On Thursday, Darden Restaurants (NYSE: DRI ) announced plans to spin off its Red Lobster restaurant chain to shareholders. For months, pressure has been mounting on the chain to make this move in an attempt to increase shareholder value. This important decision, for better or worse, will significantly impact shareholders but the big question is how.
Red Lobster has been faltering while its peers have been on the rise
Recently, Red Lobster's results have been negatively affected by a shift in consumer tastes away from both fast food and casual restaurants and toward fast-casual chains like Chipotle Mexican Grill (NYSE: CMG ) and Panera Bread Company (NASDAQ: PNRA ) .
During the company's first quarter, sales for the chain declined 5.5% (5.2% on a comparable restaurant basis) compared to the same quarter a year earlier. Similarly, its Olive Garden restaurant chain has been in decline with comparable restaurant sales falling 4%, most of which was offset by an increase in restaurant count.
This trend has, unfortunately, continued into the company's most recent quarter. Comparable restaurant sales for Red Lobster declined 4.5%, while its total sales decline came out to 4.9% when factoring in the closing of one of its locations. Olive Garden's results were less depressing, but far from something to be proud of. During the quarter, the Italian-themed chain saw revenue growth of 2.4% to $869 million. On a comparable restaurant basis, however, results were far from impressive, with sales declining by 0.6%.
Despite the poor results seen at Red Lobster and Olive Garden, some companies in the restaurant industry have been thriving. Take Chipotle, which, during its most recent quarterly report, announced that it had added 37 new locations. Combined with a comparable restaurant sales increase of 6.2%, helped push revenue for the fast-casual chain to a new high of $826.9 million. This represents an 18% increase compared to the $700.5 million the company saw the same quarter a year earlier.
The bottom line for Chipotle has also done well, despite the company's cost of goods sold rising from 72.6% of sales to 73.2%. Compared to the same quarter a year earlier, the company's net income rose 15.4% from $72.3 million to $83.4 million.
Though not as impressive as Chipotle, Panera also saw its revenue and net income improve. Compared to the same quarter last year, sales at the fast-casual chain rose 8.2% from $529.3 million to $572.5 million, while net income rose 17.3% from $36.5 million to $42.8 million. These results were aided by comparable store sales rising 1.7%.
Sometimes you just need that "push"
After reporting lackluster results last quarter, news broke that Barington Capital Group, an activist fund, had taken a 2.8% stake in Darden. According to an open letter between Barington and Darden, Barington believes that shareholders would be best served if both Red Lobster and Olive Garden are spun off into one entity while the smaller chains are kept under the Darden name. These restaurants consist of LongHorn Steakhouse, The Capital Grille, Bahama Breeze, and Eddie V's, all of whom have seen their brands flourish.
The argument behind the split is that Red Lobster and Olive Garden, as mature restaurants, should not be primarily focused on growing their operations like how Chipotle or Panera have been doing. Rather, shareholders would benefit from the separate entity focusing on cost containment as a means revitalize the business. Meanwhile, Darden could utilize its resources to more rapidly grow its smaller chains.
What will shareholders receive from the spinoff?
Currently, details surrounding the proposed spinoff are being worked out. However, if nothing changes between today and the date of the spinoff, shareholders will receive an entity that consists of 705 restaurants. This represents 32.4% of the 2,174 locations that comprises Darden. During the last quarter alone, these locations brought in revenue of $561 million. During the company's 2013 fiscal year, revenue for Darden's Red Lobster locations came out to $2.6 billion, or $3.7 million per individual restaurant.
The spinoff of Red Lobster from Darden, which, if completed, is expected to take place no sooner than May 2014, will be an interesting opportunity for investors. Here we will have a stand-alone company with a 46-year operating history that will be able to focus on improving itself without having other chains competing for the same pool of resources.
The benefit to this is that management will be able to operate autonomously and in any way that they deem beneficial for the chain without the interference of higher-ups. On the other hand, it also gives management plenty of opportunities to err if they become overly confident in their execution and to do so without the benefit of a larger body to fall back on for support. In essence, the issue here for the prospective investor is not whether or not to buy shares in the restaurant business; it's about whether or not to buy into management's ability to turn it around.
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