Darden Restaurants (DRI), operating 1,875 locations, is one of the best managed publicly held full-service restaurant companies, owning Olive Garden, Long Horn Steakhouse, “Fine Dining” (Capital Grille and Eddie V’s) and “Other” (Season’s 52 – my favorite, Cheddar’s, Yard House, Bahama Breeze). If anybody can successfully cope with the continuing challenging environment, it is “DRI”. They reported their first fiscal quarter, ending August, basically in line with previous guidance.
Total revenues in Q1 were up 6.1% to $2.4 Billion. Blended same store sales were up 4.2% and EPS was down as expected to $1.56/share vs. $1.76. On a monthly basis, blended SSS were up mid-3% in June, low 1% range in July and about 8% in August (lower gas prices?). Each of the individual segments had positive same store sales and lower profit margins. The Company repurchased $199M of its stock during Q1, with $912M remaining under the current $1B authorization. Guidance for the current year, ending May’23 remained unchanged: SSS of 4-6%, 55-60 openings, diluted EPS of $7.40-8.00/share.
The reported results are of course important, along with the formal commentary and guidance, and there are myriad places to find that information. . For our purposes, since Darden provides more complete and candid conference call commentary than most, we like to report on that event.
THE CONFERENCE CALL
The quarter ending August provided what they called “a return to normal seasonal patterns”. In Q1’, ending August, a year ago, the Covid rebound was in place. Sales were firm, and stores were of necessity understaffed, so comparing against last year’s bottom line was predictably difficult. Restaurant labor was only 50 bp higher, driven by hourly wage inflation of just over 9%, fortunately offset by better productivity. Total restaurant labor inflation, including management, was 7.5%. A larger detriment this year was CGS, up 280 bp, including robust commodity inflation of 15%. Restaurant expenses were 10 bp higher, driven by higher repairs and maintenance due to supply chain challenges and utilities inflation of 16%. Marketing was 20 bp higher, with increased testing of digital and television marketing. G&A expense was 130 bp lower, driven by a $7M reduction in deferred compensation plans and equity compensation expense. While Operating Income margin of 10% was 220bp lower than in August’21, it was 60 bp better than pre-Covid Aug’19.
Blended SSS, as indicated above, were up 4.2% and all segments against Pre-Covid August ’19 (Q1 fiscal ’20) are equally encouraging. Sales at Olive Garden were 3.7% above last year, and average weekly sales (AWS) were 101% of the pre-Covid level, especially promising considering a the heavy promotional activity and couponing three years ago. Long Horn sales were up 6.6% YTY, and AWS were up 126% vs pre-Covid. Q2 Sales in the Fine Dining segment were up 8.6% YTY, and AWS were 120% of the pre-Covid levels. The “Other” segment sales were up 9.9% YTY, and AWS were 109% of the pre-Covid levels.
Looking ahead to the balance of the May’23 fiscal year: EPS will be between $7.40 and $8 for the year. In the Q2 to date, sales trends are above the high end of the annual SSS outlook range (4-6%). Management speculated that lower gas prices recently may be a contributing factor.
Inflation seems to be “just a bit” affecting households making less than $50,000/year, most noticeable at Olive Garden and Cheddar’s. In the first quarter, total inflation was roughly 9.5% and total pricing was approximately 6.5%, almost 300 basis points below inflation, and less than most competitors. It is expected that the gap between pricing and inflation, having peaked in the first quarter., will moderate through the 2nd and 3rd quarters, and reverse in Q4. In the same way, the profit margin decline should moderate in Q2, with commodity inflation somewhat better at 13%, generating positive EPS in the second half, “flat to slightly below” for the full year.
Management’s summary of marketing principles is instructive: “First, it needs to elevate brand equity by bringing the brand’s competitive advantages to life. Second, it should be simple to execute. We will not jeopardize all the work we have done to simplify operations, which allows our teams to consistently deliver exceptional guest experiences. And finally, it will not be at a deep discount. We are focused on providing great value to our guests, but doing that in a way that drives profitable sales growth.”
It sounds like SSS comparisons YTY will continue to be difficult, depending on gas prices, going against the Covid-rebound late last year until the last week of December when, in December ’21, the Variant hit and ran through February’22.
Digital is 10% of total ($240M out of $2.4B) and 62% of Off-Premise, therefore about $387M, which is about 16% of total. Since delivery is minimal, To-Go is essentially the same as Off-Premise, which accounted for 24% of total sales at Olive Garden, 14% at Long Horn Steakhouse and 13% at Cheddar’s, apparently minimal at Capital Grille and the others. Since customers have learned new ways to get served by casual dining restaurants, the result is less dining room traffic, exacerbated by that fact that some consumers are still afraid to eat in crowds. While Long Horn is generating Dine-In traffic above pre-Covid levels, most other brands are not.
Credit to David Palmer, the analyst at Evercore, whose conference call questioning pinpointed the decline in Dine-In activity (at Olive Garden) in comparison to pre-Covid. After a somewhat confusing (to me) discussion of Guest Count Retention (“GCR”), the apparent change in Dine-In traffic, recent Q4 and Q1 vs. pre-Covid Q4 and Q1, Palmer suggested that the recent Dine-In traffic is down about 15% from three years ago. Management responded as follows:
“Yes, David. Let me start by saying your numbers are right. Does that present an opportunity in the dining room? Absolutely. But we’re going to go about it in a manner that’s actually sustainable and that’s where we go back to — over the last three years, we’ve invested so much into under-pricing inflation. If you look at where Olive Garden’s pricing has been over the three years, combined three years is at 10%. When you look at where full-service CPI — restaurant CPI was for the same time-frame, it’s 17.5%. So we’ve actually significantly under-priced the industry and that is the way we believe to build back that guest. And Rick mentioned getting that one extra visit from our loyal guest, we think this is a sustainable, durable way to really get our guests back. I would argue that we’re starting to see the fruit of some of that, but it takes time.”
“The good news is that if our dining rooms aren’t back to full, we’ve got capacity. And as we continue to see some improvement, as we continue to do the things that we have been doing over the last few years, focusing on simplification, making it easier for our teams to do what they do, investing in our food, investing in our teams, then we’re going to have an even better experience as guests come back, and they are coming back. So, that just gives us more opportunity to grow in the long run because our dining rooms in some of our brands aren’t back to pre-COVID levels. That’s being offset in most of our brands by To Go.”
THE TAKEAWAY
Darden, generating almost $10B of sales from 1,875 restaurants is doing as well as can reasonably be expected. Management accurately states four competitive advantages: Significant Scale, Extensive Data and Insights, Strategic Planning, and a Results Oriented Culture. The consistent performance across multiple brands is admirable and there is no indication that they have lost their focus or ability to profitably gain market share. They have emerged from the Covid period in a superior competitive position, and have the financial and operational strength to continue in the same vein. Their commentary indicated that the recently reported firm sales trends are continuing, with less promotional activity than several years ago. Menu pricing has lagged the CPI and that of their peers, so customers should accept increases when necessary. Store level and corporate margins are now approximating pre-Covid levels, so rebuilding Dine-In traffic, if most of the Off-Premise buildup can be retained, could provide margin leverage. It’s been a literal “jungle” out there, but the worst of it could be over in terms of the rate of wage and/or commodity inflation. The Company is “returning cash to shareholders” to the tune of 4-5% stock repurchase (annually) and a dividend yield of about 4%. The balance sheet is strong with long term debt less than one times TTM EBITDA. With (1) unit growth above 3%, (2) same store sales growth assumed in the low to mid-single digits, (3) 4-5% of the stock retired annually, EPS and EBITDA per share annual growth should be in the double digits, and margin leverage could add to that. Darden’s Restaurants (DRI), trading at an Enterprise Value of about 11x trailing twelve-month EBITDA, represents excellent value.
Roger Lipton