Darden Leaves Investors Wondering

With limited plans to buoy its largest (and heaviest) assets, Darden is keeping investors away from the success of its high-growth assets.

Mar 24, 2014 at 6:15PM

Darden Restaurants (NYSE:DRI) reported quarterly results late last week, and the numbers were pretty much as expected, with lower profit and rough same-store sales figures. For investors, the focus should not be on these short-term trends but the long-term trajectory of the business. The sale of Red Lobster continues to generate controversy, both from existing shareholders and outside pundits. The company is spending big money on a revamp plan, trying to juice up its mature, slow-growing assets (mainly Olive Garden) while accelerating the expansion of its appetizing ones. There is so much potential here for the world's largest casual-service restaurant business, but management has not delivered in recent times. Is that about to change?

Quick recap
The last quarter's numbers were predictably sour, and the coming periods likely won't be much better. Due to a combination of intense winter weather and recurring weakness in the middle-market chains Olive Garden and Red Lobster, Darden's profit dropped roughly 20% to $0.82 per share. Sales declined marginally -- just 1% -- illuminating the expenses that the company has incurred in trying to get things on the right foot, including divestiture of more than 700 Red Lobsters.

Management did investors the favor of factoring out the winter weather effects, as they skew the numbers. On a same-store sales basis, Red Lobster predictably led the downward charge with a 6.2% drop, with Olive Garden dropping 2.8%. LongHorn Steakhouse and the Specialty Restaurant Group (The Capital Grille, Yard House, Eddie V's, among others) posted another round of positive comps, again adjusted for the weather. The former grew store-level sales 2.9%, while the latter posted a smaller 1.9% bump.

Darden's current conditions are pretty much the same as they have been for some time. With such a broad reach in restaurant concepts and at different stages of growth, management is trying to figure out what it takes to reenergize the middle-market properties and allow the higher-market ones to truly exhibit their strength. It's been an expensive process with little in the way of results. The biggest news came at the end of last year, when management announced its intentions to divest Red Lobster. At first glance, the move seemed a sound enough idea -- shed the weakest link. But considering how poorly the stores are performing, the sale likely won't reflect an appealing valuation. Some believe that the company should make a more concentrated effort to revitalize the brand or organize the business differently.

Out of focus
It's an old thesis at this point, but Darden simply lacks focus. It is such an enormous business with amazing ability to scale its fast-growing assets. Starboard Capital, one of the activist investor groups in the stock, basically seeks a three-way split for Darden's operations -- real estate, lousy restaurants, good restaurants. While it, too, is a simplistic cure for the company's problems, it would at least allow for the star assets to wow the market. A more focused management team could take over Red Lobster and Olive Garden, and then hopefully figure out what to do with it. Though, without the underlying real estate, continued poor performance at these two chains could spell big-time disaster and the ultimate destruction of shareholder value.

The company would be a potential buy at a lower price, but the market appears to maintain a good amount of faith in Darden's long-term prospects. At roughly 18 times forward earnings, the stock values the company as a grower. Management may be headed toward more activist investor headwinds, meaning expensive proxy battles at worst. Investors are best to let this one simmer for a bit, and perhaps drop in price, before buying into the long-term prospects.

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