THE HEDGEYE EDGE
Brief background: Darden is the world’s largest full service restaurant company. The company operates 2,138 restaurants in the U.S. and Canada, including 828 Olive Garden restaurants, 705 Red Lobster restaurants, 430 LongHorn Steakhouse restaurants, 49 Capital Grille restaurants, 44 Yard House restaurants, 22 Bahama Breeze restaurants, 31 Seasons 52 restaurants and 12 Eddie V’s Prime Seafood restaurants. In addition, the Company owns a significant amount of real estate including the land and building on 1,048 properties and the buildings on 802 ground leases.
Darden’s management team has been under a firestorm of criticism lately for poor performance, relative to its peers, over the past five years. Hedgeye Managing Director Howard Penney has been at the forefront of this activist movement since early 2013, when he first identified the potential for unleashing significant value creation for Darden shareholders.
Less than a year later, it looks like Penney’s plan is coming to fruition. Google “Howard Penney” and “Darden” and you will see myriad recent stories in the Wall Street Journal, Barron’s and others cataloging his efforts.
Activist investor Barington Capital Group LP disclosed a 2.8% ownership stake in the Company this past October. A couple months later, they released a full-report detailing the need for change at Darden. On December 19, in a press release prior to the Company’s 2QFY14 earnings call, Darden management announced its strategic plan to increase shareholder value. This plan (which included spinning off Red Lobster) fell short of expectations. Several days later, Starboard Value, a larger activist, disclosed a 5.6% stake in the Company as well as its intentions to push for further changes at Darden.
INTERMEDIATE TERM (TREND) (the next 3 months or more)
Darden has been hampered by the performance of its two biggest brands, Olive Garden and Red Lobster. Olive Garden is a strong brand that has lost its way. Red Lobster is a disaster and Penney argues that spinning off the flailing concept may actually end up hurting the brand more than it helps. That being said, Darden still has several issues that could continue to hamper performance over the intermediate-term. Despite any short-term inconsistencies, there is still significant shareholder value to be had. With activists at the forefront, this could happen fairly soon.
LONG-TERM (TAIL) (the next 3 years or less)
Darden is a name you want to hold over the long-term.
Penney (who clearly thinks the business is grossly mismanaged and in need of a major overhaul) believes these activists will drive material change at Darden. This would obviously be extremely bullish for shareholders. In his opinion, the greatest value creation would come from getting better senior management in place, cutting excess general and administrative spending, and turning around the company’s crown jewel, Olive Garden.
Bottom line: If Barington’s changes are implemented, that would value Darden’s stock between $71 to $80 per share. If Howard Penney’s plan to fix Olive Garden is implemented, there is even greater upside in the stock.