DRI’s 2Q10 blended same-store sales did improve about 70 bps sequentially from Q1 on a 2-year average basis, but with comparable sales -8.4% at Red Lobster on a 1-year basis, -1.4% at Olive Garden and -6.2% at LongHorn, these numbers do not point to a recovery. Add to that, the 14.2% same-store sales decline at Capital Grill and the 6.1% decline at Bahama Breeze and it becomes glaringly obvious that this company is not yet out of the woods from a demand perspective.
Management seemed intent on painting a favorable picture of trends on its Q2 earnings call. Although management did say that “sales were a little more sluggish than expected,” it also said that trends look to be improving in December, which it recognizes as an early sign of a sustainable improvement in trends. I do not have access to the same level of detail as that of DRI management and I have been called the Resident Bear at Research Edge, but some of the numbers management referred to in order to highlight these improvements do not tell the whole story.
First, management said that the industry as measured by Malcolm Knapp improved during DRI’s fiscal Q2 on a sequential basis for the first time since Darden’s fiscal 4Q08. Yes, on a 1-year basis, Q2 came in -5.9%, excluding Darden, versus -7.8% in Q1, which represents a 190 bp improvement. Looking at 2-year average trends, however, Q2 trends were roughly even with Q1, coming in -5.6% relative to -5.8% in Q1. Management also highlighted the fact that both average check and traffic trends for the industry got sequentially better in Q2. This again, is not as impressive when you consider that these two metrics had already started to fall off on a sequential basis in the year ago periods.
Second, DRI went on to say that this pick-up in sales trends continued into December both for the industry and for DRI. Although management said that the sequentially better numbers were partly attributable to weak year ago results, the company also recognizes the improvement as a sign of better trends to come. Management was asked two times on the earnings call to address this improvement in December in light of last year’s numbers and whether underlying trends were really getting better on a 2-year basis. The company did not directly answer the question either time. Without this clarification, the comment that December got better on a sequential basis does not provide me with much optimism that we are experiencing a recovery in demand because the industry was down 9.5% in December last year. We would have to see sequentially better numbers in December on a 1-year basis or we would have a significant fall off in 2-year average numbers.
Third, DRI provided the monthly comp numbers for Capital Grill, which it does not typically do, to show that trends got sequentially better throughout the quarter. Again, for the quarter, Capital Grill comparable sales came in - 14.2% (or -11.2% adjusting for the holiday shift), down 17% in September, -9% in October and -6% in November (adjusting for the holiday shift). At first, this sounded like a pretty impressive tick up in trends. It is important to remember, however, that demand trends really started to fall off in October of last year. Management would not quantify last year’s results on a monthly basis but said that results were not down as much in September 2008 and that there was a significant reduction in trends in October and November 2008. I don’t understand why management would not just provide the numbers for last year, given that they gave them for this year (maybe, the numbers would point to two-year average trends that are not meaningfully better). Without context around last year’s numbers, this so called improvement throughout the quarter is less meaningful.
Malcolm Knapp just reported that November casual dining same-store sales came in -4.6% with traffic -4.4%. On a 2-year average basis, this points to a nearly 190 bp sequential improvement in comparable sales trends.
This better number might be why Darden is more optimistic about future trends as this improvement in underlying trends is impressive (and very surprising to me). This better industry number, however, makes DRI’s reported numbers look even worse because as the industry improved in November from October, DRI’s results at the Olive Garden got significantly worse in November on both a 1-year and 2-year average basis. Red Lobster’s performance on a 2-year average basis improved from October but still ended the quarter in November worse off than where it ended Q1 in August. LongHorn, on the other hand, did see some meaningful improvement throughout the quarter.
Investors seem convinced by DRI’s glass half full view as the stock is up over 5% right now. Judging by Malcolm Knapp’s November numbers, there could be some stabilization of industry demand, which would be a definite positive, particularly if it continued into December, but I think this just highlights that DRI is losing share. During Q2, DRI outperformed the industry benchmark by only 200 bps relative to its 250 bp outperformance in Q1 and CEO Clarence Otis’ expectation (as stated on the Q1 earnings call) to outperform by 300 bps for the full year. DRI’s gap to Knapp is narrowing.