Red Lobster may serve 395 million Cheddar Bay Biscuits each year, but apparently that hasn't been enough for Darden Restaurants (NYSE:DRI) to deem it worthy to stay under the parent company's official umbrella. At 705 restaurants across the U.S. and Canada, Red Lobster today accounts for about a third of Darden's total 2,100 restaurant base and about 30% of Darden's total sales. However, those restaurants are to be set afloat when Darden's sale or spinoff of the seafood chain is finalized.
Of all of Darden's restaurant chains, Red Lobster was the worst performer in this year's second quarter with a 5.2% decrease in sales and a 4.5% decrease in the third quarter, despite various attempts at promotions and the addition of more non-seafood options to attract more customers.
As a result of falling sales and profits, activist hedge fund Barington Capital Group, which owns over 2% of Darden shares, proposed that Darden break up its empire into as many as three separate businesses. This included the separation of both Red Lobster and Olive Garden, another of its chains.
Separation of surf and turf
Darden's other restaurants, such as LongHorn Steakhouse and Capital Grille, have been growing more quickly and thus should be sectioned off from the poor performing restaurants in the company's repertoire, according to Barington.
While Darden did not listen to all of Barington's proposal, it did take some of the hedge fund's suggestions into account. These include the sale or spinoff of Red Lobster and is in conjunction with other measures taken, such as the halting of opening new Olive Garden restaurants and the slowing of others. These measures will ultimately lower capital spending by $100 million annually and increase savings by at least $60 million annually, which is $10 million more than previously announced, according to Darden's recent statement.
Unimpressed, investors ended up contributing to Darden's 5% drop in stock value to around $50 after the announcement.
While Red Lobster may not be in the red just yet, consumers' tightening budgets plus intense and growing competition in the restaurant industry are stealing both customers and dollars from Red Lobster at an alarming rate for Darden.
Red Lobster may be the biggest full-service dining seafood specialty restaurant operator in North America, but consumers are now favoring cheaper, quick-service options such as Chipotle over full-fledged—and generally more pricey—sit-down fare. But surely there must be other reasons for the decline that's led to a sale or spinoff in Red Lobster's near future.
Could it be the seafood itself?
Besides a decline in revenue and profits, are there other underlying reasons that Darden might be considering this sale or spinoff? Let's take a look at Red Lobster's primary offering: seafood.
Statistics show that when a recession hits (such as back in 2008), consumers tend to favor less expensive meats like beef, pork, and chicken. Seeing as the job market has not increased dramatically since that recession and analysts even say that we are in the midst of dipping into another, this shift could be happening again. This could be one reason sales might be down at a primarily seafood-selling chain.
The seafood industry itself shows mixed numbers. Total retail sales increased from $13.3 billion in 2008 to $14.7 billion in 2012, but per capita consumption has fallen from 16 pounds of fish and shellfish per capita in 2009 to 15 pounds per capita in 2011. As previously noted, shrinking wallets during the recession was a primary cause of this drop.
However, the seafood industry has a few things going for it as well. In terms of health, consumers are more and more viewing fish and shellfish as a healthier source of protein than other meats. According to a Packaged Facts press release, "15% of U.S. adults strongly agree and 25% somewhat agree that, to eat healthfully, they often choose fresh fish over meat or poultry."
The seafood industry is also on the rise, according to one market research report. The world seafood market, which encompasses fresh, canned, and frozen seafood products, is expected to exceed $370 billion by 2015, according to Global Industry Analysts. The report predicts the market will be fueled by a rising global population, increased discretionary incomes, and technological advances such as packaging and improved transportation, and that demand will be particularly strong in developing regions including Latin America and Asia-Pacific.
Not so fresh?
On the other side, though, consumers are worried about two things: (1) the possible spoilage or contamination of fish or seafood, especially since the Fukushima meltdown, and (2) that fresh fish and seafood are healthier than frozen fish.
This is another area where Red Lobster flounders. While fronting claims that they only use fresh fish, countless reports have arisen over the years that allege that Red Lobster does indeed use frozen fish, to the point that this has essentially become common knowledge.
So why would consumers want to spend more money on a sit-down meal of frozen fish when they can patronize a restaurant that does only serve fresh fish? Or when they can simply purchase fresh or frozen fish for cheaper from their local grocery stores and fish markets and cook it for themselves at home?
Exactly why Red Lobster has run into sales trouble is debatable, but what is certain is that selling or spinning off Red Lobster makes financial sense for Darden in the long run. Will Red Lobster be revamped and grow under new management? Only time will tell if Cheddar Bay Biscuits are enough to keep customers coming back for more.
Fool contributor Carolyn Heneghan has no position in any stocks mentioned. The Motley Fool owns shares of Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.