DRI - The dividend has become a liability

This note was originally published December 08, 2012 at 08:51 in Restaurants

The recent DRI press release stating the latest disappointment stopped short of dealing with reality. 


A recent note we published highlighted the DRI Annual Report as an important document for investors given the primary takeaway which was: the growth ethos at Darden is an entrenched as ever.  Against a backdrop of sustained traffic declines, it is jarring to read the following sentence: “Our brands have strong individual and collective growth profiles”.   We believe that management has, and is continuing to, set itself up to miss expectations.


Unfortunately, the press release of December 4th did not address the most important issue that the company is facing: excessive growth.


Clearly, in light of the fundamentals at the company’s largest brands, the five-year growth plan outlined in the Annual Report needs to be reevaluated.  The thesis of our Darden Black Book this past summer expressed our conviction that Darden’s continuing acceleration of new unit growth over the past couple of years has masked evidence of secular decline in Olive Garden and Red Lobster.  Knowing what we now know about how FY13 to-date only adds to the need for management to address how its pace of growth can be sustained without further erosion to the financial health of the company.


The message from Darden’s management team highlights the economy as the biggest issue facing the company and, furthermore, sees weakness in trends at its core brands as being transitory in nature.  We have suggested that the longer-term view, as defined by the data, suggests an altogether different story. 


The traffic trends at Olive Garden and Red Lobster clearly are demanding significant action of management.  The economy is undoubtedly a factor but the poor performance of the “Big Two” versus the Knapp Track casual dining benchmark is a clear indication that the company’s sluggish traffic trends are not entirely attributable to the macroeconomic environment.  The data points – traffic trends – that we are pointing to as a primary reference for our thesis are indicative of, in no small part, self-inflicted wounds.


If the company has become dependent on growth as a drug for all ailments, management’s message is not indicating that Darden is facing up to its growth problem.  Stating that the “core brands remain highly relevant to restaurant consumers” can be supported by pointing to the average unit volumes at Red Lobster and Olive Garden as being some of the strongest in the industry.  We believe this statement to be misguided, however, when considering same-restaurant sales trends – a far more relevant metric when assessing relevance to the consumer.


DRI - The dividend has become a liability - red lobster comp detail


DRI - The dividend has become a liability - olive garden comp detail


DRI - The dividend has become a liability - longhorn comp detail


Going back to the very first conference call announcing Clarence Otis as CEO of the company, the pervading theme throughout his tenure has been “growth”.  Acquisitions of LongHorn Steakhouse and, more recently, Yard House, are testament to the unwavering loyalty Darden’s CEO has to his philosophy. 


Now the numbers don’t add up.   The balance sheet is levered up and margins are declining.  The company is not generating enough cash to pay the dividend given the current rate of capex growth.  The dividend has become a liability. 


Will management admit its past mistakes or, at least, change course and slow growth?  Or will reality continue to be ignored?  The earnings call on December 20th will be the first chance for management to face the music.  The sooner they do it, in our view, the better.



Howard Penney

Managing Director



Rory Green

Senior Analyst





Temps and Gas

The AECO spot gas price is trading at a $0.06/MMBtu premium to the Henry Hub spot (in USD). The NYMEX curve has slid since mid-November on a warmer-than-expected start to the 2012/13 winter in the US northeast, but AECO has held firm above $3.25/MMBtu (USD) on cold weather in Western Canada and a swifter fall in supply. 



Temps and Gas - canada



What’s interesting is that weather forecasts currently expect warmer-than-normal temps in the southern US for Jan/Feb/March. Conversely, forecasts call for normal temps on the east coast and a colder-than-normal winter in western Canada for the same time period. As such, expect the differential to remain tight; the $0.06 premium compares to the 2007-2011 average differential for the time-step of a $0.37/MMBtu discount.



Temps and Gas - temp


Industry data is indicating that casual dining restaurant companies saw a sequential uptick in trends in November from October. 


Knapp Track


Casual Dining comparable restaurant sales growth for November 2012 was +0.7% versus -0.9% in October and +0.6% in November 2011.  This is a sequentially better number; the two-year average trend improved by 75 bps month-over-month.


Casual Dining comparable restaurant guest counts growth for November 2012 was -0.9% versus -2.8% in October and -1.6% in November 2011.   The sequential change, in terms of the two-year average trend, was +55 bps.


This number is also sequentially better but, for the broader industry, negative traffic growth is still a concern given the ever-increasing level of discounting casual dining operators are implementing in their restaurants.


We remain bearish on DRI and BWLD.  Our favorite name, on a relative basis, in casual dining is EAT.





We believe that consensus likely remains too bullish on casual dining trends in FY13, given the 2-3% comps that are being projected for the industry, on average, for 1H13. 


The Restaurant Value Spread could be at the beginning of a bottoming process, as the first chart below suggests, but we will be looking to gain more conviction on that when the BLS releases November CPI data on the 14th of December.  If the slope of the line representing the spread does begin to reverse, it would be a marginal positive for casual dining traffic.




CASUAL DINING UPDATE - knapp rvs ttm





Howard Penney

Managing Director


Rory Green

Senior Analyst

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Deflating Commodity Bubbles

One of our big macro themes for back half of 2012 and into 2013 is that the super commodity bubble that’s occurred due to the Federal Reserve’s inflation-inducing policies will deflate. Sure enough, if you look at the chart we offer up below, you can see that the cycle is moving and that commodities are deflating after a massive run in 2010 and 2011. For the record, the CRB Index is down -17.7% since the start of 2Q11 and down another -4.3% quarter-to-date. Interestingly, deflation could act as an economic stimulus of sorts through disinflation in actual consumer and producer prices.


Deflating Commodity Bubbles - select commodities

European Banking Monitor: Momentum Remains Broadly Positive

Takeaway: Globally, bank swaps tightened last week, while sovereign swaps widened. Euribor-OIS is continuing its slow, but steady, rise.

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .


Key Takeaways:


* European Bank CDS: In Europe, swaps were tighter in nearly all banks we track. 36 out of 37 bank swaps tightened. German and French banks saw considerable tightening along with banks from Spain and the U.K. Interestingly, Mario Monti, prime minister of Italy, resigned overnight. All in all, Monti's resignation came as a surprise and may increase uncertainty in Italy and in the Eurozone.   


* Euribor-OIS: The Euribor-OIS spread, a measure that gauges European counter party risk, rose 2 bps last week. 


* On OMTs Reporting: The ECB has stated that Aggregate Outright Monetary Transaction holdings and their market values will be published on a weekly basis and the average duration of Outright Monetary Transaction holdings and the breakdown by country will take place on a monthly basis. There is no indication that the OMTs has been initiated to date.



If you’d like to discuss recent developments in Europe, from the political to financial to social, please let me know and we can set up a call.


Matthew Hedrick

Senior Analyst





European Financials CDS Monitor – European bank swaps posted an impressive rally last week with 36 out of the 37 reference entities we track tighter. Banks in France, Germany, Italy, the United Kingdom and Spain all were notably tighter. 


European Banking Monitor: Momentum Remains Broadly Positive  - 22. banks


Euribor-OIS spread – The Euribor-OIS spread widened by 2 bps to 14.2 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 


European Banking Monitor: Momentum Remains Broadly Positive  - 22. euribor


ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  


European Banking Monitor: Momentum Remains Broadly Positive  - 22. facility

The Global Connection

Client Talking Points

Saving Europe

Europe is back in the spotlight, just in time to distract us from the mess in the United States known as the fiscal cliff. While the 10-year yields on various Eurozone countries are relatively low compared to levels we saw during the summer of this year, global growth continues to slow. France’s Industrial Production growth is down 1.1% for October after a -2.5% drop in September, Italy’s GDP growth is down -2.4% year-over-year for Q3 of 2012 and Japan’s GDP growth is down -3.5% quarter-over-quarter SAAR for Q3 of 2012. For anyone who thought things were peachy keen, think again. Factor in the fact that we’re two weeks away from hitting the debt ceiling and there’s plenty of cause for concern. 

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

New unit openings in China and strength in YRI and US should offset China weakness in 1H13. China SRS growth is sensitive to the economy but new unit growth and ROIIC are likely to be supported by continuing growth of the consuming class in China. Looking at operating income by geography for YUM/MCD/SBUX, we can see that YUM is the most geographically diverse. This is manifest in YUM’s more stable EPS growth and price performance over the last 10 years.


Uncertainty in US from a macro perspective (jobless claims uptick) gives us pause from TRADE perspective although coffee prices will serve as a tailwind going forward. Company is becoming more complex, taking on risk as it acquires new brands. Longer-term, we view Starbucks, along with YUM, as one of the most attractive global growth stories in our space.


Margins are in a cycle trough as the USPS is on the brink. FDX is taking more share in the U.S. and following the recent $TNT news flow we think $UPS is in a tough spot.

Three for the Road


“Your dad's "distribution model" is crumbling.” -@ReformedBroker


“None but a coward dares to boast that he has never known fear.” -Ferdinand Foch


McDonald’s saw a stronger-than-expected 2.4% rise in sales in November. Same  restaurant sales rose 1.4% in Europe, US sales at established restaurants rose 2.5%.