It has been six months since Darden Restaurants (NYSE:DRI) completed the sale of Red Lobster over the objections of hedge funds, Barington Capital and Starboard Value, who warned of dire consequences if management moved rashly and failed to take a holistic approach to resolving the restaurant operator's problems.
The highly contentious battle ultimately saw Darden CEO Clarence Otis resign and the entire board of directors swept from office in favor of Starboard's handpicked nominees. Now with a new team leading the way, how has Darden Restaurants performed?
Quite nicely. Since the sale of Red Lobster:
- Darden shares are up over 35%
- Olive Garden has posted four straight months of positive same restaurant sales, reversing an eight-month slide
- $1 billion worth of debt was paid down using the Red Lobster proceeds
- Between $500 million to $600 million is expected to be used for share repurchases in fiscal year 2015
That hardly seems to be the doomsday scenario laid out by the activist investors, so it is fair to ask, was Darden Restaurants right to engage in a catch-and-release strategy with the seafood chain?
No thanks to the old regime
First, a lot of the stock gains can be attributed to the changing of the guard in the boardroom. Shares had only moved 5% higher between the sale and the annual meeting held last October, but they jumped almost 30% afterwards.
Second, although Olive Garden remains the premier Darden brand with almost 850 restaurants spread across the U.S. and Canada, the Italian food eatery remains a troubled chain. The four-month streak of rising comps benefited from major promotional efforts conducted to bring customers into the restaurants. The Never Ending Pasta Bowl campaign was launched during that time, and the restaurant was going up against weak comparison figures from the year before. Despite such favorable conditions, the best it could do was eke out a 0.5% gain in same restaurant sales.
Equally worrisome is that traffic remains negative, with average guest counts down 1.3% in the second quarter and off 1.8% over the first six months of the fiscal year, though the company has been able to offset that with slightly higher average guest checks. And guidance of flat to plus 1% comps for the rest of the year is against comparables that are some 500 basis points easier.
Moreover, while Longhorn Steakhouse also remains a powerful brand for Darden, with comparable sales largely rising quarter over quarter, it too is suffering from declining traffic trends, perhaps brought on by rising beef costs that have hit record levels.
Third, although Darden has benefited from the lower interest payments as a result of the pay down in its debt -- adding $0.18 per share to full year earnings guidance -- the hedge funds always thought it was the real estate portfolio Darden held that was key to unlocking shareholder value. And they still do.
They're not making any more land
During the conference call in December, management maintained that its first priority would be determining how best to handle its real estate, ahead of any efforts at rebuilding the Olive Garden brand or deciding whether to spin off the high-growth restaurant chains.
We can probably expect management to announce sooner rather than later that the company will create a REIT to house most or all of its 1,200 or so properties. The company previously stated that owning the real estate offered no strategic value and created an inefficient corporate tax structure. As a result, creating a publicly traded REIT as the hedge funds originally suggested would give all investors a chance to share in the gains from the streamlining process.
And spinning off the Specialty Restaurant Group would likely follow soon afterwards. Darden has collected a slapdash assortment of concepts over the years. Eddie V's is a luxury seafood restaurant; The Capital Grille is an upscale steakhouse; the Yard House serves contemporary American fare; Bahama Breeze is a casual, island-themed chain; and Seasons 52 is described as a "casually sophisticated fresh grill."
These are concepts that need would greatly benefit from their own management team separate from the one running the more mature Olive Garden and Longhorn Steakhouse chains. But that is unlikely to materialize until the real estate portfolio is sorted out.
Change comes slowly
So there are still levers Darden Restaurants can pull to generate value for shareholders, and the gains witnessed so far have come despite the sale of Red Lobster. Barrington Capital originally thought Darden shares could trade between $69 to $76 if its proposal was fully implemented, but that obviously included the seafood chain being part of the reorganization.
Casual dining faces broad challenges from industry trends working against Darden at the moment. Consumers are gravitating toward fast-casual outlets, and restaurants still face higher expenses. And Darden needs to work all of that out while still trying to shore up its ailing Italian food business.
With its stock having come so far in such a short amount of time, investors should not expect to see much more happening with Darden Restaurants stock for the rest of the year.