In the past year, shares of Darden Restaurants (NYSE:DRI) has performed worse than DineEquity (NYSE:DIN) and Wendy's (NASDAQ:WEN). Darden's share price grew by 12.43%, while DineEquity and Wendy's enjoyed share price growth of 33.90% and nearly 77%, respectively. However, the future might be bright for Darden thanks to the ongoing activism of hedge fund Barington Capital, which has called for splitting Darden into two separate businesses.
What business separation would mean for Darden Restaurants
Darden is considered one of the largest full-service restaurants in the world, operating nearly 2,140 restaurants in the U.S. and Canada under brands that include Olive Garden, Red Lobster, LongHorn Steakhouse, The Capital Grilled, Yard House and Bahama Breeze. Olive Garden and Red Lobster are the two biggest sources of revenue for Darden, contributing $3.68 billion and $2.62 billion, respectively, to fiscal 2013 sales. LongHorn Steakhouse ranked third with $1.23 billion in sales.
Although they are Darden's two main revenue sources, Olive Garden and Red Lobster have matured and their guest counts have recently declined. In fiscal 2013, Olive Garden reported that same-restaurant guest count decreased by 2.8% while Red Lobster's same-restaurant guest count declined by 1.8%. LongHorn and other specialty brands showed higher growth during the period. LongHorn enjoyed 1.1% growth in its same-restaurant guest count and a 0.1% increase in its average guest check, which resulted in same-restaurant sales growth of 1.2%.
Barington has been pushing to split the business into Darden Mature (Olive Garden and Red Lobster) and Darden Growth (LongHorn and other specialty restaurant brands). Darden Mature should end future restaurant unit expansion and improve efficiencies. This would maximize its return on capital to make its dividend sustainable. Darden Growth, on the other hand, should keep building its loyal customer base, trying new menu options, and growing its restaurant count. Moreover, its operating expenses could be reduced by around $100-$150 million by streamlining operations and improving advertising efficiencies. A breakup move could also unlock the value of the company's extensive real estate assets, which could increase Darden's share price by at least 50%.
Wendy's and DineEquity have implemented restructuring initiatives
Wendy's plans a restructuring initiative. The company expects to divest more than 400 corporate-owned stores to its franchisees, lowering the company's net revenue but increasing its overall profitability and cash flow. Due to its refranchising plan, Wendy's estimates that its long-term adjusted EPS could grow in the mid-teens next year. DineEquity also made a refranchising move earlier with its Applebees restaurants in 2012. The refranchising program along with G&A restructuring have helped its G&A expenses decline by 11% year-over-year in the third quarter. Because of the refranchising program, I expect that DineEquity's revenue growth and cash flow going forward will be quite stable.
Compared to DineEquity and Wendy's, Darden seems to be a good pick in terms of both valuation and dividend yield. Darden has the cheapest valuation at 16.1 times its forward earnings while the forward earnings valuations of DineEquity and Wendy's come in at 18 and 28.9, respectively. Income investors also prefer Darden to both DineEquity and Wendy's due to its much higher dividend yield. At $51.60 per share, Darden offers investors a sweet dividend yield at 4.10%. DineEquity ranks second with a 3.60% dividend yield, while the dividend yield of Wendy's is the lowest of this group at 2.40%.
My Foolish take
With a lower valuation and a much higher dividend yield, Darden could be a better pick than both DineEquity and Wendy's. Darden could also head much higher in the near future if Barington's business separation idea is implemented.