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