DRI – IS THE REIT PRICED IN?

Takeaway: All the conversations I’m having with investors about DRI are focused on the potential of an Olive Garden REIT.

DRI is due to report FY4Q15 earnings on Tuesday and it’s going to be a great quarter!

Three things to think about following the print:

  1. Are the margin trends sustainable?
  2. What is the stock discounting?
  3. What is management doing to fix Olive Garden?

The current street consensus has DRI FY4Q15 EPS at $0.93, up 150% year-over-year.  Personally, I don’t think it’s out of the question that the company can print $1.00 for the quarter.  The headlines will make for great press as the current management team is doing a great job realigning the cost structure of the company.  Like Bob Evans recent announcement, I also suspect DRI will formally announce it is looking to do a bigger deal in the real estate space. 

Other themes coming out of the FY4Q15 earnings call will be similar to the FY3Q15 themes:

  1. Management is attacking G&A and bringing it to the bottom line
  2. There is significantly less discounting in FY4Q15 vs FY4Q14
  3. Olive Garden sales trends have improved but signs of a renaissance remains elusive
  4. Restaurant margins will improve 130bps in FY4Q15 vs 66bps in FY3Q15
  5. Operating margins will improve 343bps in FY4Q15 vs 264bps in FY3Q15
  6. There will be an intense focus on Olive Garden’s real estate and the potential for a REIT

With the stock at $69 and trading at 11.12x EV/NTM EBITDA, the street is discounting that DRI is going to have a great quarter.  The question becomes how great is great and what is the upside from here?  The bigger question shareholders need to ask is with all the improvement in profitability are they starving Olive Garden of essential capital and the initiatives to be relevant again? 

All the conversations I’m having with investors about DRI are focused on the potential of an Olive Garden REIT. The potential for a REIT was a big focus of the Starboard presentation on value creation.  To be clear, all of the talk of a REIT is temporary as it’s the last financial lever the board can pull to create value. The REIT discussion is also distracting the conversation away from the real issue and that is the Olive Garden renaissance plan. 

I have no edge on the potential of a REIT, but the chances of a REIT seem very slim in the restaurant space.  Contributing to the heightened expectations for DRI REIT are Hudson's Bay, Bob Evans and others announcing plans to potentially monetize their real estate into separate publically traded companies?  Time will tell!

So what is DRI stock discounting?

Using the same price to Price/Sales analysis we used to determine that DRI was undervalued three years ago now shows that the company is overvalued.  At the very least, there is a significant component of the current value that accounts for the value of the real estate portfolio.

Referring to the Starboard presentation on the Darden real estate opportunity, the investors valued the DRI real estate portfolio (including Red Lobster) at $3.8-$4.2 billion.  Assuming Red Lobster was $2.2-$2.5 billion of the total, the remaining Olive Garden real estate is worth around $1.4-$1.7 billion (before tax leakage).

Our sum-of the parts analysis of DRI has the collective brands worth an enterprise value of $7.4 billion or approximately $49.74 per share.  This implies that the market is valuing the DRI real estate at $2.4 billion or more than 100% of the value of Olive Garden’s real estate. With the stock at theses levels there is significant pressure on management and the Board to come up with a creative real estate transaction that makes Olive Garden relevant again.

If a deal can’t get done does DRI run the risk of becoming the Sears holdings of the restaurant industry? Nobody wants to follow the example of Sears Holdings Corp, Eddie Lampert, who had been criticized for starving the retailer of the capital reinvestment needed to keep stores refreshed and relevant in the minds of consumers.

Once we get past the DRI financial engineering and cost cutting the ultimate value of this company will be driven by Olive Garden and right now it’s being starved of capital to be relevant to the consumer.

DRI – IS THE REIT PRICED IN? - DRI Chart 1 

DRI – IS THE REIT PRICED IN? - Chart 2 DRI 

DRI – IS THE REIT PRICED IN? - Chart 3 DRI