DRI | ARE OLIVE GARDEN EXPECTATIONS TOO HIGH?

Darden Restaurants (DRI) remains on the Hedgeye Restaurants SHORT bench.

 

We like it when you can keep a thesis on a stock simple and straightforward!  Expectations for a recovery at Olive Garden have gotten way ahead of reality.

 

DRI is going to report EPS in early December and the chances are high they have a good quarter.  The current street estimate for Q2 ’15 is $0.42, up 50% YoY.  Since November ’14 that estimate has moved up from $0.34, so expectations have increased 24% over the past 12 months.  In addition, since Jan ’15 the estimate for FY ’16 has gone from $2.99 to $3.68, up 23%.    

 

Over the last three quarters the company has beaten estimates by 18%, 16% and 18%, respectively.  I suspect the company can beat the number but the days of the “big beat” and raise are over.   

  

It’s been a year since Chairman Jeff Smith and his team took over Darden and what a year it’s been.  Consider the following improvements to the P&L:

  • Consolidated SSS have gone from flat to nearly 3% growth
  • SSS for the OG have gone from 0.5% to 2.7% in 1Q16
  • LTM Food Costs have improved 56 bps
  • LTM Labor Costs have improved 34bps
  • LTM Other Expenses have improve 95bps
  • LTM Restaurant Margins up 186bps
  • LTM G&A has improved 81bps
  • LTM Operating Margins have improved 310bps
  • EPS has nearly doubled to $3.17 over the last four quarters

 

Management has executed a strong recovery in financial performance over the past 12 months.  As you can see most of the gains have come from below the line cost cutting items, which are one time in nature.  Importantly, the company has announced and filed the relevant docs to create a new real estate company.  I understand there is an arbitrage that creates value by putting the OG rents in a vehicle, but what’s left is also very important.

 

As of 1Q16 this is what management is doing to post sustainable same-store sales growth at OG:

  • Value Proposition -  “Olive Garden is where people of all ages gather to enjoy the abundance of great Italian food and wine, and to be treated like family”
  • Leveraging Core Brand Equities – Breadstick nation and Tour of Italy
  • Table top tablets
  • Refresh 19 restaurant with 25 more planned for 2016

 

As you can see there is not an abundance of new innovation and management is not investing behind the brand or the assets!  As you can see from the chart below street expectation call for a significant acceleration is 2-year sales trends at Olive Garden.  As we see it the slope of the red line is way too steep given there is little investment in the OG brand and the industry trends are slowing.     

DRI | ARE OLIVE GARDEN EXPECTATIONS TOO HIGH?  - CHART 1

 

Given the current overall industry is slowing down, is it possible the trends at Olive Garden are that good? We don’t think it is logical to think that in 6 months Olive garden will be doing a 2.2% same-store sales on a 2-year basis.

 

Olive garden is the engine of growth for DRI.  Olive Garden represents 56% of sales for the company we believe accounts for roughly 42% of the total value of the company after parsing out the REIT.  Where Olive Garden goes, Darden goes.

 

Multi-concept casual dining restaurant companies struggle for the simple fact that it is difficult to allocate capital correctly. OG needs a lot of capital to reassert itself in the market while you have growth engines like Capital Grille and Yard House that need it in order to grow. The simple fact is Olive Garden is not getting the attention/capital it needs in order to return to meaningful long-term growth. This thinking coupled with a slowing casual dining industry is not good news for Olive Garden and the other concepts at Darden.

 

VALUATION

In a slowing sales environment with compressing casual dining multiples, if DRI were to trade at one of its closest competitors multiple, EAT, there is downside to the low $40’s.

DRI | ARE OLIVE GARDEN EXPECTATIONS TOO HIGH?  - CHART 2

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 

 


Neurofinance: The Psychology Behind When To Sell A Bull Market

"Most momentum investors stay invested too long, under-reacting and holding tight after truly bad news finally arrives to break the trend," writes MarketPsych's Richard Peterson.

read more

Energy Stocks: Time to Buy the Dip? | $XLE

What the heck is happening in the Energy sector (XLE)? Energy stocks have trailed the S&P 500 by a whopping 15% in 2017. Before you buy the dip, here's what you need to know.

read more

Cartoon of the Day: Hard-Headed Bears

How's this for "hard data"? So far, 107 of 497 S&P 500 companies have reported aggregate sales and earnings growth of 4.4% and 13.2% respectively.

read more

Premium insight

McCullough [Uncensored]: When People Say ‘Everyone is Bullish, That’s Bulls@#t’

“You wonder why the performance of the hedge fund indices is so horrendous,” says Hedgeye CEO Keith McCullough, “they’re all doing the same thing, after the market moves. You shouldn’t be paid for that.”

read more

SECTOR SPOTLIGHT Replay | Healthcare Analyst Tom Tobin Today at 2:30PM ET

Tune in to this edition of Sector Spotlight with Healthcare analyst Tom Tobin and Healthcare Policy analyst Emily Evans.

read more

Ouchy!! Wall Street Consensus Hit By Epic Short Squeeze

In the latest example of what not to do with your portfolio, we have Wall Street consensus positioning...

read more

Cartoon of the Day: Bulls Leading the People

Investors rejoiced as centrist Emmanuel Macron edged out far-right Marine Le Pen in France's election day voting. European equities were up as much as 4.7% on the news.

read more

McCullough: ‘This Crazy Stat Drives Stock Market Bears Nuts’

If you’re short the stock market today, and your boss asks why is the Nasdaq at an all-time high, here’s the only honest answer: So far, Nasdaq company earnings are up 46% year-over-year.

read more

Who's Right? The Stock Market or the Bond Market?

"As I see it, bonds look like they have further to fall, while stocks look tenuous at these levels," writes Peter Atwater, founder of Financial Insyghts.

read more

Poll of the Day: If You Could Have Lunch with One Fed Chair...

What do you think? Cast your vote. Let us know.

read more

Are Millennials Actually Lazy, Narcissists? An Interview with Neil Howe (Part 2)

An interview with Neil Howe on why Boomers and Xers get it all wrong.

read more

6 Charts: The French Election, Nasdaq All-Time Highs & An Earnings Scorecard

We've been telling investors for some time that global growth is picking up, get long stocks.

read more