Dardens Struggles to Remain Relevant

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Restaurant group Darden (NYSE: DRI), owner of chains like LongHorn Steakhouse, Red Lobster, Olive Garden, and Yard House, warned that its second quarter results will be weaker than expected. Net operating earnings are expected to total $0.25-$0.26 per share, well below the consensus estimate of $0.46 per share, with $0.05 lost due to the acquisition of Yard House and one penny lost to Hurricane Sandy.

Perhaps the most surprising portion of the announcement was the momentum we were seeing going into the quarter, particularly at Red Lobster and LongHorn. Olive Garden saw same-store sales fall 3.8% in September, 3.9% in October, and 2% in November, driven mostly by huge drops in traffic. Red Lobster, which had finally seen some more stable footing after adjusting pricing, saw same-store sales fall 7% in October and 2.8% in November after a roughly flat September. Even LongHorn, which has been the standout restaurant of the group, saw a decline during every month of the quarter, though traffic held up much better than it did at the others.

The firm also cut its guidance going forward, slashing its revenue growth outlook to 7.5%-8.5% from its previous guidance for 9%-10%; it also cuts its same-store sales growth outlook to the range of -1% to 0%. Earnings had previously been forecasted to grow 5%-9%, but now the company expects earnings of $3.29-$3.49 per share (net of Yard House costs), which implies an earnings decline.

What’s going on at Darden? Management seemed to acknowledge the severity of the situation, mentioning that promotions from previous years are not working and that it needs to shift strategies. Unfortunately for Darden, we think the company is encountering some powerful headwinds that are damaging its largest brands. With the emergence of Panera (NASDAQ: PNRA), Chipotle (NYSE: CMG), and other “high-end” fast food options, we think the dining space is becoming increasingly competitive, especially as consumers continue to seek value.

In addition to providing quality food at a cheaper price, these fast-casual concepts often exclude wait-staff, saving consumers a few extra dollars each trip. A premium item, Panera's signature salad sales surged 11.6% year-over-year during the third quarter (salad sales have known grown at least double digits for 12 of the last 13 quarters). The firm also noted that the roasted turkey and avocado BLT sandwich propelled signature sandwich sales 28% during the period. Panera’s continued focus on new products should help drive traffic gains while competitors’ menus stagnate.

Even Chipotle isn't looking so hot after the previous quarter. We thought the firm’s guidance was negative, but not alarming for the company’s long-term growth story. Every company hits a critical mass when momentum begins to retreat and sales growth starts to stall—exactly what we believe has happened to the burrito maker. The company’s focus on keeping costs reasonable and creating excellent products has not wavered, so we certainly don’t think Chipotle is heading towards extinction anytime soon.

Furthermore, Darden has to deal with concerns about the healthfulness of its food, particularly the carb-heavy Olive Garden and the fat-heavy LongHorn Steakhouse. Higher-income consumers tend to prioritize healthfulness, so we think the company could be losing sales from both ends of the market—one squeezed by income, while the other is squeezed by waistlines.

We like the acquisition of the Yard House brand, which focuses on premium alcohol sales and premium bar foods. However, considering the lackluster results of BJ’s Restaurant (NASDAQ: BJRI), which we’d consider a similar concept, we question how well the Yard House is growing sales in the current environment. Same-store sales at BJ's grew just 2.3% in the most recent quarter, compared to 6.5% during the same period a year ago. We think the company could be overestimate the resiliency of its concept.

Even after a decline in the share price, we continue to believe shares are fairly valued (the share price falls within our fair value estimate range). We’ll be monitoring the company’s change in marketing and promotions, but we currently believe fiscal year 2013 will remain fairly challenging. A score of 4 on the Valuentum Buying Index (our stock-selection methodology) suggests that the near-term picture doesn’t look too great.

Valuentum has no positions in the stocks mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill, Darden Restaurants, and Panera Bread. Motley Fool newsletter services recommend BJ's Restaurants, Chipotle Mexican Grill, and Panera Bread. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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