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Why Darden Restaurants Is Seeing Red

By Demitri Kalogeropoulos - Dec 4, 2012 at 9:56PM

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It’s bad news all around for the restaurant operator.

Darden Restaurants (DRI 1.77%) is in retreat. Shares slumped to a 52-week low on Tuesday after the company ratcheted down its earnings projections. The announcement was a case of bad news followed by worse news.

Broadly speaking, Darden said it expects profits of about $3.40 for fiscal 2013. That's down from the $3.58 the company reported in its 2012 fiscal year. The about-face in projected profits has been dramatic. As recently as September, Darden was expecting full-year earnings to rise by between 5% and 9%. Instead, the company now projects a 5% decline.

And wrapped up in that gloomy forecast were five things turning Darden's fortunes for the worse.

Bad news
First, the company's same-store-sales growth has hit a wall. Traffic at Darden's flagship Olive Garden brand fell by 7.5% in September and was down by more than 8% in October.

Next, Hurricane Sandy dinged November's sales across Darden's portfolio of restaurants, causing the equivalent of 475 restaurant-days of closings. And third, the company's purchase of the Yard House brand is proving a bit more expensive than planned and will knock $0.05 a share off earnings this quarter.

While the level of drop-off in store traffic is worrying, the fact that sales growth is slowing shouldn't come as a surprise. McDonald's (MCD -0.35%) and Yum! Brands (YUM 1.59%) both reported a pullback in growth over the same time period. In fact, the entire restaurant sector is going through a tough stretch right now.

Worse news
But the worst two updates that Darden announced go directly to the company's competitive position and can't be dismissed as just symptoms of industrywide troubles. For one, the company's pricing strategy failed in Q2. As CEO Clarence Otis put it, Darden's promotions "did not resonate with financially stretched consumers as well as newer promotions from competitors." That's forcing Darden to go back to the drawing board to completely rethink menu offerings and prices. Whether the company can win back the customers who preferred competitors in Q2 is an open question.

And Darden also said the surge of unflattering news coverage surrounding its labor practices is taking a toll on sales. Reports that the company is planning on restricting some employee hours to save on health-care costs haven't reflected well on the brand. Darden can look to Papa John's (PZZA 1.12%) recent experience as a cautionary tale here. The pizza maker saw loads of negative publicity after it waded into the health-care debate. It's gotten so bad that CEO John Schnatter took to the op-ed pages, writing in the Huffington Post that his company has "no plans to cut team hours as a result of the Affordable Care Act."

A good deal?
The drop in Darden's shares might make them look like a bargain at just 13 times earnings and sporting a dividend yield that's now over 4%. But given all the uncertainty that's attached to the company's business right now, I think investors would do well to pass on that deal.

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Stocks Mentioned

Darden Restaurants, Inc. Stock Quote
Darden Restaurants, Inc.
$121.93 (1.77%) $2.12
McDonald's Corporation Stock Quote
McDonald's Corporation
$247.03 (-0.35%) $0.87
Yum! Brands, Inc. Stock Quote
Yum! Brands, Inc.
$116.24 (1.59%) $1.82
Papa John's International, Inc. Stock Quote
Papa John's International, Inc.
$84.56 (1.12%) $0.94

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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