Darden is No Garden
Board: Value Hounds
Darden is eight restaurant concepts under one ticker. Olive Garden is 43% of total revenue with Red Lobster second at 31%. The other six concepts are 24%. Unfortunately, its Olive Garden is the most fatigued brand and has had declining traffic and comps for the past two years. Red Lobster is not much better. The newer smaller chains create more consumer interest but at such a small and splintered part of the business, can have no significant effect on Darden’s growth.
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The blended comps are mediocre and the best performer is the Capital Grille but it’s only one of 5 concepts that combined are 24% of revenue. Most of the growth in revenue is from new restaurants. The Olive Garden and Red Lobster restaurant base may be close to saturation. Olive Garden has 828 stores and Red lobster is at 705. Olive Garden has net additions of around 35-40 per year and Red Lobster adds far fewer sometimes adding as little as one unit and no more than 10 (2009).
Olive Garden investment in restaurants is high at $4.1 million and Red Lobster costs are $4.2 million. Neither is cheap to build and with the only perceptible growth for both of these in recent years being additions of stores, this is an expensive way to grow. Most concerning is the negative comps are largely decreases in traffic indicating failure of the concepts to generate a new customer base even with the aggressive advertising we see on television – Never-ending Pasta Bowl and "We sea food differently".
The $8.6 billion in revenue DRI did in 2013 isn’t unimpressive, but smaller amounts of that get to the bottom line every year. Margins are slipping.
Even more bad news for Red Lobster, Olive Garden and Long Horn are the declining/flat average sales in 2013. Again, the Capital Grille is Darden’s one success story.
By the numbers Darden is not much of investment story. Olive Garden and Red Lobster have been around long enough to be unexciting to diners if same store sales and traffic are indicators. Both are down over the past few years. Some of the new acquisitions are interesting especially the Capital Grille. There are 49 of these restaurants doing $7 million per unit--$343 per year of $8.6 billion or just 4% of total revenue. The concept is upscale and moderately expensive. The Capital Grille is also known for fresh seafood flown in daily, dry aged steaks and culinary specials created by its chefs. There is an award-winning wine list offering over 350 selections, personalized service, comfortable club-like atmosphere, and premiere private dining rooms.Most dinner menu entrée prices range from $28.00 to $51.00 and most lunch menu entrée prices range from $12.00 to $39.00. In 2013, the average check was $70.00 to $72.50.
The Olive garden average check is $16.25-$16.75. Diners will pay for quality and the Olive garden cuisine is mediocre. I have talked to some of the staff and many of the main course offerings are microwaved.
The dividend is reasonably good but the risk of investing in Darden is high. The yield is now 4.4% or $2.20, but the restaurants are in slow decline and with growth coming mainly from expensive new restaurants rather than high traffic and increasing comps, cash flow gets used up for growth leaving less for shareholders.
The last two year’s acquisitions were not included but if added in, put Darden even further in the hole and there is nothing to pay dividends with capital expenses exceeding cash flow. Issuing net debt of $594 million made it possible to meet the obligations and give them some cash left at the end of the year. In other words, they may keep paying but it isn’t looking solid if growth needs to be paid for by opening new restaurants.
The return on invested capital in 2013 was 15% and cost of capital 8.5%. Darden is using the investments to create value and they do have positive cash flow. The ROIC is dropping—it was 20% in 2011.
If Darden’s flagship brands were stronger, this would be a great investment. However, the trend for Olive garden and Red lobster is one of decline and lost traffic.
Even their own filings stress the health of a restaurant is measured by comps and traffic:
Increasing same-restaurant sales can improve restaurant earnings because these incremental sales provide better leverage of our fixed and semi-fixed restaurant-level costs. A restaurant brand can generate same-restaurant sales increases through increases in guest traffic, increases in the average guest check, or a combination of the two. The average guest check can be impacted by menu price changes and by the mix of menu items sold.
For each restaurant brand, we gather daily sales data and regularly analyze the guest traffic counts and the mix of menu items sold to aid in developing menu pricing, product offerings and promotional strategies. We view same-restaurant guest counts as a measure of the long-term health of a restaurant brand, while increases in average check and menu mix may contribute more significantly to near-term profitability. We focus on balancing our pricing and product offerings with other initiatives to produce sustainable same-restaurant sales growth.
If the above is true, then unless the Olive Garden and Red Lobster turn declining traffic and plummeting same store sales around, short-term growth is all there will be. For the dividend to be payable and raised, Darden needs more than short-term growth through raising prices and building new stores. They will need to find a way to revitalize the two flagship brands or start aggressively growing the smaller, more successful concepts.