DRI – ESTIMATES MAY HAVE GONE DOWN TOO MUCH

The likelihood that consensus has gotten too bearish on DRI is high. The world knows that sales trends in casual dining are very tough in October and November and there is no reason that things will get better in December. However, the holiday season is upon us and more people will be coming out of their holes and shopping for family members. They might be spending significantly less this year but they will be shopping and getting hungry. Our model suggests that estimates are about 5% too low.

The consensus numbers suggest that current sales trends will continue for the balance of FY 2009 for DRI. Although I would agree that in the current fiscal quarter (2Q09) sales trends will decelerate further as September and October have proven to be more difficult than the summer from a traffic standpoint, I think casual dining companies will get some relief in early calendar 2009. It’s unclear what the Obama administration will do to help the beleaguered consumer, but help is on the way. We know the new administration is working on a plan to hopefully be in place shortly after he takes office in January.

Casual dining stocks have been in liquidation mode for the last three months. Yes, sales trends are bad but negative sentiment begets negative sentiment. Over the past three months DRI is down 49% and down 40% year to date. The stock now trades at 6x EPS with a 5% dividend yield. One of DRI’s most important competitors, EAT, is down 68% this year and trades at a 7% dividend yield. EAT trades at 5x EPS! Neither of these companies is going away, but the market seems to think otherwise.

My number one concern about DRI continues to stem from the company’s new unit growth targets and overall use of cash, which I don’t think properly reflect the current environment. Last quarter, management acknowledged the tough environment saying, “There's no question it has been a difficult quarter and given the difficult economic environment, it looks like it is going to be a challenging year. Our current sales and earnings outlook reflects that.” The analyst community does not agree with management! I think management’s EPS guidance and same-store sales target of flat to up 1% for FY09 is aggressive, but I think numbers will look better than what the street is forecasting.

Despite these challenging times when operating profit growth declined at each of the company’s core concepts, Red Lobster comparable sales declined for the third consecutive quarter with traffic down about 5.5% in 1Q and LongHorn posted a 4.9% same-store sales decline with traffic down about 7%, DRI maintained its FY09 unit growth targets (75-80 new restaurants, or 4%-5% unit growth). Total capital spending for FY09 will be north of $600 million. In addition, given where the company’s stock price is and management penchant for share repurchase, they are still buying back stock. Given the times, it’s an aggressive use of cash at a time when cash is king!


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