If Darden Restaurants (NYSE:DRI) gets its way and sells the Red Lobster brand for $2.1 billion to private equity firm Golden Gate Capital, the onus will be on management to prove it was right that the Olive Garden Italian eatery was worth hanging on to and can return to a growth concept. It's going to be a hard case to make.
The restaurant operator's stiff neck in refusing to lop off that branch along with the seafood chain means it will need more than cosmetic changes like a new menu to turn it around. Fiscal third-quarter sales of $929 million were down 3.4% over last year due to a 5.4% decline in same-restaurant sales at its U.S. locations even as it opened 18 more stores.
A large part of the problem is that the Italian restaurant market has grown far more competitive even as consumers shy away from casual-dining restaurants. The secular decline in sales and units is widespread as the fast-casual niche grabs the attention of diners' imaginations and wallets. The combination of a pleasant dining atmosphere, fast service, personalized menus with fresh ingredients, and reasonable value makes it a hard combination to go up against.
According to the market researchers at NPD Group, fast-casual chains once again outpaced the rest of the restaurant industry's unit growth in 2013, expanding the total number of locations open by 6%, compared to a 1% decline in the number of casual, midscale, family, and fine-dining establishments. And where total industry traffic was flat year over year, the fast-casual segment was the only one experiencing growth, rising 8% from 2012.
Bloomin' Brands (NASDAQ:BLMN) says its Carrabba's Italian Grill could not drive incremental traffic despite a new menu, and witnessed a 5% drop in traffic in the dinner daypart in the first quarter while lunch was down 2%. It maintains that until the concept can prove it's able to lift traffic, it won't be expanding the chain aggressively, particularly as both its Bonefish Grill and Outback Steakhouse offer far more opportunities for growth than does the Italian chain.
Maggiano's Little Italy also dealt owner Brinker International (NYSE:EAT) a similar setback, as traffic was down almost 1% in the quarter, though as the months progressed the numbers improved. Darden itself experienced dramatic declines in traffic at Olive Garden, at times even surpassing Red Lobster's double-digit falloff, while Ignite Restaurant Group (NASDAQ:IRG) saw same-restaurant revenues at Macaroni Grill, which it bought last April, were down 4.1%, though it blamed poor winter weather for half or more of the decline. Still, that means it has problems beyond the "snow in winter" effect for falling sales.
And Darden also has significant problems generating sales at its Italian restaurant as comps maintain a steady continuous slide. While sales bounce around from month to month, and yes, weather can play a role, we also see that the spikes never quite reach the highs previously attained and that the depths to which they fall seem to get steeper.
Activist shareholder Starboard Value accused Darden management of leaving more than $800 million on the table at the time it was trying to spin off Red Lobster, and the case was made that it was really the two chains together that was the anchor dragging Darden down, so a holistic approach was needed to correcting the problems.
With the entire space weak or declining, consumers moving away from casual dining, a systemic problem still in place at the restaurant group, and a management team apparently unwilling to listen to shareholders, there doesn't seem to be any significant change for the better on the horizon.
Yet because Darden's management chose to burn the bridges behind it as it unloads Red Lobster, it has only a few months before the annual shareholders meeting to prove it charted the correct course. Investor anger may well boil over at the yearly gathering, and those directors up for reelection may find themselves tossed overboard.
Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.