Why I’m Throwing Darden Back

Darden’s performing admirably on sustainability issues -- but the business is the thing.

Jan 14, 2014 at 12:06PM

In November 2011, I purchased shares of Darden Restaurants (NYSE:DRI), which owns a large portfolio of restaurants including Red Lobster and Olive Garden, for the Prosocial Portfolio I manage for Fool.com. When it comes to its socially responsible elements, the restaurant company has done well and it's even made some progress over the ensuing time. When it comes to its core business, though, things are lagging, including my confidence in the stock.

I seek out companies that exhibit strong indicators in both worlds in this portfolio -- strong brands, strong financials, and strong social, environmental, and governance factors to the greatest extent I can find. That's why I'm selling the Darden stake.

First, the good news
When it comes to environmental and social elements, I still see quite a few Darden positives. Check out the disclosure in its Form 10-K filed with the Securities & Exchange Commission; it's serious about environmental goals as part of its business:

"Over the last several years, we have come to see that our commitment to sustainability is a central part of achieving our larger purpose... While global sustainability challenges necessitate a global response, we understand their potential impact to us, either through increased energy costs or commodity prices, the depletion of certain species of seafood and/or other disruptions to our food supply chain. In this challenge, we see opportunity. Conservation will be a competitive advantage-it will lower our operating costs, insulate our supply chain, help us attract and retain employees-all increasing the success of our business ."

In 2008, Darden vowed to reduce per restaurant energy use by 15%; it's almost there, having reduced it by 12% in that timeframe . The company currently has an irrigation pilot program, and it's working on its zero landfill goals by working on pilot programs for composting and recycling cooking oil, the latter of which it's already started .

Darden also works on a sustainable supply chain, given its large emphasis on seafood (of course -- it owns Red Lobster). It's been working to help troubled fisheries here and there, and in fiscal year 2009, it helped launch the Atlantic Lobster Sustainability Foundation .

It's one of the companies whose management comprehends that cost savings are part of solid sustainability strategies. Since 2009, Darden has saved $20 million through its environmental initiatives.

Even though the restaurant industry isn't known for good treatment of workers, Darden has made Fortune's 100 Best Companies to Work For, jumping from 99th place to 65th in 2013. It offers health benefits for employees who work 30 hours or more, focuses strongly on promoting from within, and offers across-the-board dental and vision plans as well as a "First Day Choice" program to help pay for office visits, prescription drugs and hospital stays.

However, this reputation has been tarnished in the last year or so. The company has waffled back and forth about how it will treat its workers in light of Obamacare; at one point it experimented with hiring more part-time than full-time employees. It had to reverse its course as public opinion responded negatively and sales dropped.

Now, the bad news
Unfortunately, Darden's core business appears to be struggling. Both Olive Garden and Red Lobster -- its major concepts, making up the lion's share of its business -- are floundering right now. Although it could turn that situation around, given other aspects, being too patient doesn't feel prudent.

Two activist investors, Starboard and Barington Capital, are currently agitating for change at Darden. One possibility that's currently on the table is the sale of Red Lobster. That may be good in some ways, shedding a flailing business, but on the other hand, there'd be few leftovers and a lot of questions for the long term.

Over the last several years, sales growth has been negligible. Since the fiscal year ended May 2011, net income has dropped from $476.3 million to $411.9 million for the year ended May 2013.

Last month, Darden forecast that its earnings per share will fall by 15% to 20% in fiscal 2014, a significant downward revision for previous guidance for a drop of 3% to 5 %.

Here's another negative: additional debt. Upon the original purchase, I wasn't too high on Darden's debt-to-capital ratio of 48.5%. Now, its debt-to-capital ratio has increased to 58.2% in the last 12 months, given its Yard House acquisition.

Meanwhile, although insider sales don't always indicate bad news, they can be flags. CEO and Chairman Clarence Otis, Jr. recently sold shares valued at $2.8 million . That isn't a comforting turn of events in a precarious and uncertain time.

Throwing this one back
My general rule of thumb is to sell stocks as infrequently as possible, and I don't do it lightly. I consider myself a long-term buy-and-hold investor, and I'm philosophically opposed to frenetic, frequent trading. My general philosophy is to target strong companies with great managements, as well as admirable moves in environmental, social, and governance factors.

Obviously, though, the numbers aren't telling a very heartening story about Darden's future growth and strength. In many cases, if I feel confidently enough about a company, I will hold patiently through ups and downs, but I'm having a harder time envisioning Darden turning its ship. The major headwinds facing Darden's major brands don't make a pretty long-term forecast. Meanwhile, there's even more uncertainty added into the mix through activist investors.

When we investors find that our original theses no longer seem like they hold water, it's time to sell. When it comes to Darden's position in this real-money portfolio, that time is now.

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Alyce Lomax 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.

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