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$DRI - RESTAURANT IMPOSSIBLE?

Takeaway: “Good morning, Mr. Otis. Your mission, should you choose to accept it, involves the recovery of lost customers from your core business"

This note was originally published December 11, 2013 at 08:21 in Restaurants

“Turning around a failing restaurant is a daunting challenge under the best of circumstances.”

- Robert Irvine, Restaurant Impossible on the Food Network

 

To steal the structure of the opening line from Mission Impossible: “Good morning, Mr. Otis.  Your mission, should you choose to accept it, involves the recovery of lost customers from your core business Olive Garden.”

 

$DRI - RESTAURANT IMPOSSIBLE? - mi8

 

Needless to say, fixing Olive Garden is going to be a daunting challenge.  Will the introduction of a burger and fries to the menu make the challenge more or less daunting?  In our opinion, it may very well be the final straw that breaks the camel’s back and drives shareholders to the tipping point.

 

In March 2013, our call was that an activist investor would get involved to make the necessary changes at Darden; many of which we’ve been chronicling.  Since Barington filed on the company, nearly every research report written about Darden has focused on a breakup/real estate analysis and valuation.

 

None of these notes, however, focus on fixing the core business – Olive Garden.  We believe the biggest upside in the stock today would come from the successful turnaround of Darden’s most important franchise in the portfolio.  Yet, management has not even begun to outline a cohesive strategy to fix Olive Garden.

 

DRI will report 2QFY14 results on December 20th.  This call will be the most important call of CEO Clarence Otis’ career.  His choice of direction will determine if a dramatic shift in strategy is pursued at Darden to provide the necessary focus in order to achieve significant increases in shareholder value, or if the company will continue with the status quo.  As we see it, the company could push forward in one of three different directions:

  1. Adopt the Hedgeye or Barington model of breaking up the company. 
    • This strategy is intended to significantly increase shareholder value.
    • It would not be unlike what McDonald’s successfully accomplished over a decade ago by focusing on its flagship brand to build enormous value, and spinning off Chipotle, Pret a Manager and Boston Market, each of which also achieved significant increases in value due to a newfound focus.
    • Brinker has also recently achieved strong success with Chili’s in the casual dining sector by focusing on this flagship brand, and spinning off several of its smaller brands.
  2. Throw shareholders a bone by making another small cut to its growth capital expenditures.
  3. Do nothing and push forward with the current flawed strategy.

On some level, we believe the case for significant change at Darden could be strengthened when the company reports 2QFY14 results.  An earnings miss is very likely.  The street currently expects EPS to come in around $0.22, but we are modeling somewhere between $0.12-$0.15.  Despite the string of recent disappointments, we could see management digging their heels in and sticking with the “change nothing” philosophy.

 

$DRI - RESTAURANT IMPOSSIBLE? - ol9

 

Their overall strategy is uncertain.  What appears certain, however, is that we may not hear a comprehensive nor compelling plan to fix Olive Garden on this earnings call.

 

Olive Garden is a brand with tremendous future value if it were in the right hands.  Olive Garden is no longer the “Italian” brand that made it so successful.  If you recall, the brand was on the brink of extinction back in 1994, before it experienced an Italian Renaissance.  This revival led to 57 consecutive quarters of same-restaurant sales increases and consistent margin improvement, leading to accretive value creation and substantial incremental value for all Darden shareholders.

 

Unfortunately, the brand has gone so inexplicably and destructively off course since this "industry leading performance."  Once again, Olive  Garden has moved so far away from its core vision of “Genuine Italian Dining,” to the point where it now feels more like an “Italian Applebee’s.”  And this was before Olive Garden introduced a burger and fries to the menu!

 

Olive Garden is out of touch with the consumer base in aggregate, but has particularly lost its relevance as it pertains to Millennials.  Where is the vision for this brand?  Is it reasonable to believe that Millennials want 1990’s style Americanized food that is fried, overly stuffed with cheeses, covered in cream sauce and served with overcooked pasta?    

 

And now on the heels of a “Buy One, Get One Free to Take Home” promotional offer, the recent roll-out of hamburgers will most likely turn out to be an act of desperation, and ultimately yet another mistake in a series of ill-advised decisions.  The idea that this will lead to incremental customers is nothing short of facile, a futile hope that a burger and fries will recoup the lost authenticity of the concept’s roots, and a hope that the shine of a hamburger will blind the customer to the fact that there is a lack of progressive thinking anywhere in the company.  There is an overall sense of fear and confusion that has led to a significant decline in consumer acceptance.

 

Olive Garden needs a talented team that can bring innovation back to the company.  It needs “fresh eyes” that are forward looking to create positive change.  It needs improved, more authentically Italian food.  It needs leadership that will ensure consistency of execution to deliver the required financial results on an on-going basis.   

 

Olive Garden is still a large and well-known brand.  It once had a crystal clear and compelling vision that was executed flawlessly to achieve the largest turnaround in casual dining history.  This performance can be realized again with the right team in charge.  Shareholders deserve better.

 

Restaurant impossible will be possible with the right vision, the right leadership, and a management team that can look ahead of the legacy issues plaguing the company!

 

Howard Penney

Hedgeye Managing Director/Restaurants Sector Head

 

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Inflation: It's Back!

Takeaway: Monetary policy has consequences.

Inflation is essentially antidemocratic

-Ludwig von Mises

 

It's back!

 

After bottoming in mid-November, one proxy for global inflation (CRB Commodities Index) has put in a big +3% move off the year-to-date lows (the CRB Index was down -8% year-to-date on the lows, fueling real-consumption growth).

 

Inflation: It's Back! - inflation 500

 

Almost every major economic region (other than Europe because they have #StrongCurrency) will see inflation pickup sequentially in Q1 verses Q4.

 

Yes – monetary policy has consequences. More to be revealed.

 

Inflation: It's Back! - Venezuela

 

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Budget Deal: Pigs Fly In Washington?

Takeaway: There is some (potentially) positive and negative news for the ailing U.S. Dollar as flying pigs descend upon Washington.

This note was originally published December 11, 2013 at 11:30 in Macro

Budget Deal: Pigs Fly In Washington? - pig

 

For the 99% of Americans who fail to find the vagaries of federal budget accounting and the interminable tragicomedy that is bipartisan budget negotiations scintillating, the following link provides a summary review of sequestration and the key provisions/budget impacts  >>    SEQUESTRATION 2014: WHAT'S THE IMPACT AGAIN?

 

Below we provide a quick update on how the emergent accord between Representative Ryan and Senator Murray impacts the numbers.

SEQUESTER RELIEF  

Late yesterday we got the latest (prospective) chapter in the budget debate and ongoing evolution of the Budget Control Act – the 2011 legislation which defined discretionary spending levels over the balance of the decade.   The crux of the budget deal – ‘sequester relief’ via higher spending - is highlighted in the following table. 

 

Summarily, the agreement proposes to raise spending levels by a combined $63B over FY2014 and FY2015.  It would also provide for a net deficit reduction of $22.5B over ten years, stemming primarily from higher user fees (airlines), increased pension and benefit expenses for federal workers, and a 2Y extension of Medicare payment cuts.  

 

Budget Deal: Pigs Fly In Washington? - drakepiece1

Dollar Bearish (kinda), Consumption Bullish (maybe):

In isolation, a budget agreement calling for higher spending is dollar bearish on the margin.  However, to the extent that increased fiscal policy clarity pulls forward the tapering timeline, a multi-year accord could be viewed as a positive for the currency. 

 

On balance, and if the Fed is, indeed, data dependent, the investment conclusion is somewhat equivocal.  We’ll continue to let the market act as arbiter, using price as our signal.  Investors have been net sellers of dollars for 5 consecutive weeks and, as it stands currently, the dollar remains broken on both TREND and TAIL durations with the next level of TRADE support at $79.67 on the DXY.   

 

In the intermediate term, higher federal spending offers some potential upside to consumption growth.  As we’ve highlighted (HERE), government sourced income has been a discrete drag on aggregate personal and disposable income growth as sequestration/furloughs and ongoing federal employment loss have driven negative income growth for ~17% of the national workforce. 

 

If the decline in federal employment bases and government salary and wage growth goes positive (against easy compares) in 2014, consumption growth could see some moderate upside. 

 

Budget Deal: Pigs Fly In Washington? - Government Drag

 

Christian B. Drake

Associate

 

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Budget Deal: Pigs Fly In Washington? - cartoon

 


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"SEQUESTER RELIEF": REVIEWING THE SETUP (CORRECTED)

For the 99% who fail to find the vagaries of federal budget accounting and the interminable tragicomedy that is bipartisan budget negotiations scintillating, the following link provides a summary review of sequestration and the key provisions/budget impacts  >>    SEQUESTRATION 2014: WHAT'S THE IMPACT AGAIN?

 

 

Below we provide a quick update on how the emergent accord between Representative Ryan and Senator Murray impacts the numbers.

 

 

SEQUESTER RELIEF  

Late yesterday we got the latest (prospective) chapter in the budget debate and ongoing evolution of the Budget Control Act – the 2011 legislation which defined discretionary spending levels over the balance of the decade.   The crux of the budget deal – ‘sequester relief’ via higher spending - is highlighted in the following table. 

 

Summarily, the agreement proposes to raise spending levels by a combined $63B over FY2014 and FY2015.  It would also provide for a net deficit reduction of $22.5B over ten years, stemming primarily from higher user fee’s (airlines), increased pension and benefit expenses for federal workers, and a 2Y extension of Medicare payment cuts.  

 

"SEQUESTER RELIEF": REVIEWING THE SETUP  (CORRECTED) - Sequestration Budget Deal 3

 

Dollar Bearish (kinda), Consumption Bullish (maybe):

In isolation, a budget agreement calling for higher  spending is dollar bearish on the margin.  However, to the extent that increased fiscal policy clarity pulls forward the tapering timeline, a multi-year accord could be viewed as a positive for the currency. 

 

On balance, and if the Fed is, indeed, data dependent, the investment conclusion is somewhat equivocal.  We’ll continue to let the market act as arbiter, using price as our signal.  Investors have been net sellers of dollars for 5 consecutive weeks and, as it stands currently, the dollar remains broken on both TREND and TAIL durations with the next level of TRADE support at $79.67 on the DXY.   

 

In the intermediate term, higher federal spending offers some potential upside to consumption growth.  As we’ve highlighted (HERE), government sourced income has been a discrete drag on aggregate personal and disposable income growth as sequestration/furloughs and ongoing federal employment loss have driven negative income growth for ~17% of the national workforce. 

 

If the decline in federal employment bases and government salary and wage growth goes positive (against easy compares) in 2014, consumption growth could see some moderate upside. 

 

"SEQUESTER RELIEF": REVIEWING THE SETUP  (CORRECTED) - Government Drag

 

Christian B. Drake

Associate

 


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