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Darden is being mismanaged, plain and simple.


DRI is scheduled to report 1QFY14 earnings on 9/20 and expectations across the board have been reduced significantly for the quarter.  The only question that remains is: how bad is bad?  The current FY14 EPS consensus estimate is $2.99 on Bloomberg.  We could easily get our model down to $2.50.  And, unfortunately, the company needs to pay a $2.25 dividend, which makes earning anywhere near $2.50 a real problem.


DISMANTLING DARDEN - dri eps v price



We continue to believe 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 benefit holders of the company’s stock.


There have been four times in my career when I have seen a company in desperate need of a major overhaul.  In all four cases, I wrote extensively about the issues, much to the ire of management.  Darden and its problems are no different!


The following companies have undergone major corporate overhauls that have led to significant improvements in shareholder value:

  1. McDonald’s (2002): MCD formulated the “Plan to Win” in 2002, which later became a template for success at Brinker.
  2. Wendy’s (2004): The sum-of-the-parts were greater than the whole!
  3. Starbuck’s (2008): With Schultz back at the helm, SBUX focused on attacking the middle of the P&L and improving the guest experience.
  4. Brinker (2010): Facing an industry in the midst of a secular decline, senior management formulated a plan to win, which entailed attacking the middle of the P&L and driving traffic.
  5. Darden (2013): Will the current management team recognize the need for a major restructuring?

We are of the view that DRI is in a secular decline and, until management makes significant changes, we will continue to see erosion in the earnings power of the company.  We believe it is best to wait for these significant changes to occur before we get more aggressive on the LONG side.



Low-Hanging, Bountiful, Fruit


Looking at the four prior examples of past significant corporate action, it is clear that these companies had similar traits.  Specifically, each company had low-hanging fruit and the potential to create significant value for shareholders.  Many of these are similar to the opportunities we currently see in Darden:

  • Tremendous cash flow potential
  • Huge real estate value
  • Non-core, under-utilized assets that can be sold at rich valuation
  • Core assets represent a classic reorganization opportunity
  • Market’s valuation of the whole is far below what we believe the sum-of-the-parts would represent in a reorganization or breakup
  • G&A rationalization opportunities


DRI’s Biggest Problem – It’s Too Big, Too Complex, To Perform

  • This company has over 2,000 restaurants spread out among 8 separate concepts
  • Olive Garden and Red Lobster account for roughly 75% of total revenues




The Complexity Has Led To A Bloated Cost Structure

DRI management has contended for years that its multi-concept structure creates operational efficiencies.  But, a closer look at the numbers suggests the exact opposite.  The average unit volume of DRI’s big three brands is $3.68, which is 23% larger than the average unit volume of EAT’s core brand, Chili’s.

  • Restaurant level margins for DRI are 32% larger than EAT’s and 17% larger than the average of its casual dining peers

The math is quite simple.  If DRI generates more revenues per store and has higher margins per store than its competitors, then it should generate higher operating profit margins as well.  But, this isn’t the case.  The only real explanation we can find for DRI’s lower operating margins is a bloated G&A cost structure.

  • DRI’s operating margins over the TTM are 7.5%, which is 27.2% below EAT’s and 3.7% below the average of its casual dining peers
  • If DRI were to cut G&A by 200 bps, and achieve 9.5% in operating margins, the company would generate an additional $1.10 in earnings per share






Our Vision Of The New DRI


Below we offer our view of what the new Darden should look like.  We believe the company should be broken up into three segments – Seafood, Steak and Italian.  Yard House should be spun off and taken public and Bahama Breeze should be sold.  This would leave each of DRI’s three operating segments with a large brand, in addition to a smaller one in order to help, over time, improve the growth profile of the company.  Additionally, each company would finally be able to focus and zero in on their operations, which, we believe, would allow for a more streamlined operating structure.







It’s Only A Matter Of Time – Restaurants Are An Attractive Sector For Activists

  • McDonald’s (2006): Real estate was the fulcrum of Bill Ackman’s thesis, but better operating performance, including new management, and capital allocations decisions were the real drivers of returns.  The company sold off non-core assets.
  • Wendy’s (2008): Real estate was, once again, the anchor of the thesis here, but the business was also undervalued.  The company, under the influence of Trian Fund Management’s Nelson Peltz, sold off non-core assets.
  • Applebee’s (2006): Breeden Capital Management threatened a proxy contest at the 2007 Annual Meeting of Stockholders, which ultimately was settled with two board seats being opened up for the activist entity.  The company was sold following a period of lackluster returns.
  • Cracker Barrel (2005): Nelson Peltz, again, held real estate central in his thinking on taking the company private.  In 1Q06, the company’s board authorized the use of proceeds from a sale of Logan’s Roadhouse to fund a modified “Dutch Auction” tender offer for $250mm of the company’s common stock (roughly 35% of common shares outstanding).
  • Cracker Barrel (2011): Biglari Holdings contested two proxy battles, but has failed to secure any board seats.  Pressure from Sardar Biglari led to the replacement of CBRL’s CEO and the stock price has appreciated significantly since BH first took a stake in October 2011, rising from $45 to over $100 a share today.
  • DineEquity (2012): Marcato Capital Management suggested a dividend payment in order to maximize its equity value.  The company announced a $0.75 quarterly dividend and a $100mm share repurchase, which amounted to 8% of equity value.  Richard “Mick” McGuire of Marcato was previously an analyst at Bill Ackman’s Pershing Square Capital Management.


Piecing It All Together

  • The current outlook for DRI is dire and we suspect that 1Q14 results will be a disaster
  • There is no cohesive plan to fix the asset base and address significant inefficiencies
  • As we have seen many times before, continuing deterioration will lead ultimately lead to intervention, in one form or the other
  • Given the current trends, the dividend, which was once an asset, could become a liability
  • We know how this is going to end, the only question is when?



Howard Penney

Managing Director



The KKD management team touched upon each of the three key tenets to our bullish thesis at the C.L. King & Associates Best Ideas Conference this morning.  We continue to have a favorable view of KKD’s international growth opportunity, accelerating U.S. unit growth, and the financial profile of the company.  For a more in-depth analysis of these topics, we suggest you revisit our note “KKD: Room to Run.”


The presentation largely highlighted management’s growth strategy, which includes a plan to expand to 900 international stores and 400 domestic stores by FY17E.  We believe KKD will be able to reach this target and will do so while driving strong financial returns, especially as the smaller format shops begin to resonate with the franchisee community.  Management also acknowledged their commitment to increasing beverages as a percentage of sales mix.  Loyalty initiatives are not expected to provide a lift until calendar 2015.


Although KKD reported 2Q14 results that were disappointing to some, we remain comfortable with our thesis.  In fact, despite a miss on the bottom line, we thought KKD had a good quarter and one that was in-line with our expectations.  The company managed to grow both revenues (+10.4%) and same-store sales (+10%) in the quarter – both impressive numbers, in our opinion.


The one point of contention we hear from some of our counterparts concern difficult same-store sales comparisons on the road ahead.  As everyone already knows, this is true, but, we believe management will be able to weather these difficult comps without ceding much sales momentum. 


Highlighted by the chart below, KKD generates some of the best returns on incremental invested capital in the restaurant space.  This, in addition to its capital-light model and accelerating franchise unit development, should allow for high returns to continue well into the foreseeable future.






Howard Penney

Managing Director


Replay: Podcast and Slides of Energy Drink Conference Call with Dr. Deborah Kennedy

Below are links for the presentation materials and a replay of the conference call we held today with Dr. Deborah Kennedy titled "Are Energy Drinks Harmful?"


Materials: CLICK HERE




The call was very well received and we encourage you to take the time (one hour in length including a Q&A session) to listen to Dr. Kennedy's passion about the health considerations surrounding energy drinks. 


We will also be providing a summary of the call. 


-Matt Hedrick






As expected, the MCD management team did not share much at the GS conference.  The initial comments from the presentation suggest that they believe that the economy is to blame for the difficult sales trends. 


Despite a flurry of recent initiatives regarding new items and menu changes that might give support to some more optimistic forecasts, we remain comfortable with our thesis.  In fact, we’ve had a rather bearish take on this news, as we believe these initiatives could add to the operational complexities of McDonald’s stores.  Please see our recent note “MCD: A Pending Mighty Disaster” for more thoughts on this topic.


When questioned, management brushed aside any complexity concerns surrounding the Mighty Wings limited-time offer, citing their focus on training and hiring initiatives in anticipation of the rollout.  They also appeared excited about a “clever tie-in” with the NFL that should help promote the product.


On Tuesday, MCD reported that sales were solid in Europe despite a very difficult year-over-year comparison (+3.1% in August ’12).  The results benefited from continued strong performance in the UK and Russia, but France also improved. Importantly, France benefited from the Ramadan shift, while the UK benefited from the introduction of Smoothies & Frappes. 


Highlighted by the chart below, McDonald’s introduction of Smoothies & Frappes in the U.S. only had limited appeal and, we can argue, masked a decline in the core sandwich business.







Howard Penney

Managing Director


Don't Get Piggy

Client Talking Points


Japan up a beep (only one down day for the Nikkei so far in September; Up +39.6% year-to-date). China and KOSPI both punch fresh TREND highs, and the two laggards (India and Indonesia) stopped going up after Indonesian FX (Rupiah) has its worst day in three weeks. This is a good spot for a breather for anything you like long side. It's also a good spot to re-short some indices too.


I'm selling my long German Equity (EWG) position on the immediate-term TRADE overbought signal. There’s no fundamental reason to sell it. It’s just called managing the immediate-term risk of a trade-able range. The FTSE and MIB are both overbought within their bullish intermediate-term TRENDs here too.


The S&P 500 is up +3.12% for the month-to-date. Yet another one of the 2013 bear cases bites the beta dust. Meanwhile, oil corrected in a hurry down -3.5% from the highs. The VIX? It's down -18.4% since people sold fear again in August. That’s really the story of the year, fade the fear – but also have the discipline to sell some at the high end of the risk range on the recurring squeezes.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road.


Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks.  T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.

Three for the Road


Mostly every Global Equity market we like is now immediate-term TRADE overbought; dont get piggy



"Time is passing. Yet, for the United States of America, there will be no forgetting September the 11th. We will remember every rescuer who died in honor. We will remember every family that lives in grief. We will remember the fire and ash, the last phone calls, the funerals of the children." -President George W. Bush, November 11, 2001


#RatesRising? It isn't just a USA thing; 10-year Bund is up +40 basis points month-over-month to 2.08%; Gilt is up 56 basis points month-over-month to 3.02%.

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