Yesterday, DRI announced that interim CEO Gene Lee will become the new CEO of Darden. Once the company finds a new CFO, the transition to the new management team will be complete.
Next comes the hard part – fixing Olive Garden.
It’s been 2 years, 7 months, and 11 days since we first said DRI needed major changes, when it was evident the CEO’s reckless growth strategy was destroying shareholder value. What followed was an amazing story of sloppy corporate governance, blatant disregard of shareholder returns, and a level of mismanagement that we’ve never seen in the casual dining industry. In the end, it’s truly amazing that the failed strategies lasted so long without more shareholder outrage. What’s more amazing, however, is that one of the key players that contributed to those failed strategies is now the new CEO of the company. Maybe his knowledge of, and first-hand experience in, the failed strategies of the past will make him a better CEO than COO. Time will tell.
Either way, it seems counterintuitive that, following the historic unraveling of the Darden Board in October 2014, the new Chairman of the Board, Jeff Smith, would choose a Darden insider as a new CEO. Given how long it took to name a CEO, one thing is clear: it was not an easy decision. Our sentiment about the qualifications of the new CEO was reflected in the lack of conviction in yesterday’s press release. It seemed obvious, to us, that Jeff Smith struggled to accurately frame why Gene Lee was chosen as the new CEO. The endorsement of Mr. Lee was not only generic, but also failed to cite what he has accomplished at Darden that would position him as the new CEO – outside of being the last man standing.
The contradictions between the Chairman of the Board and the new CEO are apparent. Consider the following:
- Jeff Smith and the current Board of Directors trashed Gene Lee and Dave George’s Olive Garden “Renaissance Plan.”
- The Olive Garden remodels show a lack of discipline for ROI.
- Under Gene Lee, Seasons 52 opened a significant number of underperforming units – further showing little concern for ROI.
- The overall profitability of the Specialty Restaurant Group, run by Gene Lee for six years, is not significant enough spin it off as a separate company.
It will be interesting to see how they’ve solved these contradictions in the coming months.
Having said that, appointing Gene Lee as the new CEO is the safe choice, especially with the stock above $62 and improving industry trends. We won’t truly know if this was the best choice for the company until we begin to lap the improvements made six months ago.
We suspect there will be structural changes made within the company before we see any sustained improvement in operating trends. Given the industry backdrop, DRI will likely report strong comps when they release earnings on March 20th. However, it will be difficult to tell whether these reported comps are the result of improved industry trends or improved operations. We suspect it will be the former.
The next 25 days will be the most important of the new CEO’s career. That’s how long he has to write a script that shows the investment community he can make difficult decisions that will lead to a multi-year improvement in the fundamentals of the business.
The plan should include:
- A new strategic direction for Olive Garden’s menu.
- A new look and feel for Olive Garden’s asset base.
- A plan to improve LongHorn’s relatively low AUV’s and below average returns.
- Significant changes to capital allocation strategies, including limiting new unit growth and the potential sale of real estate and other non-core assets.
- Franchising – including selling stores – of non-core brands.
- Strategic priorities for improving the cost structure of the enterprise.
- Setting a timeline for restoring EBIT margins to 10% or better.
We look forward to seeing how the new CEO presents the future opportunities at DRI. We’re confident there is significant low hanging fruit, but we need to see how these opportunities manifest themselves for the benefit of shareholders.
In the short-run, this stock is way ahead of a turn in the fundamentals.