Bountiful, Low-Hanging Fruit
Darden’s core concepts, Olive Garden, Red Lobster, LongHorn Steakhouse, account for approximately 90% of the company’s consolidated sales and have average unit volumes of roughly $4.1 million. Chili’s accounts for 83% of Brinker’s sales and produce average unit volumes of $3 million.
On a trailing-twelve-month basis, Darden’s consolidated restaurant-level operating margins are 560 bps higher than Brinker’s. While part of the gap in restaurant-level operating margins can be explained by Darden’s large real estate position, it is interesting to note that Brinker’s operating margins are, on a trailing-twelve-month basis, 100 bps higher than Darden’s. The money Darden saves by not paying rent is being spent on a fat corporate structure. We think that fat can be cut by an activist either by straightforward cost-cutting measures alone or by reorganization or both.
What About Scale?
Darden management has been exalting the efficiency-related benefits of a multi-brand portfolio for years. If that were true, the company’s operating margins would be better. However convincing, or convinced, Darden’s executives may seem when discussing the “economies of scale” of the business model, we do not see it in the numbers.
Cutting SG&A is the best way to achieving the 10-11% operating margins that we believe are within the company’s capabilities. On a trailing-twelve month basis, the company’s operating margins have been running at 7.7%.
We estimate that cutting SG&A by $239mm on an annualized basis, or 28% versus current levels, would bring margins to 10.5%.
In our recent Black Book, we discussed a sum-of-the-parts analysis that suggested a $17 premium to the current share price based on a valuation of the company's chains and real estate. Combining this with the SG&A savings of $239 mm pretax, or $1.40 per share, implies $37 per share of potential upside available if the company is reorganized and SG&A levels are rightsized.
This implies a 75% premium to the current share price.