Darden: Eat up
Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Darden Restaurants (NYSE: DRI), the company that brings you Olive Garden, Red Lobster, LongHorn, and SRG, reported solid third quarter earnings last Friday. The stock is held by Ray Dalio, David Dreman, Richard Driehaus, and John Fichthorn. Reported EPS beat consensus estimates by $0.01 to $1.25. Blended revenue comparable store sales, meaning inclusive of all restaurant brands, was up an impressive 9.3%. There were no updates to fourth quarter guidance of EPS of $1.12 to $1.20 and comparable store sales of 1.5% to 3.0%. March trends were not addressed, but management admitted results had been “volatile” given economic factors like improved employment data and increasing fuel prices.
Third quarter comparable store sales were encouraging with a return to the positive in February. Most of that improvement can be attributed to promotions such as the Baked Pasta Romana promotion in December/January and the three-course Italian Dinner in January/February. DRI has made meaningful investments to enhance the brand's value proposition through a new menu and marketing message. Meanwhile, the “Via Tuscany” remodeling program is being honed, and DRI will be upgrading 430 existing locations through 2015. We view management’s efforts as helpful in sustaining the long-term prospects for Olive Garden.
Red Lobster has also been enhancing operations via a new marketing campaign and store remodelings. The $14.99 Four-Course Seafood Feast in January/February proved to be effective helping boost sales for the brand. There is talk of potentially making the promotion a permanent menu item, which will help drive traffic and revenue. We believe the remodeling program called Bar Harbor and the “Real People” advertising campaign will support the strong momentum Red Lobster currently has.
LongHorn is also seeing strong momentum with comparable store sales ahead of the industry—this is its thirteenth quarter of outperformance. Again, remodeling activity has helped strengthen the brand image and the new lunch menu increased traffic. Promotions have seen a lot of success. Early in the third quarter, stuffed filets and the $11.99 signature steak promotion both performed well. Management has been aggressive in unit development and improving those units’ return on invested capital. DRI reported that recent openings achieved 150% of return hurdles, an impressive result by any measure. New unit volumes have also seen strong growth due to more brand awareness and increased seating capacity in the new unit prototype. We think management’s efforts are paying off with regard to LongHorn and that the new initiative and unit buildout will drive strong volume numbers in the upcoming quarter.
Specialty Restaurant Group (SRG)
We really like SRG’s potential as a driver of long-term earnings growth. The segment has strong unit volumes and good cash flow generation. Over the next five years, management plans to more than double unit count and add another $80 million in operating profit. Growth will be driven by Seasons 52, expansion of The Capital Grill, Bahama Breeze, and Eddie V's brand.
Balance Sheet and Cash Flow
As of the third quarter, DRI has cash and equivalents of $88.5 million and total debt of $2.1 billion. It has a respectable free cash flow yield of ~5.7% and a dividend yield is 3.4%. In the second quarter, DRI repurchased 1.8 million shares during Q2 and management plans to repurchase $25 million to $50 million during the fourth quarter. Overall, we like the strong balance sheet and cash flow, but if DRI can reduce its depreciation and amortization (currently at 50-60% of capex), that would make the financials markedly more attractive to us.
From a long-term perspective, we look favorably upon management's proven success in running promotion-driven programs at both Red Lobster and LongHorn. The proposed revamped advertising campaign and core menu in 2013 will serve as a catalyst though no details have been released. DRI should be able to grow sales in the mid to high single digits with Red Lobster, Olive Garden, and LongHorn continuing to be leaders in the casual dining industry for seafood, Italian cuisine, steak, respectively. We are particularly bullish on the specialty restaurant group, which is filled with earnings growth potential, and can see the company trading close to the casual dining historical average of 15.0x to 16.0x P/E. DRI trades at a noticeable discount of 12.7x 2013 earnings, leaving some upside potential. The Cheescake Factory (NASDAQ: CAKE) trades at 14.2x with a 3% FCF yield, Brink (NYSE: EAT) trades at 12.0x with an 8% FCF yield, P.F. Chang’s (NASDAQ: PFCB) trades at a lofty 20.0x with a 6% FCF yield, and Texas Roadhouse (NASDAQ: TXRH) trades at 15.5x with a 3% FCF yield.
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