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Easy comparisons and a beneficial cost environment should translate into strong fiscal 1Q11 results.

Darden is scheduled to report its fiscal 1Q11 earnings after the market close on September 21st.  The company is lapping extremely easy blended same-store sales comparisons in the first half of the year of -5.3% and -4.7% in 1Q10 and 2Q10, respectively.  Of the three larger concepts, the comparisons are particularly easy at Red Lobster as comps declined 7.9% and 8.4% in 1Q10 and 2Q10, respectively. 

These easier comparisons should allow Darden to report positive comps during 1Q11 even if trends slow slightly on a two-year average basis.  That being said, given the current macroeconomic backdrop, I continue to think the company’s full-year same-store sales guidance of +2% to +3% could prove aggressive.  Lower food costs in 1H11, lower YOY labor costs as a percentage of sales, expected incremental cost savings initiatives of $10 to $15 million and accelerated share repurchase during fiscal 2011 leave me less concerned about the company’s ability to achieve its 14% to 17% EPS growth target.

For reference, casual dining same-store sales trends on a two-year average basis, as measured by Malcolm Knapp, slowed about 50 bps through the first two months of Darden’s fiscal 1Q11 (June and July) from the prior quarter.  Darden’s reported results will provide the first real glimpse of casual dining trends in August and insight into whether or not the industry was able to sustain the sequentially better results from July on a two-year average basis after posting declines for the prior three months.

Increased leverage from positive same-store sales growth, combined with the expected beneficial cost environment, should lift margins during the first quarter and for the entire first half of the year.  The company guided to continued food costs favorability during fiscal 1H11 but expects costs to level out during the second half of the year.  To that end, management has good visibility on its food costs through the first half of the year as it has contracted most of its commodity needs through December.

Also helping YOY margin growth during fiscal 2011 is the fact that the company is lapping significantly higher labor expenses as a percentage of sales from fiscal 2010, largely in the first half of the year.  Management attributed these higher labor costs in fiscal 2010 to sales deleveraging, increased benefit costs, wage rate inflation and higher manager bonuses.  For fiscal 2011, the company guided to lower labor costs as a percentage of sales and I would expect the biggest YOY benefit to come during 1H11.

Darden’s cash flow story remains intact.  The company recently increased its quarterly dividend 28% to $0.32 per share and expects to repurchase about $300 to $350 million of shares during FY11, up from $85 million in FY10. 

Howard Penney

Managing Director