecasted higher.

For fiscal 2014, Darden Restaurants sees earnings declining by 3 to 5%. Analysts on Yahoo Finance think the company will report earnings per share of $2.90, an 8 percent decrease from the previous year. Total sales are expected to grow 5.8% in fiscal 2014. In fiscal 2015, analysts see earnings increasing to $3.18. Total sales are once again expected to increase 5.8% to hit $9.58 billion.

Darden is a great company with or without the breakup of brands. I have recommended the company several times on Seeking Alpha. The company is working on expanding its brands internationally and also has strong small brands that it could take national. While Olive Garden and Red Lobster have seen poor same-store sales numbers, they still are well recognized brands that bring in cash to pay a generous dividend. Take a flyer on Darden and win with a breakup or win with the five-year plan and dividends of the combined company.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BWLD, DRI, PEP over the next 72 hours. 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.

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