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The following is a brief summary of why we want to be LONG DRI at these levels.  We will be hosting a black book conference call entitled "DRI: The Unthinkable Long Case" on Thursday, March 14th, at 1:00pm EST. to talk through in more detail the summary thoughts below.   

By way of background, we initiated a short call, “The Unthinkable Short Case”, on DRI on July 19th, 2012.  The following is a recap of our prior stance:

  • Accelerated unit growth masking other issues
  • Cash burn was unsustainable
  • Waning ability of Darden to be all things to all people (buyback, dividend, growth, fortress balance sheet)
  • Secular macro headwinds were changing the industry’s operating environment
  • Leverage outlook was set to impede future growth
  • Declining ROIIC

The current setup for the stock looks like this:

  • Stock price depressed but dividend yield highly supportive at these levels
  • Unit growth is being reined in (albeit modestly)
  • Secular nature of industry change being acknowledged
  • Guidance is for EPS to decline 11% in FY13 and little-to-no earnings growth in FY14
  • Promotions underperforming
  • Underinvestment in Olive Garden showing in results
  • LongHorn no longer a jewel in the crown
  • Significantly lagging peers in international expansion efforts
  • Self-evident that managing portfolio is proving difficult

But on the bright side:

  • The investment community has become far more bearish on the stock
  • Room for improvement with the “Big 3” (Olive Garden, Red Lobster, LongHorn) same-restaurant sales growth is lagging the benchmark (Knapp Track) by 340 bps
  • Management is outwardly admitting past mistakes and the reality of the environment it is operating in
  • Potential changes within the C-Suite could greatly improve the company’s prospects – can current roster turn things around?

In the end the Low-Hanging, Bountiful, Fruit are too sweet not to harvest

  • Tremendous cash flow potential
  • Huge real estate value
  • Non-core, under-utilized assets that can be sold at rich valuation
  • Core assets represent a classic reorganization opportunity
  • Market’s valuation of the whole is far below what we believe the sum of the parts would represent in a reorganization/breakup
  • G&A rationalization opportunities
  • Buying the stock today, an argument can be made that investors get Olive Garden  for free!

We see the current setup as a "win-win" for the stock:


Howard Penney

Managing Director

Rory Green

Senior Analyst