Why I’m Throwing Darden Back

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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Read/Post Comments (8) | Recommend This Article (11)

Comments from our Foolish Readers

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  • Report this Comment On January 21, 2014, at 10:22 AM, burkE621 wrote:

    Recently I was in Homestead, Florida visiting a friend in a nursing home there. This was quite some distance from my home in Oakland Park, Florida. I was with three other friends and we went to the local Red Lobster. This was the emptiest lunchtime Red Lobster I had ever visited! The salads were not fresh (wilted), the lobster that I received did not appear to be any where near 1/4 pound. Perhaps this is why sales are declining?

  • Report this Comment On January 21, 2014, at 2:37 PM, Truth2Power wrote:

    Thanks, Alyce, for making me aware of their socially responsible policies: something I didn't know about before.

    I've been bearish on Darden for quite some time. I think the fast-casual trend is really hurting sit-down family restaurants like Darden's for the budget conscious consumer. And for the consumer who isn't budget-conscious, there are plenty of fine dining options in most cities and towns that can defeat Darden on quality hands-down.

  • Report this Comment On January 22, 2014, at 4:00 PM, TMFLomax wrote:

    Thanks for the comments; burkE621, there is definitely a sense that the quality has been flagging and yes, if that's pervasive, customer traffic would decline as a result. I have heard from some of the folks who comment on the discussion board for the Prosocial Portfolio talk about the skimpier and skimpier portions particularly at Red Lobster and definitely changes that should be made.

    But to speak to Truth2Power's point, I also agree that the fast-casual is hurting the sit-downs. After the past several years, the sense that those sort of "middle-of-the-road" places are under a ton of pressure really messes with the original thesis. I couldn't get into that in the article, but I definitely agree that that sector is not in a good position right now (and that definitely doesn't bode well for Darden).

    Best,

    Alyce

  • Report this Comment On January 22, 2014, at 11:09 PM, MelissainVA wrote:

    It would have never in a million years occurred to me that Darden had any commitment, let alone results around social responsibility. I don't own the stock and I don't plan to. But this has been a good reminder to challenge my assumptions and do the research around social responsibility before coming to any conclusions.

    Thanks!

  • Report this Comment On January 24, 2014, at 4:26 AM, TMFVelvetHammer wrote:

    Hi Alyce!

    Honestly, I'm not sure I agree with your timing. It seems like the Red Lobster sale/spinoff creates some potential value for 2014.

    Maybe Jim Royal sticks it in his Special Situations portfolio now...

    ... or Jim Mueller in his Messed-up Expectations portfolio?

    :)

    Jason Hall

  • Report this Comment On January 24, 2014, at 11:04 AM, TMFLomax wrote:

    MelissainVA, isn't it surprising? I really didn't think so, but one of the smart folks who comments and adds a ton of good insights put it on my radar on the portfolio discussion board long ago. It IS always good to challenge assumptions! We can find so many interesting things.

    Jason, agreed that those things could happen! And it'll be interesting to watch. Over the years though, I've noticed just how difficult turnarounds can be. I feel like there are far more failures in that area than successes. And, of course, sometimes I'm wrong! I just feel like the risk really increased. And for what seemed a fairly "stable" company with popular brands, I do feel worried.

    Good points though, as usual. Fool on! :)

    Alyce

  • Report this Comment On January 24, 2014, at 3:35 PM, LeeG3 wrote:

    There are two things that a business must do right no matter what else they do: provide good service and provide a good product. The last couple of times that we went to RL, the service was not as good and the food was not as fresh or as big a portion as in the past. But the price had gone up. So until they fix those issues, I don't see a turnaround for the company.

  • Report this Comment On January 27, 2014, at 3:00 PM, CromulentBrad wrote:

    The thing crushing Darden is not just the fast-casual sector. It’s the Food Network, celebrity chefs and the explosion of overall food knowledge in the American consumer.

    Food is expensive. Time is precious. You have an entire generation of consumers growing up with Iron Chef, Marcus Samuelson, Rachel Ray, etc...People don’t want to settle for mass produced, flavorless slop. Even fast casual restaurants understand that more people want authentic, fresh, locally sourced food.

    I appreciate your socially conscious investment style, but I’ve also had the displeasure of eating at Olive Garden. For Darden, green isn’t enough.

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