After Dumping Red Lobster, Does Darden Restaurants Have a New Lease on Life?

Darden Restaurants recently unloaded its Red Lobster unit, likely hoping that the move would rejuvenate its troops and recharge its profit growth. Is it time to buy in? And how do its prospects measure up to Chipotle and Buffalo Wild Wings?

Jun 14, 2014 at 12:05PM

It has been a difficult last 12 months at restaurant chain Darden Restaurants (NYSE:DRI), epitomized by declining customer traffic volumes at its key brands. These chains have anecdotally been hurt by the rise of a host of so-called fast-casual restaurant players, led by Chipotle Mexican Grill (NYSE:CMG), offering fresh, quality food at more reasonable prices. A lack of business momentum has led to a stagnant stock price for Darden and has raised the ire of some of its shareholders, including activist hedge fund Starboard Value, currently bidding to dethrone the board.

However, Darden recently sold its Red Lobster unit for roughly $2.1 billion, over the vocal objections of Starboard, a transaction that should provide the opportunity to pay down some of its debt and refocus resources on its key brands, like Olive Garden. So, is it time to bet on a new day at Darden?

What's the value?
Darden is the nation's largest casual-dining restaurant company, operating a network of more than 2,100 locations that run the gamut of price points, from Capital Grille on the high end to Bahama Breeze on the low end. Its diversified portfolio has generally been a winning formula, with growing brands offsetting declining brands, thereby allowing the company to generate consistent overall profitability. The net result for Darden has been solid cash flow, fueling the expansion of its existing store base and investments in new concepts.

In its latest fiscal year, though, some chinks have started to appear in Darden's armor, as evidenced by declining comparable-store sales at its key brands. In addition, rising marketing and store labor costs put a dent in the company's average per-store profit margin, leading to a double-digit decline in its overall operating income. More important, those same trends have continued unabated in fiscal year 2014, compounded by higher commodity costs, especially for seafood and beef.

An uphill battle
Certainly, selling the underperforming Red Lobster operation should help Darden in theory, allowing management to focus on reinvigorating its stable of remaining brands. Indeed, most of management's current efforts seem to be centered on upgrading the attractiveness of its Olive Garden brand, which accounts for nearly 40% of its total store base, through new menu introductions like its lower-priced Cucina Mia platform.

That said, Darden seems to have an uphill, though not impossible, battle in its quest to recapture lost customers from the fast-casual segment, especially players like Chipotle Mexican Grill  that benefit from a shared healthy-eating mission with their customers, not to mention a pricing advantage. While some members of the fast-casual crowd have had trouble maintaining customer volume growth in the current environment, Chipotle has had no trouble finding new customers, reporting volume growth in its latest fiscal quarter despite the weather-related issues that stymied players like Panera Bread and Noodles & Co. Combined with higher average prices, the net result for Chipotle was solid operating profit growth, up 13.1% during the period, helping to fund its growth initiatives, including plans for another 10% addition to its overall store base in 2014.

A better way to go
Given the negative volume trends at Darden, investors looking for gold in the casual dining space would probably find better returns with players that continue to add to their overall customer base despite the challenging environment, like Buffalo Wild Wings (NASDAQ:BWLD). More than 30 years after its founding, the king of wings continues to report strong top-line growth, up 21.7% in its latest fiscal year, benefiting from its ability to position its locations as ideal sports-watching venues for rapid fans.

More important, the company's stores continue to find new customers, as evidenced by rising comparable-store sales during the period, a trend that has helped it to keep its operating profitability at a healthy level, despite volatility in raw chicken wing prices. The future is also looking bright for Buffalo Wild Wings, as its concept seems to have some portability, with early-stage success in Canada and Mexico.

The bottom line
Mr. Market didn't seem particularly enthralled with Darden's sale of its Red Lobster unit, giving the company only a marginal push higher since the announcement of the transaction in mid-May. That likely indicates a view that Darden's problems won't be a quick fix and profit growth may still be a ways off. As such, investors should probably watch the action in Darden from the safety of the sidelines.

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Robert Hanley has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Buffalo Wild Wings, Chipotle Mexican Grill, and Panera Bread. 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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