When I previewed DRI’s fiscal Q1, I said that sales would come in worse than consensus expectations. Sales came in even lower than my expectations with blended same-store sales down 5.3%, which would explain DRI’s stock performance today. Comparable sales slowed on a 2-year basis at each concept. Red Lobster’s underperformance was the most surprising with same-store sales growth coming in down 7.9% in the quarter, which represents a 540 bp sequential decline on a 2-year basis. Management attributed the softer than expected sales trends to the difficult economic environment and the company’s decision to not participate in the deep discounting tactics of its peers. DRI’s CEO Clarence Otis even stated that DRI does not want that type of unprofitable customer in its restaurants. Highlighting just how prevalent industry discounting has become, management commented that in fiscal Q1 the casual dining industry’s average check declined 1.5% on a sequential basis and was down 3.5% YOY.
Despite the fact that DRI delivered worse than expected sales numbers, the company, like so many of its peers, beat the street’s EPS expectations by $0.01. Although this was not surprising given the benefit from favorable YOY commodity costs and cost saving initiatives implemented in 2Q09, I continue to maintain that the street’s full-year EPS estimate of $2.80 is too high. After these Q1 earnings results, this number is sure to come down. The question now is will it come down by enough.
Despite lowering the low end of its full-year same-store sales growth guidance range by 1%, DRI maintained its EPS growth range of -2% to +8% as a result of lower than expected food costs. Going into the quarter, I did not think DRI would have to revise its EPS guidance given the wide range of DRI’s EPS forecast. Management did say, however, that the lower end of the range is now more likely. Based on current sales trends, achieving -2% EPS growth is no longer a given. DRI’s new blended same-store sales guidance of flat to -3% assumes an acceleration in same-store sales trends. Management stated that some of this improvement will result from the “arithmetic” or easy comparisons, but in this environment, I am not sure that easy comparisons matter. Instead, I am looking at 2-year trends and a -3% number assumes an improvement in 2-year trends as well.
Management stated that blended same-store sales growth in September is running similar to August, which was down about 4% to 5% versus the reported -5.3% number in Q1. Based on those quarter-to-date trends, Q2 is not going to fare as well on an earnings basis relative to Q1. EBIT margins improved on a YOY basis in Q1 but even with the continued favorability in commodity costs, margins will likely decline in Q2 to the magnitude of about 100 bps. Fiscal Q1 was also helped by the cost saving initiatives that the company implemented in 2Q09. Management said that it is still finding increased cost saving opportunities but not of the same magnitude as last year so the YOY benefit of these initiatives will moderate in Q2 and beyond. As DRI correctly stated on its earnings call, it is one of the few casual dining restaurants that is still growing. This growth will make it increasingly more difficult for the company to continue to cut costs.