I’m still stunned by the sheer arrogance of Darden management. It’s been rumored that, shortly following the emergence of activist shareholders, Matt Stroud (VP: Investor Relations) said shareholders had no say in the running of the company. I laughed when I heard that comment, but the truth is he’s right.
The message from Darden management and the Board is fairly straightforward: “As long as we are in office, we get to run the show.” All the activists can do now is turn up the heat and try to replace directors at the upcoming annual meeting. To that end, the deadline for nominating board candidates for this meeting is today. The ultimate outcome, however, will likely not be known until sometime later this year. Until then, we are confident that management will continue to destroy shareholder value under its current operating plan.
Moving forward, management has introduced two or three initiatives that could appease shareholders, but we believe the core value destructive initiatives remain in place:
- The current management team has proven they are incapable of fixing broken brands.
- Carrying on with excessive unit growth – growing the Specialty Restaurant Group is not a value creating strategy.
To be clear, increasing market share in an industry in secular decline by growing new units is a value destructive strategy. According to NPD, visits to casual dining restaurants were at a six year low in the twelve months ending February 2014. Since 2009, casual dining traffic has declined nearly 2% each year, totaling a loss of 7.1 million visits. Meanwhile, Darden's CEO Clarence Otis has been excessively compensated to open 417 net new stores since the end of FY09.
As we see it, the investment case for the new Darden is centered on fixing Olive Garden. According to management, they plan to “continue to execute our comprehensive Brand Renaissance Plan at Olive Garden, building on progress simplifying operations to enhance food quality and taste to improve the guest experience.”
We have major concerns with the lack of visibility around this plan and believe management is in “trust us” mode – a truly scary thought. Given their track record, we have little reason to believe this plan will be successful and won’t see any evidence of this, supportive or not, for at least another 12-18 months.
All told, the sale of Red Lobster does very little to change our view of the company. We firmly believe that the only legitimate way to create shareholder value will come from a shakeup of senior management. At this point in time, significant changes (e.g. Starboard gets controls of the board) are not likely to have any significant impact until late in FY15, if at all. Absent this, the earnings power of the company will continue to deteriorate.
On a pro-forma basis, we are currently projecting FY15 EPS of $2.20 versus street estimates of $2.72. This puts the fair value of DRI, under the current management team, in the low $40s.
Absent any significant changes to the Board, this stock is headed lower!