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Thankfully, this could be the last note I write about one of the worst managed companies I've followed in my 20-year history as a restaurant analyst.  My criticism of Darden has been very harsh at times, but given the state of the company it’s been more than justified.  Personally, I’m tired of being negative.  I’m also tired of witnessing the biggest destruction of shareholder value in the history of casual dining.

It’s hard to believe, but I’ve been vocal about the need for significant change at Darden for precisely 746 days now.  It was back in July 2012, when I first introduced my “unthinkable short” case on Darden in which I harped on the severe mismanagement of the company. 

The value destruction we’ve been speaking of since then can be seen in the consensus FY15 EPS estimate of $2.26 (Hedgeye is at $2.00).  As a point of reference, the consensus FY15 EPS estimate was $5.30 back in FY13.   The ironic part of all of this is that the CEO and the Board want you to leave what is left of the company in their hands.  Brinker International, one of Darden’s largest competitors in the casual dining space, has seen its consensus FY15 EPS estimate go from $2.80 to $3.10. 

Given the success of Brinker over the past 746 days, Darden management cannot blame a difficult casual dining environment for their troubles.  Instead, the trouble lies in their inability to recognize, manage and allocate capital appropriately in this difficult consumer environment.

For the sake of shareholders, Starboard must get control of the Board on September 30th.  Without a change of this magnitude, they can expect more of the same: dismal returns, value destructive initiatives, and a complete disregard for shareholder concerns.

This week, Starboard reiterated its commitment to fixing the issues that have consistently plagued Darden.  In addition, they increased their ownership in the company to 7.1%.  While this is good news, we believe any upside potential in the stock has been negated by the continual blunders of management and the Board.

I once used the phrase “a generational opportunity” to describe the upside potential for Darden shareholders.  Alas, that phrase is no longer applicable – the sale of Red Lobster changed everything.  It’s now much more difficult to create significant value. 

I applaud Starboard’s continual effort to push for significant change at Darden, but the fact of the matter is they’re facing an uphill battle.  The issues the company faces are similar to those back in July 2012 when we first began calling for change at the company – unrealistic guidance, poor capital allocation and constant cash burn.  Without new management in the next 12-months, the current team will either need to cut its plans for new unit development or cut the dividend.

In short, management’s current business plan doesn’t produce enough cash to execute the Brand Renaissance plan at Olive Garden.  As seen on page 19 of the most recent company presentation, management suggests there are only 300 restaurants in need of a remodel.

DRI: PERPETUALLY MISGUIDED (FOR 46 MORE DAYS) - chart2

Source: Company Presentation 

However, if management wants the chain to have a consistent look and feel, and accomplish its goal of “bring[ing] the Brand Renaissance to life in every guest touchpoint,” it will need to remodel all 837 restaurants.  We estimate this will cost the company approximately $550 to $600 million in capital investment.

According to current guidance, the company will generate $87 million in FCF in FY15 – but we know the company’s ability to provide accurate guidance is highly suspect.  This guidance implies that it will take between 5-6 years to complete the Brand Renaissance remodels.  Obviously, this plan is a non-starter and should be unacceptable to any shareholder.

As we have modeled, the company needs to spend significantly more to fix Olive Garden in a timely manner.  Spending $200 million a year would allow Darden to complete the remodel program in 3 years, but it would put the company in a negative FCF position. 

Why does management consistently put the company in a box, where it has no choice but to lower capex or cut the dividend?

DRI: PERPETUALLY MISGUIDED (FOR 46 MORE DAYS) - chart1

Call with questions.

Howard Penney

Managing Director

Fred Masotta

Analyst