DRI - A CLOSER LOOK AT THE NUMBERS

Darden is scheduled to report fiscal first quarter earnings on September 29 after the market closes and sales trends will not look good.  The company’s same-store sales growth had fallen off rather significantly on a 1-year basis in May (last month of fiscal 4Q09) at its two biggest brands, Red Lobster and Olive Garden.   Judging from what we have heard from other companies about trends in June and July and Malcolm Knapp’s numbers, which show that casual dining comparable sales growth got sequentially worse in June and July (approaching December levels), DRI’s sales results may come in worse than expected.  DRI did not provide same-store sales guidance for the first quarter, but said that comparable sales growth at Olive Garden, Red Lobster and LongHorn Steakhouse on a blended basis would be flat to down 2% for the full-year.  Fiscal first quarter numbers are likely to come in below that full-year guidance range. 

 

On its fiscal 4Q earnings call in June, management stated that from a sales perspective that it was seeing some variation in trends from month to month but that it was not experiencing any deterioration in June.  In making that comment, I think the company was referring only to 1-year trends because DRI faced difficult sales comparisons in May, particularly at the Olive Garden, as a result of the stimulus checks that went out in May 2008.   Management pointed out that in June 2008, gas prices spiked north of $4 so easier comparisons are at play in June relative to May.  On a two-year basis, however, I would expect sales trends to show a sequential slowdown from both May and the fourth quarter across all of DRI’s concepts.  With overall casual dining sales trends approaching December levels, no concept is immune.  Even the Olive Garden, which has significantly outperformed its peers, experienced a 4.5% decline in same-store sales growth in December 2008, and the Olive Garden’s gap to Knapp had already narrowed rather substantially in May.

 

This weak sales performance will not be unique to Darden, but Darden is one of the first casual dining companies to report June, July and August numbers (CBRL will report its 4Q09 numbers for the period ended July 31 two weeks earlier).  Even with sales slowing on a sequential basis, I do not think DRI will report an earnings miss relative to the street’s expectation for Q1 EPS of $0.66.  But, if we continue to follow the calendar 2Q earnings season trend, including the reaction to DRI’s fiscal fourth quarter results (ended May), of stocks going down despite positive earnings surprises, we could see DRI take a hit. 

 

The good news for DRI, however, is that the company provided such a wide full-year 2010 EPS guidance range of -2% to +8% that even if sales come in worse than expected, I do not think the company will have to take down its sales or EPS projections for the year.  That being said, I would not be surprised to see the street’s full year EPS expectation of $2.80 come down.  Given that we don’t experience a dramatic recovery in restaurant demand, a number in the $2.70-$2.75 range seems more reasonable. 

 

In fiscal 2009, DRI captured about $45 million of cost acquisition synergies and generated about $35 million of savings from business strengthening initiatives.  In fiscal 2010, the company expects to capture another $10 million of acquisition synergies and an additional $5 million of cost savings (primarily in the first quarter).  Although these cost saving initiatives will benefit earnings, the incremental savings are coming down on a year-over-year basis so it will become more difficult for the company to offset continued sales weakness in fiscal 2010.  This inability to continue to offset sales deterioration with an accelerated pace of cost cutting highlights one of the biggest headwinds for casual dining operators in the coming quarters.  


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