Over the past year, DRI has underperformed the S&P 500 and the XLY by 26.9% and 39.3%, respectively. These numbers make DRI the second worst performing casual dining company, only behind BJRI, during this period.
Since the end of FY12, DRI has lowered its annual guidance 3 times. A consistent lowering of guidance indicates that management does not have a feasible plan to fix the company and, given the current industry conditions, things may be getting worse before they get any better.
Below we run through three signs that suggest management is struggling to fix the company and lead us to believe that they will lower guidance moving forward and could, potentially, announce a restructuring charge:
- Shrimp prices are up +56% YoY
- The company has supply chain issues
- July and August sales trends look to be well below industry trends
Shrimp Prices – Urner Barry’s White Shrimp Index has shrimp priced at around $6 a pound, up +56% YoY and approaching an all-time high. The main culprit: the emergence of a disease that has severely reduced shrimp output in China, Thailand and Vietnam.
Supply Chain Issues – In late June and early July, the FDA linked the outbreak of a rare parasite found in Iowa and Nebraska to a salad mix produced by Taylor Farms de Mexico. This salad mix was served at an undetermined number of Olive Garden and Red Lobster restaurants in these two states.
Since that time, nearly 500 people have been sickened in 16 states, while at least 30 more have been hospitalized. While DRI has not been linked to all the foodborne illness incidents, its initial association with the outbreak was not good news for company. We can only wonder whether all of the DRI cost cutting initiatives, particularly in its supply chain, led to this unfortunate incident.
Sales Trends – DRI’s discounting strategy began to move the needle on traffic in 4Q13, but it came at the expense of margins. We believe there is a potentially disastrous situation brewing in FY1Q14, whereby DRI’s discounting efforts are not having the desired impact on traffic, causing a more severe blow to margins than expected. This scenario, combined with significantly higher food inflation in FY14, leads us to believe DRI could be looking at significantly lower earnings in FY14.
As we have said many times before, DRI is being mismanaged, plain and simple. DRI’s 4Q13 earnings call underscored our argument that the company needs a shakeup in the C-Suite. When approximately $1 billion in annual operating cash is not being put to productive use and a company’s leadership team consistently disappoints, this suggests that they do not have the ability to turn the company around.
That said, we believe DRI’s performance over the past five years has been consistent with that of a mismanaged business and one that will need a massive undertaking to fix. In the end, this may include rationalizing the assets of the business.
Hedgeye’s Take – The sum of the parts is greater than the whole, at Darden, and we believe there is a striking opportunity for an activist to enter the fray, unlock value and, ultimately, benefit shareholders.