We recently downgraded our rating for Darden Restaurants Inc. (DRI), one of the world’s largest casual dining restaurant operators which owns and operates restaurants chains primarily under Red Lobster, Olive Garden, LongHorn Steakhouse, The Capital Grille, Bahama Breeze, and Seasons 52 names, from Outperform to Neutral.
Downgrading was primarily due to a host of factors including declining same restaurant sales, much dependence on the core brand Olive Garden and Red Lobster which are approaching saturation, recent gulf oil spill affecting Darden’s supply and/or demand for sea food, and stiff competition.
Q4 Results Lags Zacks Consensus
Darden’s fourth-quarter adjusted earnings of 81 cents per share fell short of the Zacks Consensus Estimate of 88 cents per share. Earnings were hit by a $12.7 million pre-tax reduction in sales associated with a correction to its third quarter estimate of gift card redemptions.
Total sales from continuing operations decreased 5.7% to $1.86 billion, as blended comparable restaurant sales were down 2.3%. Darden Restaurants witnessed its first positive growth in the third quarter of fiscal 2011 after nearly two years. For the full year, sales from continuing operations were $7.11 billion, representing a year-over-year decline of 1.4%.
The quarterly comps also fell behind the 1.4% expected decline for the Knapp-Track benchmark of U.S. comparable restaurant sales, excluding Darden Restaurants while full-year comps fared better than the expected decline for the same benchmark.
By restaurant concepts, sales increased only at The Capital Grille concept, while growth in comps was witnessed in three concepts named LongHorn Steakhouse, The Capital Grille and Bahama Breeze.
Management pointed out same-restaurant sales at its core Red Lobster, Olive Garden brands and LongHorn Steakhouse are expected to grow 2%-3%, with total revenue growth of 5.5%-6.5%. This coupled with continued margin improvement translates into earnings per share growth of 14% to 17%.
Downgraded to Neutral
We believe Darden Restaurants boasts a unique position due to its strong value proposition, menu improvements, cost effective measures, massive advertising and excellent unit-level execution with differentiated brands. Since the last five years, Darden Restaurants has kept its restaurant operating cash flow margins stable at 22%-23% despite recent economic headwinds.
Darden Restaurants is one of the few casual dining chains expanding amid the sluggish economic environment. The company expects to open 70 to 75 net new restaurants in fiscal year 2011. Additionally, Darden’s continued share repurchase activity and 28% hike in dividend payment would hold promise for investors.
Although we like Darden’s stock for the above-mentioned factors, decline in same-restaurant sales along with still-somewhat-uncertain economy may be a drag on the stock. Recent Gulf oil spill will likely create difficulty for the company impacting its seafood supply (and demand), which represent around 30.0% of the company’s total food costs. However, Darden Restaurants does source some product from the Gulf, all of it, with the exception of oysters, is from areas not currently affected by the spill. We expect sales to see slightly adverse impact on consumer demand for seafood at Red Lobster due to consumer perceptions about the Gulf oil spill.
We believe, amid the high unemployment rate along with cash strapped consumer, decreasing commodity inflation will lead to persistent promotional offers and higher discounting rates among the casual dining operators hurting Darden Restaurants’ relative value proposition.
Again, Darden’s core brand Olive Garden and Red Lobster are approaching saturation. Despite a strong early summer promotion, comps remain negative at Red Lobster in fourth quarter, which remains a cause for concern. We believe, Darden Restaurants needs to concentrate more on its other brands which are faring better. Hence, we downgrade the stock from Outperform to Neutral.