Even with the all of the brands in Darden Restaurants' (NYSE:DRI) portfolio, Olive Garden remains the crown jewel. Lately, however, the chain has been under-performing. A turnaround is necessary to restore the nation's largest Italian restaurant chain to its former glory.
Most of Olive Garden's woes are self-inflicted as Darden has gotten too big to focus on all of its brands. Besides Olive Garden, Darden owns Red Lobster, LongHorn Steakhouse, The Capital Grille, Bahama Breeze, Seasons 52, Eddie V's, and Yard House.
There's plenty of speculation on what's going to happen next with Darden. There's no denying that CEO Clarence Otis has built an impressive collection of restaurant brands during his nine-year tenure. Some brands are performing better than others, but the largest brand remains Olive Garden with 826 locations in the U.S.
Activist investor Barrington Capital wants the business to be broken up into two companies. One company would be Red Lobster and Olive Garden, while the second entity would consist of the smaller and faster growing brands.
A break-up makes sense
The results from the latest quarter make the case for Darden to be broken up. Overall, earnings per share decreased 37.6% compared to the prior year. U.S. same-restaurant sales decreased 4% at Olive Garden and 5.2% at Red Lobster. This compares to the 3.2% increase at LongHorn Steakhouse and a 0.5% increase at the specialty restaurant group.
The weak performances from Red Lobster and Olive Garden are masking the strength seen at Darden's other restaurants. Based on this, an argument can be made that it makes sense to break up Darden.
What needs to happen next
With the calls increasing for a breakup of the company, it's safe to say that Otis knows his job is on the line and doesn't want to see the company he built broken up.
To start, the company is going to reduce costs by a total of $50 million through a reduction in employees and spending. Next, the focus needs to be on Olive Garden. The Olive Garden needs to serve more authentic-style Italian dishes and be more creative with its menu items.
While Olive Garden remains the largest Italian restaurant chain in the US, it faces notable competition from Romano's Macaroni Grill, owned by Ignite Restaurant Group (NASDAQ:IRG), and Maggiano's Little Italy, owned by Brinker International (NYSE:EAT). Maggiano's is more upscale than Olive Garden, while Romano's serves a similar clientele to Olive Garden.
Romano's is dealing with many of the same issues as Olive Garden. In its most recent quarter, same-restaurant sales decreased 2.7%. To boost sales at Romano's, the company is running several specials. Romano's is offering 25 specials per day at its restaurants, which includes a four-course tasting menu for $15.
Romano's is increasing its TV advertising to drive awareness, and so far the reaction on social media sites has been positive. As always, Romano's has an open bottle of wine on every table to start the night right for its guests.
Maggiano's bucked the trend in the Italian casual-dining segment by posting a 0.6% increase in same-restaurant sales in the latest quarter. This marked the 15th consecutive quarterly increase. Brinker International now has both of its concepts, Maggiano's and Chili's, on a single-operating platform. This will help improve margins across the board for both concepts.
Secondly, Maggiano's continues to innovate and improve its menu offerings. The focus is on classic pastas, which include quality Italian ingredients. Additionally, guests have the option to take a free classic pasta dish home for tomorrow. Maggiano's proves that good food and a great menu will keep diners coming, and that's a lesson for both Olive Garden and Romano's Macaroni Grill.
In choosing which restaurant is best for your portfolio, both Darden and Ignite have under-performed Brinker in the past year. Shares of Brinker International have had a stellar performance with an increase of 57% in the past year. Meanwhile, shares of both Darden and Ignite are relatively unchanged. Darden pays the best dividend with a 4.1% yield. Darden also has the lowest P/E at 19.
The Olive Garden is still the cash cow for Darden that has been able to fund its expansion plans. Even though Olive Garden posted the largest drop in same-restaurant sales among the Italian restaurant chains, it is still by far the No. 1 chain in Italian dining. A renewed focus on Olive Garden will boost sales and drive more customers into its restaurants.
I think Darden has the most potential over the next 12-to-18 months. Darden is the largest company in the casual dining space and CEO Otis has assembled a great portfolio of brands. With an activist hedge fund as a shareholder, I think the focus will be on unlocking shareholder value. That's great news for shareholders, and that makes Darden a better buy than Ignite or Brinker.