From the very first conference call announcing his promotion to the post of CEO, Clarence Otis, wanted to make an acquisition. His rational has always been that DRI could add 2-3% points to the top line growth rate. Personally, I never thought he would pull the trigger. I always found that to be counter intuitive to the success the company was seeing. For the first part of this decade, DRI outperformed its competitors with significantly lower revenue growth. DRI's rational pace of new capital deployment was the best in the industry, which allowed the stock to significantly outperform it peers. The company's slower growth rate allowed the company to focus on the existing system, while returning significant amounts of cash to shareholders. In the past we have referred to this as sustainability and DRI was the best in the casual dining class.
- To me, the Rare Hospitality transaction was a game changer. The acquisition gave Clarence his top line growth, but at the expense of capital allocation. This is not to say the Rare deal was bad or a mistake, it just changed how the company deploys its capital, and DRI's stock price has since reflected the fact that it was an expensive acquisition and a poor short-term (1-2 years) allocation of capital. Unfortunately, for DRI, since the acquisition, the world has changed and the U.S. has entered into a consumption recession. For DRI to capture faster revenue growth, it needs to increase its spending on growth capital expenditures. Relative to other alternatives, this has the lowest potential return. So, DRI is accelerating growth at a time when the industry is slowing. On top of that, one of the new growth vehicles is seeing slippage in same store sales and increased commodity costs. That being said, overall, DRI has maintained the best same-store sales trends in casual dining.
- Needless to say, the best thing that could happen to DRI shareholders would be for the company to reallocate how it deploys its capital as a return to more rational capital allocation should again be reflected in DRI's stock price. DRI is one of the strongest companies in the casual dining space and has a rich history of making shareholders money. Clarence needs the RARE acquisition to work, and integrating the two cultures of the company is critical, especially the employees at LongHorn Steakhouse. I believe management will get there. Right now, there is a full court press on getting the integration right.
- From a cost perspective, the company is about two quarters away from lapping the big disaster that caused a significant amount of pain for shareholders. So the two key things we are keeping our EYEs on are signs of improved capital deployment and how happy the employees of LongHorn are!
