Red Lobster Steamed, Served Up for Hedge Fund

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In its second-quarter earnings announcement, Darden Restaurants (NYSE: DRI  ) revealed that it was planning on ditching Red Lobster. Management said that the Red Lobster brand had diverged from the Darden pack, and that it made more sense to spin it off or sell it than to keep running the business. The move is likely a nod to the pressure that hedge funds -- notably Barington Capital -- have applied to Darden recently, calling for the business to slim down its structure and separate its underperforming businesses.

A fiscal brunch with hedge funds
While the Red Lobster division and other cost savings announced today will go part of the way toward meeting Barington's demands, the original vision of the hedge fund is still a ways away from being realized. The company, which holds more than 2% of Darden's stock, had wanted to see Red Lobster and Olive Garden split into their own businesses. Both brands have slowed in recent years as the market reached saturation and more fast-casual dining chains came into vogue.

In the recently announced quarter, the company fell short of earnings estimates on weaker sales. Red Lobster saw a total brand decline along with a comparable location drop compared to last year. Olive Garden fared only slightly better, increasing overall revenue but still seeing a drop at the comparable store level.

Barington's original plan was to shuffle the slow growers into a retirement home of a business, where they could sit on the porch and watch the wheat grow. Meanwhile, the young up-and-comer brands like LongHorn Steakhouse and Capital Grille -- which is apparently run by poor spellers -- would have gotten their own, faster-moving business.

Half-soup and side savings
Instead of taking up that whole plan, Darden opted to jettison Red Lobster, while making some investment changes to save cash. The plans revealed today also include slowing unit growth at Olive Garden and LongHorn, saving the company $100 million per year. The business is also going to cut back on operating support costs, sending the combined savings back to shareholders through stock repurchases and dividends.

Darden's change comes as its sector is under new threat from faster, lighter chains. Competitors, like DineEquity (NYSE: DIN  ) , have also had difficulty. DineEquity's Applebee's brand has languished this year, seeing comparable restaurant sales fall for the first nine months. The brand has recently undergone a revitalization, though, in an attempt to stem the tide.

The companies have suffered from competitive fatigue, as chains like Panera Bread (NASDAQ: PNRA  ) take over. The fast-casual brand has been growing sales at its locations, taking market share away from older businesses. With a focus on fresher, quicker food, Panera and similar chains have been able to bring in cost- and health-conscious consumers in a way that Olive Garden and Red Lobster have simply been unable to manage.

Good news with a side of bad
In the long run, the Red Lobster spinoff will likely be good news for Darden and its investors. While the business still has a long way to go before it's turned itself around, shedding some dead weight seems like a good plan. The downside of the new outlook is clearly the slowing growth at LongHorn.

The steakhouse is one of the few bright spots in Darden's portfolio, actually seeing an increase in comparable sales this year. Cutting back on expansion costs seems like selling off momentum for some short-term shareholder gains. Unless that plan develops into something with a long-term focus, I'd be worried about its efficacy at generating real shareholder value.

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9/26/2016 1:44 PM
DRI $62.49 Down -0.56 -0.89%
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