We still see the stock setup as a win-win for investors. Management continues to fall short of the standards we believe the investment community is demanding but equity holders shouldn’t panic.
Win-Win
Holders of the stock can win in two ways:
- Management continues to demonstrate that it cannot effectively manage the business as it exists today, rolling out the red carpet for an activist or group of activists
- Sequential improvement in industry trends should help Darden in 4QFY13.
Conference Call Underscores the Need for Change
In our Black Book outlining our short thesis on Darden, published in July 2012, we highlighted a disconnect between management’s commentary and reality. We described a “problematic line of reasoning in Darden’s quarterly discussion of sales results”. If anything, our rating of management’s grasp on its business has deteriorated further since then. The investment community clearly sees that the strategy being employed by the company is proving ineffective. From our perspective, it seems they are attempting to limit check growth by:
- Introducing promotion to only those that need it
- Betting that there are customers willing to pay more to offset margin degradation
We believe this strategy will prove as ineffective as the majority of the company’s recent efforts. We have seen management struggle to forecast customers’ adoption rate of various promotions over time and do not buy into the “new learnings” idea that is repeated each quarter as a reason why the same strategies will yield different results.
Bottom Line
The company is trying to manage margin without attacking the middle of the P&L. Until we hear management change course, and follow Brinker’s lead, we believe that the company will continue to underperform versus its potential. There is plenty of fat to cut at Darden but it may take an activist for shareholders to reap the rewards of it being shed.
Earnings Recap – Little Surprise Given Preannouncement
Darden delivered a slightly better-than-expected quarter this morning with same-restaurant sales for the blended “Big 3” (Olive Garden, Red Lobster, LongHorn), coming in at -4.6% in 3QFY13 versus -4.5% preannounced in February. Earnings per share for the quarter came in at $1.02 versus the Street at $1.01.
Howard Penney
Managing Director
Rory Green
Senior Analyst
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