Keith added a short position in Darden Restaurants (DRI) to the Hedgeye Virtual Portfolio today. As we discuss below, our fundamental view on the stock, along with recent industry data, corroborates with his quantitative view of the stock. For our recent Darden Black Book, please email us.
Quantitative Setup
Darden is immediate-term TRADE overbought with TREND support at $51.56. If that line does not hold, the stock will likely drop to the low $40’s in short order.
Fundamental Perspective
Our view on Darden is predicated on the company’s focus on growth at a time when its two most important revenue drivers (Olive Garden and Red Lobster) are producing sustained traffic declines. Multi-brand restaurant companies typically historically encounter difficulty when attempting to grow brands with weak fundamentals. The company is using its balance sheet to grow what are currently poorly performing concepts. Should the dividend come under threat, we believe that could force an entire constituency of shareholders to reconsider their positions. Below are some of the concerns we have about Darden from a fundamental perspective:
- Anemic sales trends at Olive Garden, Red Lobster
- Focusing on growth rather than remedying issues at OG & RL
- Capex growth outstripping sales growth
- The company is burning cash
- Maintaining the dividend, growth profile, and operating margins not possible with current fundamentals
- Difficult macro outlook is not encouraging
- Absent a resurrection in sales trends, we believe downside in stock is significant (to $43)
Industry Data Shows No Resurrection in Sales
We are non-believers in an Olive Garden or Red Lobster sales resurrection. Industry data is indicating that no such sales recovery is happening.
Malcolm Knapp released his estimates for July's Knapp Track Casual Dining Same-Restaurant Sales Index. Comparable sales grew 0.6% versus July '11 while traffic declined -1.8%. On a sequential basis from June, July’s estimates imply a sequential deceleration in two year average trends of -80bps and -45bps for comps and guest counts, respectively. This is not encouraging for Olive Garden or Red Lobster, both of which have had difficulty growing guest counts versus the industry over the last few years.
The Black Box Intelligence casual dining same-store sales data also implied a slowdown, on a sequential basis, in growth from June to July. Comparable sales growth in July was 0.8% while traffic declined -1% year-over-year compared to the -0.6% slowdown in June.
Our takeaway from the Knapp Track data is that a sales pick up at Olive Garden and Red Lobster is unlikely. The Black Box data seems to be confirming this, from an industry standpoint, and we remain bearish on Darden at this price.
Howard Penney
Managing Director
Rory Green
Analyst