Darden's Profits Gored by Longhorn
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Quite a few companies have been effected, one way or another, by fluctuating food prices lately. A lot of the food inflation has been brought on by the super-drought the United States experienced this year. Tyson Foods has been effected from an increase in chicken feed prices. Buffalo Wild Wings has seen the prices of chicken wings spike 70% since last year. This has cost both companies profits they would have liked to have kept. Darden Restaurants (NYSE: DRI) is not immune to fluctuations in food prices either. Here's a recap from their most recent quarterly conference call:
- Beef up
- Seafood down
- Poultry up
- Wheat down
- Dairy down
There are three main restaurants that make up this company: Olive Garden, Red Lobster, and Longhorn Steakhouse. This helps diversify their exposure to the food service industry. Just by taking a quick glance at what is up and what is down, you should be able to guess what happened. Red Lobster did well because seafood prices are down. Olive Garden was ok because of wheat and dairy prices. Everything was looking pretty good...until you got to Longhorn. The steakhouse drug the whole report down because of lower profits from higher beef prices.
Management would very much like you to look at the results while excluding Longhorn: "Individually, Olive Garden, Red Lobster and the Specialty Restaurant Group saw absolute operating profit dollar and margins increase this quarter."
It was frustrating for investors. To have one page of your portfolio hold you down is not fun. But, maybe we can look for the silver lining here. Although Longhorn Steakhouse saw profits and margins down for the quarter, total sales grew 12.7%. The margins, and consequently profits, were not the result of poor sales. Sales were actually really strong.
The Beef
Beef has been sliding down a troubling slope. 100% ground beef in January of 2009 cost $2.36/pound. This past July prices hit $3.09/pound. That means in 3 and a half years, prices are up about 31%. That has well outpaced inflation.
2012 has been tough because of the record drought that affected virtually all the farmland in the United States. Higher feed leads to higher prices. Darden, not wanting to raise menu prices, simply absorbed this added cost. Longhorn from many angles had a very good quarter. But in the end it was these beef prices that robbed them of a good report.
So what does 2013 hold? With feed prices still high, it is likely that farmers are going to go ahead and slaughter their cattle to avoid feeding them all winter long, and to take advantage of the good beef prices. Short term, beef may drop due to a flood of meat on the market. But many are then expecting beef prices to continue spiking throughout 2013.
The Outcome
If beef prices remain high, or even worse, if they continue to rise, Longhorn is going to keep having profitability problems. The damage this does to restaurant profits varies depending on how dependent a chain, or company, is to beef. Companies like Ruth's Hospitality Group (NASDAQ: RUTH) and Del Frisco's Restaurant Group (NASDAQ: DFRG) are very much affected by fluctuations in beef prices, as their primary revenue is driven by their steaks. For example, while Ruth's latest quarter beat expectations, food costs spiked for the company because of "unfavorable beef costs." Del Frisco's costs were up 16.6% this past quarter over the same quarter last year.
While what has been happening at Longhorn Steakhouse is not fun for investors, at least Darden has a diversified portfolio that helps balance out these tough beef prices.
What to Do
I'm planning on staying away from investments in restaurant industry that aren't fairly diversified across several different sub-sectors. Companies that are in the steakhouse arena seem to be a pretty risky investment right now. Companies that are well distributed over a variety of segments, like seafood and Italian, seem to be the safer investment. Darden has many challenges ahead, but they do have diversification in their favor.
thequast has no positions in the stocks mentioned above. The Motley Fool owns shares of Darden Restaurants. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
