Takeaway: Barington's proposal is not the solution. Here's our take:

We are pleased to see Barington is putting pressure on Darden’s management team to increase shareholder value.  Darden is a company with many strengths but, as we and others have demonstrated, the company is grossly underutilizing its considerable assets. The financial results of the company have, in our view, long been a leading indicator of a need for management to rethink its approach to creating shareholder value.  


Yesterday, we read Barington’s letter to the Board of Directors of Darden calling for the company to essentially create two separate companies – a mature brands company and a higher-growth brands company.  While we tend to agree with Barington on a number of aspects in their assessment of the company, we do not believe that splitting the company into two is the optimal course of action.  Furthermore, we believe the Barington plan stops short of addressing the critical issues at Darden.


Under the Barington proposal, splitting the company into two does not address the issue of current Chief Executive Officer, Clarence Otis.  On this point, we are very clear – Otis needs to resign.  While implicit in their proposal is the notion that Mr. Otis need to resign, they are not demanding it.  Therein lies their biggest problem.  We don’t believe Mr. Otis will resign, so the company will likely continue to dig in and resist the Barington proposal. 


This potential resistance by the company is imbedded in their hiring of Goldman Sachs to evaluate the Barington proposal.  In the past, the company has told us that Goldman has previously looked at different alternatives for the company’s real estate and merely suggested it “do nothing.”


Considering this, we’re very skeptical that Goldman will issue a report to Darden telling the Chairman of the Board that he needs to split up the company.  In our opinion, this hiring will simply provide management with air cover against a 3% shareholder with the hope that they will go away.


With Goldman providing analytical support, we believe the management team of Darden will continue to dismiss the Barington proposal and delay the inevitable.  We are firmly of the view that a larger player will arise as an activist to affect the changes needed at Darden.


We believe the company should take a multi-step approach to realize the inherent underlying value in Olive Garden and its other assets:

  • IMMEDIATE-TERM NEEDS: Appoint a new Chairman and CEO and realign the operational side of the business around a proven team. Bring on new board members aligned with the vision of the new company.
  • INTERMEDIATE-TERM NEEDS: Identify potential cuts from the company’s cost structure and restructure the brand portfolio around a streamlined theme; potentially unlock the value embedded in its many owned restaurant properties.
  • LONG-TERM OPPORTUNITY: Aggressively franchise international markets; reshape the company’s ownership structure of the remaining restaurant base and develop key brands that can participate in the growth of the fast casual segment.




  • As we have said many times before, the company is too big and too complex to perform.
  • Darden can deliver significantly stronger returns for shareholders.
  • If possible, the Company should unlock its significant real estate value.
  • Darden has a bloated cost structure, evident by their highly inflated G&A.


We touch on all of these points in our Black Book, “Dismantling Darden.”  In reality, these points are now known knowns.  Having read the Barington letter, we are of the view that that their proposal does not go far enough. 




  • The CEO should resign.
  • We don’t believe separating the Specialty Restaurant Group solves the problem inherent in the company today.
  • Red Lobster should be sold or the units re-franchised to an asset-lite model.
  • We believe that Yard House should be brought public.
  • Create NewCo with Capital Grill and LongHorn and bring that company public.
  • We think the Company should be whittled down to its crown jewel – Olive Garden.





The issue with Darden, as Barington has acknowledged, is that the company is too large and too complex.  To be clear, we believe the Specialty Restaurant Group is a microcosm of what makes Darden so dysfunctional.


First, it is simply a conglomeration of different brands that appeal to different cohorts of consumers.  Attempting to execute on a growth plan, when operating under the same infrastructure is extremely difficult.  Each brand needs its own management team in order to effectively manage the brand.  Suffice to say, breaking up Darden into a mature brands company and a higher-growth brands company does not eliminate this problem.


Second, comparable restaurant sales trends within the Specialty Restaurant Group have been subpar for a group of “growth” companies.  Illustrated below, the two-year comparable sales trend has essentially nosedived since FY12.  We have no reason to believe this trend will meaningfully reverse in the near future.


Third, given the company’s proven lack of discipline on investing its capital wisely, we suspect that the company has shown the same lack of discipline when growing the Specialty Restaurant Group.






When something is repeated with enough conviction, and repeated often enough, people will usually come to believe it.  The truth is, the Specialty Restaurant Group is just not that special.  As we have previously said, it does not have the potential for real growth and the concepts aren’t that great – each has its own inherent problems:



Bahama Breeze

  • Not strategic
  • Box too big
  • Too few potential units


Eddie V’s

  • High-end seafood centric menu with limited appeal
  • Limited opportunities
  • Difficult to execute on a large scale
  • Sale or IPO candidate


Seasons 52

  • Its potential has been squandered under the Darden portfolio
  • Box too big
  • Too few potential units as it presently stands
  • Food has been “dumbed” down
  • The brand could be re-configured into a fast casual brand or a much smaller box casual dining brand


Yard House

  • Not strategic
  • Box too big
  • Too few potential units
  • IPO candidate


As we said before, we also believe that LongHorn Steakhouse and The Capital Grille should be a completely separate company.  In our opinion, the company could trade at a premium to the group. These could be kept as part of NewCo for a period of time, before it is spun off as its own company.




As it stands, the company’s problems stem from the implementation of a long-term strategy, in which the current management team failed to recognize the beginning of a secular downturn in the industry back in 2008.  The Darden executive leadership team is too far removed from the restaurant operations, which is one of the reasons they are most likely incapable of building Darden’s brands.


Despite secular casual dining dynamics, the company continues to stubbornly pursue a “growth agenda,” which includes opening units with a blatant disregard for return on incremental capital in addition to dilutive acquisitions.  As a consequence, the company has essentially starved its crown jewel, Olive Garden, of the capital necessary to maintain its competitive position.


We cannot emphasize enough the need for Darden to appoint a new Chairman and CEO and realign the company around a proven operating team.  The company should also seek to bring on new board members aligned with the vision of the new company.





We believe Darden should be whittled down to the crown jewel: Olive Garden.  The successful attainment of this status, and a properly motivated team of operators would undoubtedly drive significant shareholder value. 


The overarching objective is to restore the Olive Garden brand to its rightful position as the most dynamic concept in the casual dining segment of the restaurant industry. The successful attainment of this status would undoubtedly drive shareholder value.  Olive Garden represents 44% of the company, nearing $4 billion in annual sales, and has the potential to exceed $5 billion with strong profitability.


Under the leadership (or lack thereof) of Clarence Otis, Olive Garden has lost its way. It has moved away from the genuine Italian dining vision, and has lacked any innovation to stay ahead of or even keep up with changing consumer conditions in the marketplace. The result: Olive Garden has experienced comparable-restaurant guest count declines for 51 of the past 69 months.


Our plan of action below offers a compelling solution that would help Darden, and specifically Olive Garden, regain its stature as one of the premier casual dining chains in the business.  The most important pillar for the new Darden is the formation of a closely aligned and well-functioning team of qualified, talented, experienced, and motivated personnel that would come together to execute on the following business strategy:


  • Superior financial results come from inspired, principled leadership
  • A clear, focused vision
  • A consumer-driven culture
  • Innovation
  • Measurable operational excellence
  • Distinctive brand consistency
  • Appropriate cost controls


Let’s be clear: People are not suddenly uninterested in eating Italian food. While there is a definite headwind in the casual dining restaurant industry, Italian food is universally popular. It’s just Olive Garden’s Italian food that people don’t want. Market research evidence indicates that, unlike the Bar & Grill and Steak segments, the Italian category is still underdeveloped.


The most important question is how does one peel off Olive Garden in the most lucrative way for shareholders?


In our opinion, this can be accomplished by fostering an environment that enables building a great company for the future.  Once this environment is established, management should look to acquire or develop a concept to be the pioneer in an undeveloped, yet very attractive, segment of the fast casual restaurant category – Italian. 


The most successful restaurant companies have strong beliefs that are centered on two things: food and people.  Over the long-term, success is driven by constantly leading and inspiring people in ways that allow for continuous brand and food innovation. Darden Restaurants has rested on its laurels over the last eight years, while neglecting the critical elements that are essential parts of the recipe for a successful restaurant company.


As we have worked through the process of dismantling Darden, in the end we would not want to operate Red Lobster.  The main problem is the lack of a brand strategy since the 1990’s. In today’s environment, the problem with featuring a seafood-centric menu also has its challenges.  At this point, it’s not worth trying to grow the brand.  A key priority of the ‘dismantling’ plan is how to best dispose of this brand or refranchise all the stores.


In the coming weeks, we will be offering a more detailed look at Olive Garden, including what went wrong and possible solutions that would improve profitability and restore the luster to the brand. 




We are pleased Barington is pushing management to make significant changes at Darden.  However, we don’t believe the current management team will make the necessary changes.  The main challenge here is how to best rebuild Olive Garden with a new management team, while dismantling the other operating companies.




Howard Penney

Managing Director


[video] Keith's Macro Notebook 10/18: SPY, DAX, USD

PODCAST: McCullough Guns Blazing

Hedgeye CEO Keith McCullough is back from Europe and comes out guns blazing on this morning's conference call with his latest market thoughts.


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Takeaway: Earnings miss, but strong revenue growth, traffic growth, and same-store sales acceleration push CMG higher.

We continue to believe that Chipotle is one of the best positioned growth companies in the restaurant industry.  Revenues and same-store sales beat by 80 bps and 150 bps, respectively, which helps allay any concerns over the earnings miss.  All told, the company reported a fairly strong 3Q in the midst of an unfavorable environment.  While rising food costs are a point of contention, we believe management will be able to appropriately offset this headwind in the coming quarters with minimal price increases. 


Chipotle, is one of the best managed restaurant companies in the space and we are confident that they will be able to mitigate any oncoming margin pressure.  Last quarter, we wrote that CMG was well-positioned for the balance of the year and, after reviewing 3Q13 results, we have little reason to believe this will not be the case.  For now, we expect 4Q to be another strong quarter.



What We Liked

  • Revenues: $826.9m, beat consensus estimates by 80 bps, +18% y/y
  • Same-store sales: +6.2%, beat consensus estimates by 150 bps, +70 bps sequentially
  • Traffic was positive in what was a forgettable quarter for the restaurant industry
  • CMG transactions accelerated sequentially during the year from 3% in 1Q13 to 4.5% 2Q13 to 6.2% in 3Q13 and positive trends will continue in 4Q
  • $103m left on their share buyback program
  • Targeting 180-195 new restaurant openings in 2014
  • Opening sales volumes are very strong – $1.6-1.7m
  • Plan to take 3-5% price in 2014, to offset any food inflation and the cost of removing GMOs from their menu; the timing of the price increase is unknown, although management hinted that it would be mid-2014
  • They continue to have a strong operational focus, as throughput increased by 5 transactions during the peak day hour in the quarter
  • It appears their unique marketing efforts, including the “Skillfully Made” campaign, are resonating with consumers
  • Sofritas have been impressive and should bring in incremental customers – they account for over 4% of sales in the restaurants that carry it
  • They continue to roll out the catering program, which has notable potential
  • They are not rushing their international development and will not meaningfully accelerate growth until they have properly “built the brand”
  • Likewise, they are not rushing the development of their Shop House brand, where early results have been encouraging


What We Didn’t Like

  • EPS of $2.66, missed consensus by 433 bps, +17.2% y/y
  • Food costs were 33.6%, +100 bps y/y
  • Restaurant level operating margins were 26.8%, -60 bps y/y
  • Operating margins were 16.6%, -20 bps y/y
  • Same-store sales decelerated -130 bps sequentially on a two-year basis
  • Guided to low single-digit same-store sales in 2014 – although this excludes any menu price increases
  • Guided to food costs in the 33.5-34% range for the next several quarters, excluding the cost of removing GMOs and any potential price increase  




Howard Penney

Managing Director


What's New Today in Retail (10/18)

Takeaway: HBI shows MFB accretion guidance is low. UA takes a page out of NKE's playbook. KMart turns to Nicki Minaj to halt sales decline. HIBB M TOY



VFC - Earnings Call: Monday 10/21 8:30 am




HBI - US: Hanesbrands to axe half of Maidenform's workforce



  • "...Hanesbrands will lay off nearly half of Maidenform Brands' 1,330 staff worldwide as part of its US$583m merger with the rival intimate apparel maker."
  • "...Maidenform's New Jersey corporate operations will be consolidated into Hanesbrands' headquarters in Winston-Salem and its Manhattan offices by the end of 2014."
  • "Most of the 300 positions at Maidenform's headquarters will be phased out over the next year, but Hanesbrands said many of the sales, design and merchandising personnel will remain with the company."


Takeaway: I guess we know why they bought MFB -- for the brands, and nothing else. This synchs with our view that this deal will be far more accretive than the company guided towards.


UA - Under Armour challenges techies to develop future products



  • "The sportswear maker will begin hosting innovation challenges twice a year — instead of annually — for entrepreneurs outside Under suggest ideas for new innovations the company can incorporate in future product designs. Under Armour began holding the contests annually three years ago, and the results of the first challenge will hit the market in 2014."
  • "The company is searching for developers who can help build on the technology in Armour39, Under Armour’s fitness tracking device that debuted in March. Finalists will present their concepts before Under Armour executives at a Future Show in April 2014."


What's New Today in Retail (10/18) - chart1 10 18


Takeaway: Taking one right out of Nike's playbook -- again (as they should). Note that Nike held a major competition this summer for people to come up with new commercial product to elevate Nike's technological platform and marry with marketable product.


M - Macy’s strategy for Black Friday sales uncovered when ad leaked



  • "Macy’s Inc. this week tried to titillate shoppers when it dangled a sample of what shoppers can expect when it opens stores at 8 p.m. for the first time ever on Thanksgiving day, but it seems its entire 49-page Black Friday deals ad now has been leaked, in perhaps the earliest ever such leak for a major retailer."


What's New Today in Retail (10/18) - chart2 10 18


Takeaway: They make it sound like it was a leak…but sounds to me like it was intentional.


KER - Gucci Awarded $144.2M Against Online Counterfeiters



  • "Gucci America Inc. on Wednesday was awarded $144.2 million in damages by a federal district court in Fort Lauderdale, Fla., against several organizations engaged in an online counterfeiting scheme."
  • "The federal court also ordered the immediate surrender to Gucci of 155 domain names used in the counterfeiting operation."


Takeaway: The domain names are enforceable -- and therefore are history. But KER will never see a dime of the $144mm.


HIBB - Hibbett Sports Announces Transition Plan for Mickey Newsome 



  • "Hibbett Sports, Inc. announced that effective Feb. 2, 2014, Mickey Newsome will transition from his current position as executive chairman and employee of the company to non-executive chairman. The company also announced that Jeff Rosenthal, president and chief executive officer, has been appointed to the board of directors, effective immediately, thereby increasing the size of the board to ten members."


Takeaway: HIBB might be a tiny company, but Newsome is a major dominant force. Life without him will be a definite change for HIBB.


SHLD - Nicki Minaj Launches Fashion Line for Kmart


  • "Minaj launched a new clothing line for Kmart and The Nicki Minaj Collection includes such items as color block skirts,  bandage dresses, deconstructed jean jackets and galaxy print bomber jackets."
  • "The new collection by Minaj...has items that range from $3.99 to $37.99."


What's New Today in Retail (10/18) - chart6 10 18


Takeaway: Nicki is definitely an influencer, but does her fan base shop at K-Mart? This is a binary event for SHLD, but the upside potential  is greater than the downside risk.


TOYS - No Joy in Toys 'R' Us Land



  • "The problems have their roots in a $6.6 billion leveraged buyout in 2005 that piled on the debt and left it beholden to three investor groups—Bain Capital Partners LLC, KKR & Co. and Vornado Realty Trust —each with differing game plans."
  • "The three had hoped to exit the investment with an IPO a few years ago, but they disagreed over exact timing, according to people familiar with the situation, and the window of opportunity has since closed because of the retailer's steady declines in profit."
  • "Vornado in particular is ready to get out, according to people familiar with the matter. Vornado has written down the value of its holding by $118.5 million. But because the stake had appreciated before the write-downs a year or so ago, the investment is now worth $418 million, roughly what Vornado paid for it."


Takeaway: Interesting article showing the dynamics behind the ownership structure at TRU. Be careful who you partner up with when when buying something.


Bonmarché - Bonmarché prepares stock exchange flotation



  • "Bonmarché, the fashion chain aimed at women over 50, is preparing to float on the London stock exchange in November…"
  • "The retailer, best known for its plus-size ranges, announced on Friday that it plans to sell shares on the Alternative Investment Market next month…"
  • "As well as re-fitting some of its 264 shops, the group is now scouting for new locations and plans to open stores in garden centres, as part of a tie-up with the Garden Centre Group."
  • "Since Sun European Partners took over, the company has earned £9.1m on an income measure that counts earnings before interest, tax, depreciation and amortisation."


Takeaway: Does Bonmarché really deserve to be public?




New Research Uncovers Which Email Promotions Generate the Most Revenue for Online Retailers



  • "...we have released new research today that identifies the types of promotional offers that work best – and when they should be sent – to generate maximum revenue for online retailers. The data was derived from an analysis of 100 million online transactions, 20 million user profiles and 100 email campaigns."


What's New Today in Retail (10/18) - chart3 10 18

What's New Today in Retail (10/18) - chart4 10 18

What's New Today in Retail (10/18) - chart5 10 18


Japan’s August Clothing Imports Up 21.4%



  • "Japan’s apparel imports for August were up in value by 21.4% over the same period last year, an increase to 280,732 million yen. "
  • "By units Japanese apparel imports increased by 2.9% over the same period last year, hitting 371.059 tons, according to government data."
  • "Japan’s apparel imports have increased by both value and volume for five consecutive months…"


Takeaway: The biggest import number we've ever seen out of Japan. Ever is a long time.


E-Commerce Trends in China: By the Numbers



  • " E-commerce sales in Mainland China may be growing, but the actual order submission rate is still just 10 percent and apparel as a segment represents only 9 percent of online sales."
  • "Apparel and accessories represent 80 percent of sales in China through Borderfree’s shopping service. The service allows consumers to buy at an international brand’s site, but with the Borderfree interface that automatically does currency conversions and is in the language of the country where the consumer is located…"
  • "Shirts and tops rank first, followed by dresses, shoes, outerwear, pants and handbags in top categories for sales year-to-date, but when calculated by units sold, more shirts and tops were sold than any other category, followed by dresses, pants, shoes, outerwear and then handbags."
  • "The top brands sold online occupy the luxury space, such as Gucci, Michael Kors, Tory Burch, Giorgio Armani, Kate Spade, Marc Jacobs, Prada and Stella McCartney."
  • "By demographic, 63 percent of shoppers are male, with the average age range for those who did the most shopping online between 18 and 30 and an income range of between 1,000 and 3,000 yuan a month, or $163.16 to $489.48 at current exchange."



One that doesn’t appreciate high growth, high cash flow, and a newfound propensity to distribute cash to shareholders.



LVS posted a great quarter.  We’re very happy with the Macau fundamentals, the stability in Singapore, and potential expansion of gaming in Asia.  Within that favorable industry construct, LVS is nailing it operationally.  The LVS properties yielded up their Mass tables impressively which contributed to higher margins (see the charts in the Quarterly Review section below).  And they’re not done yet.  Table yields have a long way to go and with the company’s extensive room base, cross marketing initiatives, and premium Mass push, LVS is likely to continue share growth in the rapidly growing Macau market.  On the margin and from a stock perspective, we’re probably most excited about LVS’s broadening appeal, growth and dividend investors alike.


LVS announced yet another dividend hike – this time a 42% increase, pulling the yield up to nearly 3% and $300 million in stock buybacks during the quarter.  Meanwhile, leverage remains too low around 1x.  With over $3.6 million in free cash flow next year, LVS could up its yield to a whopping 6% without levering up.  And that cash flow will continue to grow with the opening of The Parisian in late 2015 and continued same-store EBITDA growth.  We have no feel for whether LVS will pay out a special dividend – they could easily do it – but we would prefer continued buybacks and regular dividend hikes.


Valuation is the main push back but with LVS’s combination of growth and cash flow, should we really be concerned with an EV/EBITDA multiple of 13.x (excludes debt associated with Parisian)?  Certainly not, especially when considering that a good portion of LVS’s profits are not taxed (approximately 55%), a benefit that isn’t captured by EV/EBITDA.  Future high ROI projects in Macau (The Parisian), potential developments in Japan and South Korea are also not captured.  LVS should continue to garner more widespread investor appeal with its emerging cash distribution focus (dividend investors welcome) along with the existing growth investors.  We would argue that valuation concerns are of little relevance.



Per usual, we don’t want to recap the entire quarter.  As can be seen in the chart below, LVS beat us quite handily. 




Our focus is on table yields, specifically at Sands Cotai Central and Four Seasons.  These are clearly the two properties with the most upside.  Operationally, LVS is pushing the underpenetrated (for them) Premium Mass segment.  Both Sands Cotai (who will have more mass tables coming in Q2 2014) and Four Seasons made significant progress as can be seen in the following table yield chart.




Table yields should continue to move higher for LVS and drive market share gains in the coming months (probably through year end 2014).     

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