Bowing to pressure from hedge fund investor Barington Capital Group, Darden Restaurants (NYSE:DRI) said today it would spin off its Red Lobster chain, giving at least partial satisfaction to the activist investor who has been pushing the restaurant holding company to divide itself in two.
The 705-restaurant seafood chain is sailing on rough seas, suffering a 5% decline in second-quarter revenues to $561 million, as same-store sales dropped 4.5%, worse than the 0.6% drop at Olive Garden (the other restaurant Barington wanted spun off), and a 5% increase at Darden's LongHorn Steakhouse chain. With operating profits and margins below those in the year-ago period, Darden doesn't expect things to get better at Red Lobster -- in fact, it expects them to get much, much worse -- so shedding the business allows it to rid itself of an albatross while appeasing a vocal critic.
When you think about it, Red Lobster's performance is really worse than it looks. Last year's second quarter included the period when its restaurants were assaulted by Hurricane Sandy, meaning that it was going up against very weak comparisons. This year had the benefit of Thanksgiving week being pushed into the December quarter. Last year, it said 20 basis points of the 2.8% drop in sales, and 3.3% of the decline in traffic, were the direct result of the storm. No doubt that's true, as the hurricane wreaked havoc up and down the East Coast. Nearly 30% of its restaurants were located in the Eastern Seaboard states that took the brunt of the storm's fury. Yet, this year, it reported a 290 basis-point benefit due to the holiday calendar shift; but it still reported dismal numbers.
In contrast to Joe's Crab Shack, which is operated by Ignite Restaurant Group (NASDAQ:IRG) and saw comps rise 3.3% this quarter, Red Lobster is obviously still taking on water. Where it had one fewer restaurant in operation this year versus the year-ago period, Joe's had seven more restaurants open. One concept is shrinking, while the other is growing, though at 705 restaurants, Red Lobster admittedly has almost six times as many stores open than does Joe's Crab Shack.
Yet, we also see it with Bloomin' Brands' (NASDAQ:BLMN) higher-end-but-still-casual Bonefish Grill, which grew by 26 stores, from 166 to 192, a 16% expansion, while entering markets currently occupied by Red Lobster, including Connecticut, Massachusetts, and Rhode Island.
There's something to be said, then, for Barington's presentation that it released earlier this week, in which it pushed for combining Darden's more mature restaurant chains, Olive Garden and Red Lobster, into a separate company. Because they are of a different ilk than Darden's high-growth concepts like LongHorn Steakhouse, The Capital Grille, and Yard House, they need the attention of a separate management team.
But Red Lobster has problems beyond just energetic rivals. The casual-dining experience the seafood chain represents has only, until recently, seen negative growth, and last quarter, it was merely flat. The real excitement is in the fast-casual segment dominated by Chipotle Mexican Grill and Panera Bread that is expected to grow by a compound rate of 10% annually through 2017. Red Lobster's experience argues, instead, that it's a wounded fish in a shrinking pond.
If Darden does spin off the seafood chain, I wouldn't be casting any lines to reel it in. There is value in its brand, one that has been hurt by poor execution in the past, but it seems to me that having it swallowed by a bigger fish, or private equity, would be the better bet.
Darden, though, would seem to be a good catch, one that investors would likely take hook, line, and sinker.
Fool contributor Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill and Panera Bread. The Motley Fool owns shares of Chipotle Mexican Grill, Darden Restaurants, 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.