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Why Darden Got Crushed Monday

By Daniel Jones – Mar 4, 2014 at 5:00PM

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After Darden announced that its third quarter will be worse than it expected, its shares fell nearly 6%. Is now an excellent buying opportunity or should investors look to Yum! Brands or DineEquity instead?

Source: Wikimedia Commons

After the company reported its third-quarter expectations for its 2014 fiscal year, shares of Darden Restaurants (DRI 0.83%) sank around 6%. In the release, management announced preliminary results for the quarter that bring into question whether the Red Lobster operations are the only struggling aspect of the business. However, due to inclement weather, is it possible that the company's lackluster expectations are being overblown by the market and that, instead of selling, investors should be buying?

Darden's rough quarter
For the quarter, Darden expects earnings per share to come in at $0.82. This represents a 12% shortfall in comparison with the $0.93 analysts had estimated and the projection is nearly 20% lower than the $1.02 per share the company reported for the same quarter last year. In part, this likely involves higher costs in relation to sales, but lower revenue could also impact this figure.

If management is correct, Darden should see a significant decline in comparable-store sales for the quarter, as we can see in the table below:

Source: Darden Restaurants

Based on the table above, we can see that Darden experienced significant declines in sales in its Red Lobster and Olive Garden chains during the three-month time-frame. The worst performer, by far, was the company's Red Lobster segment, which saw sales fall 8.8% between December and February.

Source: Darden Restaurants

The primary driver behind the company's sales drop was a decline in comparable-store traffic. In the three-month period ending in February, traffic fell by an average of 14.3%. Just as with comparable-store sales, Olive Garden performed considerably better than this result (but far from great) with an average 7.5% drop in traffic. Not even the company's LongHorn Steakhouse segment, which saw comparable-store sales rise 0.3% for the quarter, experienced positive traffic.

Now, in all fairness, if you adjust for poor weather the company's performance was slightly better. For the quarter, comparable-store sales would have risen 2.9% at LongHorn and dropped 2.8% and 6.2% at Olive Garden and Red Lobster, respectively.

How does Darden stack up to its peers?
Comparing Darden's performance in recent years to those of other restaurant conglomerates can give us a pretty good idea of how attractive the investment might be to the Foolish investor.

Over the past five years, revenue at Darden has risen 18.5% from $7.2 billion to $8.6 billion. Over this same time-frame the business's profitability has also increased, but it has risen at a slower rate than the business' revenue as competitors like Chipotle Mexican Grill and Panera Bread Company take customers from both fast-food and casual-dining companies. Between 2009 and 2013, Darden's net income rose about 11% from $372.2 million to $411.9 million.

In juxtaposition, DineEquity (DIN 2.16%), the parent of Applebee's and IHOP, saw its revenue fall 55% from $1.4 billion to $640.5 million. Before you think that the company is about to go bust because of this, you should know that the restaurant chain has been undergoing a radical transformation over the past few years.

During this time-frame, the business has refocused its efforts away from opening and operating restaurant-owned locations and it has, instead, put energy into making the company franchise-oriented. As of its most recent annual report, the company boasted that 99% of its locations were now franchised.

The downside to this approach is that it usually brings in lower revenue, but it results in higher margins. Between 2009 and 2013, the company's net income actually rose 109% from $34.4 million to $72 million. Whether this can continue or not will have to be seen, but the results thus far have proven promising.

Another company that we should look at is Yum! Brands (YUM 2.13%). Over the past five years, the parent company of Pizza Hut, Taco Bell, and KFC has seen its revenue expand 21% from $10.8 billion to $13.1 billion. At first glance, this seems impressive, but competition has adversely affected the company's bottom line.

Between 2009 and 2013, Yum! saw its net income rise only 2% from $1.07 billion to $1.09 billion. The primary driver behind the company's lackluster profits has been a deterioration of its business in the United States and China. Also, in 2013, the company booked a significant loss due to the writedown of its Little Sheep acquisition in China. Without its one-time impairment, the business's net income would have risen 21% over this five-year period.

Foolish takeaway
Based on the data it looks as though Darden has had a nice run, but this may be coming to an end. Due to the advent of quick-casual chains like Chipotle and Panera, the company's prospects have started to decline. This negative news could signal a buying opportunity for the Foolish investor who believes that the hype is overblown and the company's future is bright. However, for those who question the actions of Darden's management and would still like to own a restaurant conglomerate, it wouldn't be a bad idea to take a look at Yum! or DineEquity.

Daniel Jones 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 and Panera Bread. 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.

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