Even as analyst MKM Partners was busy downgrading Darden Restaurants (NYSE: DRI) from buy to neutral, the company released an upbeat view of third-quarter results, spiking the stock price 8% higher for the day.
Most casual-dining restaurants are struggling to attract customers and investors these days. Ruby Tuesday (NYSE: RT), Panera Bread (Nasdaq: PNRA), and Cheesecake Factory (Nasdaq: CAKE) are all trading well off their 12-month highs. So what could make Darden so bullish on future prospects?
The company presented its reasons for optimism to an Analyst & Institutional Investors conference earlier this week. Here's an overview of management's key points.
Addressing concerns head-on
In an unusual move for this type of presentation, management began by listing recent analyst concerns and addressing them one by one. Specific concerns included:
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Consumers are trading down or trading out. While management acknowledged that the environment for casual-dining chains is tough, they noted that comparable restaurant sales for the first 11 weeks of the third quarter are running up 1.2% across Red Lobster, Olive Garden, and Longhorn Steakhouse combined.
Without giving specific third-quarter sales results by format, the company implied that Olive Garden is running up mid-single-digit comps, Red Lobster is about flat, and Longhorn is running down slightly. Not much new here -- these comps are around where the company has been running recently.
- The RARE Hospitality acquisition is not helping. Management suggested that investors believe the new segment is "distracting" and "a drag on overall results." However, the company stated that acquisition cost synergies are coming in faster and at higher levels than originally planned, and the company is enjoying SG&A cost leverage from the additional restaurant sales.
- Cash flow previously directed to share buybacks is now servicing acquisition debt. The company confirms this, but also asserts that cash flow is funding EPS growth from acquisition synergies, and will be directed back to share repurchases in fiscal year 2009, which starts in June.
The proof of these rebuttals will evidently be shown in third-quarter results, due in March. The company expects third-quarter EPS in the range of $0.83-$0.85, excluding acquisition-related integration and purchase accounting expense. This compares favorably to consensus analyst estimates of $0.77.
The case for sustainable growth
The company then outlined its strategy for sustaining strong, profitable growth in the future. At its core, this is based on a "multi-brand restaurant growth company bound together by common operating practices ... making Darden greater than the sum of its parts."
That's a mouthful, even in an 87-page PowerPoint presentation. Financially, this means:
- Annual sales growth of 7%-9%, made up of comp sales between 2%-4% and new restaurant growth of 5%.
- Operating profit growth of 10%, implying a few points of cost synergies each year.
- EPS growth of 10%-15%, including share repurchase benefits.
I won't go into all the details of how Darden expects to deliver this (there are a lot of slides with catchy phrases like "brand management excellence" and "competitively superior leadership").
But one point catches the eye: acquisition scale synergies estimated at $30 million-$50 million per year through 2010 and beyond. The company expects these synergies to be evenly split between purchasing and distribution, and corporate governance and support services.
I can buy significant synergies in both these areas. I just haven't yet seen them sustained by a restaurant company over the long haul. Steak & Ale Restaurants came close to becoming a powerful multi-brand restaurant operator about 20 years ago, with the Steak & Ale and Bennigan's brands. But Steak & Ale lost its chance to capitalize on the synergies when it let those brands get overtaken by Outback Steakhouse, TGI Fridays, and Chili's.
Brinker International (NYSE: EAT) -- comprised of Chili's, Romano's Macaroni Grill, On the Border, and Maggiano's Little Italy -- has long sought this promised land. But the company has never found that next "big" format; Chili's still contributes 86% of the company's total revenues.
Still, I like Darden's chances. The incredible longevity of the Olive Garden and Red Lobster formats, in a restaurant world marked by low costs of entry and frequent customer trials of the new kid on the block, is a strong vote of confidence for Darden management.
Price-to-earnings multiples in the restaurant sector are looking attractive these days. Darden is no exception, trading at 10 times its forward EPS. Encouraging news that could spark a bit of multiple expansion, which would do a world of good for these stocks. Keep your eye out for Darden's earnings.
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