DRI REMAINS A “WIN-WIN”

Darden remains one of our top ideas on the long side.

Expectations Unlikely To Be Met

We expect that 4QFY13 results and forward guidance for FY14 are likely to fall short of the investment community’s expectations. Despite this, equity holders should not panic, as we view the stock setup as a win-win for investors.

The “win-win” set-up, to us, looks like this:

  1. 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
  2. Sequential improvement in industry trends should help Darden in 4QFY13

Looking to FY14

DRI is scheduled to report this Friday on 6/21.  While we believe there will be some improvement in sequential sales trends during the quarter, it likely will not be nearly impactful enough to allow management to claim victory.  The biggest news during the quarter was the appearance of Olive Garden’s President Dave George on Jimmy Fallon’s “Late Night” show, on which Mr. George retired the weary Olive Garden slogan, “When you’re here, you’re family.”  We expect President Dave George to take on a larger role on the upcoming quarterly earnings call in order to outline his vision and the future prospects for the Olive Garden.

While management will likely point to the slight recovery in sequential sales trends, we don’t believe they will raise the current guidance of 0-2% EPS growth for FY14.  Highlighted by the same-store sales charts below for Olive Garden, Red Lobster, and LongHorn, street expectations are low for an improvement over the current trends.  Furthermore, the lack of a cohesive turnaround plan suggests that management cannot manage the business as it currently exists.  We continue to believe that major structural changes are necessary in order to fix DRI’s broken business model.

In the event that we are wrong, and sales trends deteriorated during the quarter, shareholders will likely be quick to demand more, potentially spelling the end of the current management team.  While none of the existing shareholders will likely surface as a voice of reason, an activist could emerge to apply pressure for the necessary changes.  Our analysis suggests that at current levels, the breakup value of the stock exceeds the current share price.

 

DRI REMAINS A “WIN-WIN” - olive garden SRS consensus

 

DRI REMAINS A “WIN-WIN” - red lobster SRS consensus

 

DRI REMAINS A “WIN-WIN” - longhorn SRS consensus

 

Howard Penney

Managing Director

Rory Green

Senior Analyst