DARDEN THOUGHTS

Darden reported 3QFY12 EPS of $1.25 was just ahead of consensus $1.24.  Blended US same-restaurant sales for Olive Garden, Red Lobster, and LongHorn Steakhouse came in at 4.1% versus guidance of approximately 4% provided a month ago at the company’s Analyst Day. 

 

Darden reported a solid 3QFY12 on Friday but there was a lot of noise in the quarter with weather and the impact of an earlier start of Lent this year versus last year.  Less severe winter weather boosted the blended same-restaurant sales number by 200 basis points while Lent positively affected results by roughly 60 basis points (including an astounding 480 basis points at Red Lobster).

 

Management’s commentary on the macro environment as “choppy” was important; the company sees improving employment being offset by the impact of rising gas prices.  The industry slowed in February, according to management, after a strong holiday and post-holiday season.  Management noted that less severe weather did help results but downplayed the impact somewhat by referring to states such as CA, TX & FL.  In the case of TX, we know from other companies’ commentary and our own research, that adverse weather conditions did impact business in Texas during January 2011 so would argue that a benefit would account for some positive impact on Darden’s Texas restaurants.

 

In terms of FY13, management will offer more comprehensive guidance on the FY12 call in June but did provide some initial thoughts during Friday’s earnings call, sounding generally bullish but offering little in the way of specifics.

 

Darden also seems to be stealing a page out of Brinker’s book when talking about the new Olive Garden promotion; Drew Madsen said, “this promotion is representative of our strategy going forward, where we plan to emphasize a broadly appealing platform idea rather than just one or two new dishes.”

 

The initial improvements in the Olive garden performance are coming from a “more overt value message as well as more affordable core menu dishes” that are pulling customers into the store.  The issue remains how effective the new initiatives are and to what degree the apparent improvements are being helped by the benefit of easy weather.  The new advertising campaign is also a welcome change, but this too needs time to prove itself out.  The biggest challenge to any real improvement in the chain’s performance will be the “bolder improvement initiatives” that include a “remodel that updates and refreshes the dining atmosphere in the 430 non-Tuscan Farmhouse restaurants.”  This suggests that 55% of the chain is suffering from a stale look in today’s competitive casual dining environment. 

 

Any big leg up in the stock price will likely come from multiple revision based on a stronger secular story from improved same-store sales.  In the short run, the dividend yield and share repurchase will likely keep the shorts on the side lines.  We will look to revisit the story after FY4Q12, which will likely bring a sequential slowdown in same-store sales.

 

The bottom line for us is that DRI is a strong company supporting a 3.4% dividend yield and that, along with our belief that management will deliver on most if not all of its long term targets, is sufficient to convince us that the longer term TAIL thesis remains intact.  However, the immediate term TRADE and intermediate term TREND prospects of the company are uncertain.  Macro concerns coupled with concept-specific concerns at Olive Garden and Red Lobster concern us over the next few months.  Olive Garden, in particular, is crucial to the stock’s performance given its relative size within the Darden portfolio and we feel that investors need to see an improving top line that is not achieved to the detriment of restaurant operating margins.

 

Olive Garden

 

Olive Garden’s 2% 3QFY12 same-restaurant sales growth lagged Knapp Track by approximately 60 basis points which was a sharp sequential improvement versus the prior quarter’s lag of 320 basis points. 

 

During the quarter, Olive Garden ran two promotions.  The first, baked pasta romana, ran from December through the third fiscal week of January and compared favorably to last year’s lack-luster scaloppini promotion.  The second, which was launched in the fourth fiscal week of January, was the three-course Italian dinner for $12.95.  This promotion succeeded in driving traffic but is also priced $2 higher the promotion from the same period in FY11 (although that promotion was for an entrée rather than three courses).  While 3QFY12 was successful for Olive Garden in that the gap-to-Knapp was narrowed sequentially, next quarter will pose a much sterner test for the chain as the weather benefit goes away.  Management described the environment as “choppy” and this is causing us to remain on the sidelines.

 

DARDEN THOUGHTS - olive garden gap to knapp

 

 

Red Lobster

 

Red Lobster posted a 6% same-store sales number for 3QFY12, as preannounced, which benefitted by 480 basis points due to an earlier start to Lent 2012 versus 2011.  The 6% number was 340 basis points above the full service industry benchmark but the benefit derived from the Lent shift will reverse in 4QFY12.  Traffic during 3QFY12 was soft, if we adjust for weather and Lent, and it seems that maintaining profitable traffic growth could prove challenging if the effectiveness of promotional efforts is declining.  Soft underlying traffic trends were a surprise given the 4 for $15 promotion that Red Lobster was running in the quarter.

 

One important concern for Red Lobster is seafood inflation but that is, according to management, going to ease in 1HFY13 and was less acute in 3QFY12 than 1HFY12.  Nevertheless, management not taking any price against seafood led to margin contraction at Red Lobster.  Going forward, the question is whether or not the “broader range of levers” that management alluded to as being core to its sustaining Red Lobster comps is going to be impactful.  Red Lobster has been a strong component of the Darden portfolio during this fiscal year but maintaining that momentum will be difficult in a choppy macro environment.

 

DARDEN THOUGHTS - red lobster gap to knapp

 

 

LongHorn Steakhouse

 

LongHorn continues to perform well for Darden.  3QFY12 same-restaurant sales growth of 6.7% was 410 basis points above the full service industry benchmark.  Negative mix was one standout from the chain’s results but the successful and profitable efforts to drive lunch business is the primary driver of that trend.  LongHorn is an important growth vehicle for Darden and new LongHorn units continue to exceed sales and earnings hurdles. 

 

DARDEN THOUGHTS - longhorn gap to knapp

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst