Darden Restaurants: Good Prospects With Yard House Acquisition and Other Efforts
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On 12th July, Darden Restaurants Inc (NYSE: DRI) announced that it has agreed to acquire Yard House USA Inc for $585 million from private equity firm TSG Consumer Partners in an all cash transaction. Yard House USA is a small chain known for a wide variety of beers and big restaurants that play classic rock. Darden plans to expand the chain to between 150 and 200 restaurants. Darden is growing through acquisitions and is becoming what Yum! Brands (NYSE: YUM) is to fast food, in casual dining. With over 1,936 restaurant locations throughout North America, Darden is now the largest full-service restaurant company in the world.
Last month, Darden announced its F4Q12 results in a conference call on the internet. DRI reported F4Q12 EPS of $1.15, in line with the consensus estimate, but SSS of -1.9% fell short of the consensus 1.2% due to weak casual dining trends. However, higher than expected restaurant margins (+$0.04 impact on EPS) and lower G&A (+$0.04 impact on EPS) offset the SSS shortfall (-$0.04 impact on EPS). Darden outlined menu and promotion initiatives that stress affordability and provided FY13 SSS guidance of 1%-2%, slightly ahead of the expectation for the casual dining industry. FY13 EPS guidance is $3.86-$4.01.
Impact of acquisition: Yard House operates 39 locations across 13 states and has strong growth potential. The chain has an impressive average unit volume of approximately $8.4 million. Due to this acquisition, Darden's earnings per share for fiscal 2013 will be negatively impacted by $0.03-$0.05. However, the acquisition will have positive impact on earnings per share after fiscal 2013. Darden will be able to reach the higher end of the company's five year plan of 2016 earnings per share of $5.85-$7.35 with the new acquisition and increased expansion.
Dividend yield and share repurchase provide support: DRI has increased its annual dividend from $1.70 per share in FY11 to $2.00 per share in FY12. Its dividend yield of 4% is the highest among restaurant companies and should provide support to shares even if SSS recover slower than expected. DRI also expects to buy back $200-$225 million of its shares in FY13, implying a total cash return to investors of $455-505 million. Dividends and buybacks are expected to be funded by $228mm in FCF, incremental debt and proceeds from options exercises.
Efforts to re-establish Olive Garden’s positioning: With Red Lobster and LongHorn performing consistently well over the last two years, Darden’s weakening SSS is mostly due to Olive Garden’s underperformance. Darden is focusing to re-establish Olive Garden’s leadership positioning in fiscal 2013. Olive Garden is moving from promotions built around a specific dish or two, which have grown increasingly less effective over the last two years, to promotions that are built around a value theme and highlight several dishes or menu categories. In 1QFY13, Olive Garden is going to have a single-minded focus on price point and affordability in its advertising. In 3QFY13, Olive Garden is going to introduce a greater number of affordable price points as well as high end distinctive signature dishes that broaden choice and variety. Thus, we believe the continued introduction of new platform idea promotions combined with the Tuscan Farmhouse remodeling program will drive the return of low single digit SSS growth at Olive Garden in FY2013 and provide a boost to Darden’s overall SSS growth.
Darden is trading at a forward PE of 11.29, which is at a ~27% discount to Ruby Tuesday Inc (NYSE: RT) and at a ~23% discount to Brinker International Inc (NYSE: EAT). The estimated earnings per share growth of Darden (~13.5% in FY13) is more than Ruby Tuesday (~4.45% expected in FY13) and is slightly less than Brinker (~17% expected in FY13). Moreover, the expected unit growth for Darden (more than 5%) is far greater as compared to Brinker (less than 1%) and Ruby Tuesday (negative unit growth; planning to close 25 to 27 stores) in 2012. Despite disappointing SSS trends, we believe DRI's current valuation at a discount to its peers is unjustified, given its relatively fast paced unit growth (5%+), the Yard House acquisition, efforts to re-establish Olive Garden's positioning, and impressive dividend yield. Thus, we believe Darden is undervalued and presents a good buying opportunity.
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