Darden Restaurants is a Master Class in Restaurant Operations
Prologue: In spite of the banking crisis, recession fears, inflation and weak consumer sentiment, Darden Restaurants stock is trading at an all-time high. Remarkably, even though the stock is up nearly 20% over the last twelve months, it is one of only 9 other restaurant stocks that currently has a dividend yield over 3%.
We have found Darden management commentary, especially following quarterly earnings reports, to be candid and informative relative to industry developments. In this update we will review management comments from the most recent conference call to highlight how the company has been able to produce industry leading operating performance in the full-service restaurant sector.
CEO, Rick Cardenas:
“I will say, go back in our history since we’ve been a public company, we’ve never had a 10-year period that we have had less than a 10-year — 10% annualized total shareholder return. So, we feel confident over the long run that we’re going to get to 10% to 15%.”
THE BOTTOM LINE
There are very few mysteries underlying success (or failure) within the restaurant industry. Analysts, operators, equity investors and lenders should experience very few surprises, if they are paying attention to the details, almost all of which are readily apparent.
As long-time readers know, we believe that listening/reading restaurant conference calls helps investors and restaurant industry competitors understand how industry-wide challenges such as staffing, commodity inflation, unit growth and product innovation are dealt with. After reading the transcripts of over thirty public restaurant companies, it becomes clear that, relative to their peers, Darden is among the “best of breed” in terms of running a full-service restaurant company. Moreover, we view Darden management to be uniquely candid and descriptively informative in this regard. They apparently have no fear of tutoring their competitors, since the “walk” is a lot more difficult than the “talk”.
Our word to the wise to Darden’s competitors in the full service casual dining industry: If you can’t provide your employees with the quantitative and qualitative benefits (as described by Darden) you will be hard pressed to attract the best personnel.
Focusing on Employees has Numerous Benefits
While every management team talks about the importance of their employees, especially their frontline employees, Darden’s commitment to helping their employees be the best at their jobs continues to manifest itself in very tangible ways. For example, in their last earnings presentation, Darden has the following slide that shows all of the awards the company has won for Employer of Choice and Best Practices. These awards are given based on metrics such as employee turnover, a brand’s employee retention as well as sales and traffic performance, gender, and racial diversity.
On the recent earnings call, management highlighted again the numerous ways that Darden has been able to separate itself from many of its competitors in terms of operating performance. For example, in the latest quarter, the company’s same store sales performance outpaced the industry by 450 basis points, and their same-restaurant guest counts performed even better as they exceeded the industry benchmark by 700 basis points. Unlike many competitors, Darden is again providing full staffs at both the frontline and manager level. Management described the competitive advantage as managers can spend more time training and developing their team members. A well trained staff improves the guest experience, leading to a virtuous cycle of repeat business, higher tips and the best possible front line service.
“Our restaurants continue to be well staffed, and our manager staffing remains at historic highs.”
“And I think, obviously, we’re in an environment where it’s important to kind of retain people and continue to pay better than your peers. How does that kind of factor into what you expect from a wage inflation perspective going forward?”
CEO Rick Cardenas:
“We have more managers per restaurant than we’ve ever had in our history. So, we feel really good about where we are. But we have a great employment proposition. Our turnover is significantly reducing. We’re hiring great people and we’re being as discerning as we had been before COVID.
“We’ve actually spent a lot more time, as I said on our last call, every one of our General Manager, managing partner conferences in August, talked about how to make each brand a better place to work — an even better place to work. Our first 90-day turnover is significantly improved from where it was just six months ago because of the focus that we’re putting on training and making sure that those team members feel up to speed before they get thrown out on a busy Friday.
“The manager role in our restaurants is the most important role we have, especially the general manager, the managing partner. And being fully staffed there gives them more time to spend with their team and train their team, develop them, make them stronger and just spend that time forecasting their business and spending time with guests. If you’re under staffed with managers, the restaurant doesn’t run as well. But the other thing about being fully staffed with managers and we have the highest staffing in our history, is that that helps us open restaurants going forward, right? If you think about our pipeline of new units, we have about 25 net openings coming in this quarter, and we are ready for it with the managers that we have. So, there’s a lot of benefits of being fully staffed so managers can spend more time with their team, they can spend more time with guests, and we have the managers to open our restaurants.”
Another Way in Which the Company’s Focus on Their Employees Show Up is with Better Customer Satisfaction Scores.
While the food quality must be high to maintain guest satisfaction, Darden’s results clearly show that food is not the only competitive advantage. Management constantly talks about how customers view Darden brands as providing a great value relative to other brands. Part of this is due to Darden underpricing inflation by over 400bps since Covid. But another important factor is the overall dining experience. The more engaged and motivated the staff is, the better the dining experience, and the more likely the customer is to return, all leading to the virtuous cycle described above.
CEO Rick Cardenas
“We know from our recent engagement survey results that our overall level of engagement is very high, and our team members understand what is expected of them at work. This is helping drive high guest satisfaction metrics, both internally and externally. Data from the American Customer Satisfaction Index shows customer satisfaction is down across all industries. However, across all of our brands, our internal guest satisfaction ratings remain exceptionally strong. In fact, Cheddar’s Scratch Kitchen, Yard House and Bahama Breeze achieved all-time highs during the quarter. Additionally, for the second consecutive quarter, the Darden brand was ranked number one among major casual dining brands in each measurement category within Technomic’s industry tracking tool.”
Darden’s Guest Traffic Continues to Hold Up Better than the Industry.
It is no secret that, over the last few years, most casual restaurant chains have seen a meaningful decline in guest traffic. Some chains are reporting that traffic is still 10-15% below 2019 levels. However, because of the company’s emphasis and success on training and maintaining managers and employees, Darden is significantly outperforming its competitors in terms of guest traffic trends.
CEO Rick Cardenas
“We significantly exceeded the industry benchmarks for same-restaurant sales and traffic, outperforming more on traffic than we did on sales. We also continued to underprice inflation, resulting in lower overall check growth relative to the industry. Our ability to make this investment and provide strong value to our guests reinforces the power of our strategy, which comes to life through our four competitive advantages and executing our back-to-basics operating philosophy.
“This same restaurant sales performance outpaced the industry by 450 basis points, and our same-restaurant guest counts performed even more as they exceeded the industry benchmark by 700 basis points. During the holiday season, Olive Garden and LongHorn Steakhouse set new all-time weekly sales records, only to break them during Valentine’s week. In fact, all of our brands achieved record total sales for the quarter. Even with the traffic growth we achieved during the quarter, to-go sales remained strong, accounting for 26% of total sales at Olive Garden, 14% at LongHorn and 12% at Cheddar’s. We continue to leverage technology to make it easier to order a pick up and pay without having to pass the added expense of third-party delivery on to our guests.. For example, to-go orders accounted for 33% of Olive Garden’s total sales on Valentine’s Day. 700 basis points of outperformance is pretty strong. It all really depends on what the total traffic growth is for the industry. If we do — if the industry is growing at 1%, do we expect to get 7% every quarter in outperformance, no? We’re very pleased with that outperformance of 700 basis points this quarter, but we wouldn’t expect to be 700 basis points every quarter. And there might be quarters that we have lower performance and traffic than our competition. But we think about this over the long term. And over the long term, we expect to outperform.”
Observations Re: Consumers Continuing to Dine Out in Spite of Economic Headwinds
While we tend to focus on bottoms up analysis of restaurant companies, many readers are interested in the impact of macro-economic trends. Management gave some very insightful observations that we believe readers can benchmark against other restaurant companies.
CEO Rick Cardenas
“What’s interesting is, for most of calendar year 2022, customer sentiment was pretty bad, but consumer spending was significantly high. So even though they were thinking that things were bad, they were still spending. And so, we think as long as the unemployment rate is low and wages are increasing, consumers should continue to spend.I will also say the data from our proprietary brand health tracker suggests that most consumers are not pulling back from restaurant visits, and they do not appear to be trading down from full service to limited service based on the data that we have. Now there is a tension between what people want and what they can afford. Consumers continue to seek value, which is not about low prices, consumers are making spending trade-offs. And food away from home is one of the most difficult expenses to give up because going out to a restaurant is still an affordable luxury for them. And so, what does that mean for us? For our brands, we believe that operators that can deliver on their brand promise and value will continue to appeal to consumers, despite economic challenges. And that’s what we remain focused on doing, no matter what happens in the industry and whatever happens to the category. The good news is we haven’t seen a material change in mix from the last time we talked to now in that lower end consumer. But if it manifests itself, it generally starts with managing check. Generally, consumers will manage their check first, and then they’ll manage their visits later. And so far, we really haven’t seen a whole lot of check management. So, that tells you, based on what I said earlier, consumer sentiment was pretty bad in ’22, but consumers still spent. And as people shifted to restaurants, we benefited. So, we haven’t seen it yet. We may see it. And when we do, it will start at check probably and then it will impact probably more likely impact our lower-end consumer brands, not that they’re lower end brands, they just have a bigger mix of lower-end consumers, and it will impact less our high-end brands.
“So I guess the question is the grocery in terms of total number of meals consumed is still bigger than restaurants, actually multiple, maybe 2-plus x restaurants depending on how you want to calculate it. Grocery pricing has actually been well in excess of restaurant pricing. It remains so now. When you guys think for it and this is, I guess, a forward-looking question, really a view of your industry. Grocery pricing often follows commodities. Commodities are expected to drop just in your own language from what was 10-plus percent to very low single digits. Is there like a way to kind of be prepared for grocery kind of retaking relative value relative to restaurants? And is that something that you think about internally and maybe to Jon Tower’s question of maybe bringing back some advertising, bringing back some promotion just to make sure that you’re keeping customers maybe the bottom 5% or 10%, whatever you want to say, still coming to your brand and using the brand even if year-over-year groceries and other brands, perhaps limited service included, start to emerge as a pricing opportunity for them.”
CEO, Rick Cardenas:
“One of the things I want to let everybody make sure they hear is we’re not going to risk margin, significant margin declines because of what happens in the economy. If food costs go down, think about what we’ve said in the past, a 1% decline in commodity inflation will offset a 2% decline in traffic, all else equal, with us doing nothing. So if commodity costs come down and inflation comes down, we can weather a little bit of a traffic decline and still get to the same EBITDA……So, I think we have to think — and the industry has to think long term about how they drive traffic through discounting. And we have made that shift, even started it before COVID to drive traffic through better experiences, better overall value and not discounting to a very small — a small portion of our guest base. So, that’s our strategy going forward. If things change, we’ll let you know.
Construction Costs are Increasing, But Opening Volumes are Above Average and Offsetting Those Increases.
One of the biggest problems facing restaurant chains that are growing units is rising construction costs. Darden is one of the few companies that provides detailed numbers about construction costs of new restaurants at the brand level. Comparing the numbers from FY19 to FY23 shows the increase in costs per square foot over the last four years. The company will provide updated information in its 10K that will be filed after the next quarterly report.
What is interesting is that the company says that the returns on the new, more expensive units are actually similar to the returns it was achieving before the increase in construction costs because the new units are opening at volumes that are above historical levels.
CFO Raj Vennam:
“As far as the comment on the returns, when we look at our new units actually — especially the recent openings have actually outperformed on the top line more than we expected going into. So, they are actually opening at most of our brands. They’re opening at volumes that are exceeding what we would have estimated going into the — when we approved the capital for the project.
SUMMARY: AS DESCRIBED IN “BOTTOM LINE” ABOVE