DRI: Still Lacking Direction

As promised, the “new” Darden is cutting costs and streamlining the organization.

 

Unfortunately, the recent press release reads like the “old” Darden.  It lacks conviction, enthusiasm, new thinking and a new strategic direction.  We do recognize, however, that the new board was recently elected and that we are in the early innings of an overhaul.

 

While “winning market share, improving same-restaurant sales and achieving best-in-class profitability” are the right things to say, these objectives pale in comparison to the other strategic changes that must be made at Darden, which includes fixing the broken culture of the company.

 

Commensurate with the changes at the board level, the company needs an entirely new strategic direction.  We understand the company is in the midst of a CEO search, and now in need of a new CFO, but FY15 is rolling on and there appears to be little sense of urgency.  With the stock up 13% and 17% over the past one and three months, respectively, it appears as though there is anticipation of better times ahead.

 

The company needs a new strategic plan that addresses the issues brought forth by Starboard in its 297 page activist presentation.  Until then, the move in the stock is premature.

 

Since Starboard’s impressive victory in early October, the “new” Darden has issued four press releases:

  • October 14, 2013 - Darden names Gene Lee Interim CEO
  • October 16, 2014 – Darden’s Board Appoints Additional Director
  • November 5, 2014 – Darden Retains Korn Ferry for CEO Search
  • November 13, 2014 – Darden Announces Corporate Governance Reforms and Sets Second Quarter Earnings Release for December 16, 2014.
  • November 18, 2014 – Darden Announces Leadership Changes and Strategic Actions

 

These are important steps, but we’re still waiting for the big one.  We will likely not reach an inflection point in the business until we see a press release that reads:

 

“Darden to Hold Conference Call for New CEO to Outline a New Strategy for the Company.”

 

The plan would need to include:

  1. A new strategic direction for Olive Garden - DRI’s future valuation depends on this brand being fixed.
  2. A plan to improve LongHorn’s relatively low AUV’s and below average returns.
  3. Significant changes to capital allocation strategies, including limited new unit growth and the potential sale of real estate and other non-core assets.
  4. Strategic priorities for improving the cost structure of the enterprise.

 

Our point is that the majority of Darden’s announcements over the past month are insignificant relative to what needs to take place for this company to turn the corner.  Importantly, the list of executives that have left the company since interim CEO Gene Less was appointed COO back in September 2013 is staggering:

 

Dave Pickens, Drew Madsen, Clarence Otis, Michael Barnes, Leonard Berry, Odie Donald, Christopher Fraleigh, Victoria Harker, David Hughes, Charles A. Ledsinger Jr., William Lewis Jr., Senator Connie Mack III, Michael Rose, Maria Sastre William Simon, Brad Richmond, Daisy Ng and Bob McAdam.

 

Importantly, zero new executives have joined in order to breathe new life into the company.  It seems like more of the same – a “trust me” mentality that got Darden into trouble in the first place.

 

Recall that during the past year, the current management team said they could not fix Red Lobster.  So what did the company do?  They promptly sold the business.  Following the sale, there was some very conflicting commentary about the Red Lobster opportunity.  We feel it could have been ‘saved’ under the right leadership and ultimately sold for a significantly better return for shareholders.  In other words, we believe the company was in need of some new leadership and oversight. 

 

While Darden has a new board in place, we must recognize that this is only the beginning and further changes are needed.

 

Now the same management team says they have a plan to fix Olive Garden.  Again, why should we play the “trust us” game?  We believe that a new CEO-CFO team will be central to any strategic turnaround plan.

 

We continue to believe that DRI, with a healthy Olive Garden (positive same-store sales and guest count growth), would have the potential to be a tremendous investment over time.  Like all great restaurant turnarounds, DRI would likely go on a multi-year run of shareholder value creation if this is achieved.

 

Here’s our takeaway from the news flow since October:


The $20 million in cost cuts announced is underwhelming relative to the $216 million Starboard thought was possible.

  • Hedgeye: Since there was no indication that more cost cuts are on the way, is this $216 million number still a relevant benchmark?

 

There are only a few days left in the quarter, meaning management knows what the numbers look like. If the company’s core brand, Olive Garden, was participating in the industry upturn in sales wouldn’t they have given shareholders the good news?

  • Hedgeye: The Company was making progress on the Renaissance Plan in 1Q15. Has there been any follow through into 2Q15?

 

There has been no indication the company will cut spending on new units and stop the egregious spending on Olive Garden remodels.

  • Hedgeye: This is a must.  Why was this not a part of the strategic actions revealed in the November 18th press release?

 

Even with the current round of cost cutting, 2015 EPS guidance is aggressive.

  • Hedgeye: If I’m the interim CEO, and trying to become the full-time CEO, there’s no way I’m cutting guidance this quarter.  I’d rather push it out three months from now.

 

We suspect that the last time Darden issued earnings guidance; they assumed a recovery in the Olive Garden business.  While there may be an industry upturn, there is no renaissance happening at Olive Garden.  There is a chance the company makes 2Q15 numbers, but the hockey stick improvement the street expects in 2H15 is far too aggressive.

 

DRI: Still Lacking Direction - 894949

 

As we’ve said many times DRI can be a great company once again.  We just don’t see the path to prosperity yet!

 

Feel free to call, or email, with questions.

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst