In the beloved villages of Greece, goods salesmen travel via overloaded pickup trucks, touting their offerings over a megaphone to inspire the convenient sale to the isolated townsfolk. Executives of Darden Restaurants
If you call Darden's corporate offices these days, as I did, you will find few at headquarters. You see, much of Darden's executive team is on the road, promoting its new and improved strategy for overcoming its growth issues. And in this edition of "Fool on the Street," I'll look into Darden's plan and at its outlook, considering the challenging operating environment.
Darden appears to be a company with a plan. After the company's latest presentation -- having seen one of its presentations before and having carefully analyzed the stock long ago, while later profiting from its rise -- I view the current situation as a bit less appealing.The problem
While Darden's plan for growth keys on a more rapid expansion of its leading concept, The Olive Garden, that plan appears to be driven by necessity, not decision. In reviewing the presentation, as they say, it's like deja vu all over again. Darden's management, a well-respected group both within the industry and among analysts, harps on patience when developing a new concept. We've heard that before. With failures over the years involving a Chinese cuisine concept, and more recently, its Smokey Bones concept, I question the company's skill in identifying winning ideas. By now, the operator of nearly 1,400 Olive Garden, Red Lobster, Bahama Breeze, Smokey Bones, and Seasons 52 restaurants should be able to make a new concept work if the idea is marketable.
Darden knows enough about operating a restaurant to manage the ins and outs. So when management comes out and says it's planning to grow through further Olive Garden expansion, it seems to me that that's only because there is no other choice. In May, Darden threw in the towel on Smokey Bones, closing 56 of the barbecue and grill spots, with a plan to sell the other 73 properties. During this month's presentation, management indicated that by the time it could work out "experience" and margin issues at Bahama Breeze, it couldn't expand the concept until fiscal 2009. Nonetheless, Darden is building a property pipeline. The company's latest restaurant idea, Seasons 52, is a higher-ticket concept, and the company sees its opportunity limited to only about 100 spots nationally.Not your garden variety
Restaurants and retailers alike are notorious for estimating a certain market size, and then when it's reached and the company becomes faced with the dilemma of what to do with capital, that number often increases. It seems Darden is no different. So, expect to see 40 new Olive Garden locations in fiscal 2008 versus 32 in fiscal 2007, which ended in May. Olive Garden was the company's main engine in fiscal 2007 also, as the segment grew sales 6.6% on 2.7% same-store growth. Darden expects that a new point of sales system, an automated meal pacing system, and menu and advertising changes will help same-store sales continue to expand this fiscal year.
Red Lobster, a cash cow yet seemingly endless renovation project, is undergoing another makeover. There's a new store prototype, and the company plans to later get around to putting the new look into existing locations as well. Red Lobster is also renovating its image, with a focus on the freshness of its seafood. The end goal is to maximize the seafood staple's brand potential and improve same-store traffic. Red Lobster's sales only rose 0.9% in the year just passed, and that included just a 0.2% contribution from same-store growth.
The company enjoys the cash-cow benefits of its many Italian and seafood restaurants. Darden has two clear uses in mind for its cash: to pay more dividends and to continue to seek growth. Some might argue that given what's happened with its recent new concepts, maybe Darden should accept the status of a mature business and pay out its profits in the form of dividends. In fact, Darden increased its dividend by about 56% this past year, and during the Q&A session of its presentation, declared it would likely continue to boost dividends.
Still, executives the world over are not the type to just sort of sit on their steak-filled rears, except perhaps in certain family-owned operations that miss the benefit of activist shareholder inspiration. I believe Darden could pursue the purchase of a large concept outright. This shouldn't be a surprise, though, because the company mentioned it might do as much at the conference where it gave its presentation.
In fact, Darden could take on a large operation, and thus a more proven concept. Management says it's not beyond buying into an operation of more than 100 locations, as long as it has two-thirds of its market potential still open to it. So a steakhouse like Ruth's Chris
Or maybe Darden is hungry for Chinese again. P.F. Chang's China Bistro
Darden is trying to please both worlds, and seems to have the luxury to do so. As management pointed out, the stock has returned 22% on average over the past 10 years. The company's shares have done OK this year, providing a 9.4% total return, and over 52 weeks, the shares are up about 31%. Even so, casual dining is coming under pressure as investors worry about consumer spending in light of expensive gasoline and other costs of living. Darden's forecast for 7% to 9% overall casual dining chain store growth in the near term represents an increase over the past five years. However, it's based on management's expectation that employment will remain stable or improve, while inflation is driven lower. This analyst disagrees, seeing instead a weakening employment situation, which is in line with the Federal Reserve's forecast, and persistent inflation, which is not.
As far as valuation goes, Darden trades like an industry leader.
The Foolish bottom line
While I think Darden has the right idea in consolidating its weaker segment operations at a challenging time, its industry outlook seems hopeful and its valuation appears lofty for the environment this Fool expects. Still, with Darden's conservative growth and stable cash cows, the shares should remain a staple in many large mutual funds. That could help moderate cash outflows from its stock. Even so, this Fool would steer clear of the chain, even if it looks to buy a steakhouse.
For further Foolishness:
- Fool on Call: A Fresh Look at Darden
- A Bland Quarter at Darden: Fool by Numbers
- Who Wants These Bones?
Think you could pitch your favorite stock -- or ditch your least favorite -- in 27 seconds or less? That's what we're doing over at Motley Fool CAPS. Check out our new stock videos.
Fool contributor Markos Kaminis has no ownership interest in any of the companies discussed here, but he wants to remind all his grad school pals at Pittsburgh's Katz School of Business that he recommended Darden 10 years ago in his valuation project. The Fool has a disclosure policy.