Yesterday, we announced that we will be doing a conference call on Thursday, July 19th at 11am EST titled "DRI: Too Big To Perform?" Shortly after notifying clients of this, Darden announced a dilutive acquisition of Yard House USA, Inc., which in our view will only complicate the issues the company is experiencing.
The acquisition highlights one of the issues that may be causing the recent underperformance and may represent, at least in part, an example of a company growing when perhaps focusing on the core business might better drive shareholder value. Time will tell, but we were surprised by some of the initial details.
- Acquiring Yard House USA, Inc. for $585 million in cash ($555 million after tax savings)
- Yard House offers American cuisine and has grown to 39 restaurants in 13 states since its launch in 1996. AUV’s are $8.4 million. Implied price paid is $15 million per store or 1.8x sales
- FY13 EPS outlook revised to account for transaction-related impact of $0.03-0.05
- FY13 Sales growth expected to be 9-10% versus 6-7% prior guidance
- Share repurchases now expected to be $50 million in FY13 versus $200-250 million prior guidance
We expect the company to add leverage to the balance sheet (and stop buying back stock) to finance the acquisition which appears to be at a growth premium of roughly 17x and 13x 2012 EV/EBITDA and 2013 EV/EBITDA, respectively.
“Too Big to Perform” is a turn of phrase that our CEO, Keith McCullough, loves to use to describe the mega-banks that make up the Old Wall. We think Darden is in danger of falling into that same category within the restaurant space. While the company generates ample cash flow (to make expensive acquisitions like the Yard House), the reasons to own this stock, in our view, are increasingly moving away from fundamentals such as market share and toward a blinkered perspective on "hitting numbers" and the “growth” mantra of senior management.
The acquisition of the Yard House only amplifies the issues we see the company is facing over the next three years. Yard House may be one of the country’s best positioned casual-dining concepts; its upscale position with consumers highlights one of the competitive disadvantages Olive Garden and Red Lobster are currently burdened with. The guest counts data at Darden’s two largest brands tell a sad story; both chains require extensive changes to begin the process of growing again.
Our conference call next Thursday will address all of this in greater detail. Topics include, but are not limited to;
- Management (and executive compensation) is laser-focused on growth. We think that is a problem when the company's two largest brands are struggling to gain any sustained traction with consumers
- Blind dedication to a "rate of growth" target independent of a changing operating environment can be a fatal mistake. Growth can mask issues, particularly of the transient variety, but the issues at Olive Garden and Red Lobster are long-standing and require significant attention.
- Inconsistency in the company's rationale behind its top-line strategy at Olive Garden. We are not deducing a clear message from the company regarding its ability to stop the sustained traffic losses at Olive Garden.
- Massive CapEx demands. The company is facing a prolonged period of investment into its largest chain. Getting this effort started in earnest is taking more time than many were expecting.
- The margin gap between Darden and some competitors offers clues as to how management could seek to bring about sustainable positive momentum in their largest business.
Howard Penney
Managing Director
Rory Green
Analyst
