DARDEN REPORTS FOURTH QUARTER – AN EDUCATIONAL CONFERENCE CALL AND AN EXCELLENT INVESTMENT VALUE
Darden reported fourth quarter and full year (ending May’22) results late last week. The headlines were mostly positive, but with lowered guidance for the first half of fiscal ‘23. Fourth quarter EPS was $2.24/share, beating estimates by $.02. Guidance for May ’23 was $7.40-8.00/share, below the $8.00+ previously expected. The quarterly dividend was raised from $.1.10 to $1.21 and a new $1 billion stock buyback (about 6% of the equity value) was announced, after buying back $237M in Q4. Comp sales were strong in the fourth quarter: Consolidated same store sales up 11.7%, with Olive Garden up 6.7%, Long Horn Steakhouse up 10.6%, Fine Dining up 34.5% and Other Business up 18.5%.
Beneath the surface, fourth quarter results were not quite as compelling as the headlines, with Q4 segment profit down at both Olive Garden and Longhorn Steakhouse. With the guidance in H1’23 lowered, the stock, after initially rising from $115 to $122, sold off and closed at around $115. It rallied the next day to $127, within a strong daily stock market, and analysts remembering that Darden is THE class act within full service casual dining.
We have long felt that Darden’s quarterly conference calls should be required reading for restaurant operators as well as investors, because management’s candor, as well as long term operating performance, has been “best of breed”. Though long time CEO, Gene Lee, is retired, Rick Cardenas (President) and Raj Vennam (CFO), can be expected to maintain that standard. Within that context, the most salient points as we see them, are as follows:
The general menu pricing strategy is to increase prices slower than inflation. Though sales have softened a touch in June, they are still in the 4-6% guidance range and stronger than industry peers. Operating costs were inflated by 7.5% in Q4, partially offset by pricing of 6% for the quarter and 3% for the year. Food and beverage expense was 300 bp higher in Q4, with food up 12%. Restaurant labor was down 40 bp, driven by operational simplification. Labor inflation was 7% YTY, primarily driven by hourly wages up 9%. Marketing spend was 230 bp lower. G&A expense was 140 bp lower. Restaurant level EBITDA was 19.9%, 40 bp above pre-Covid level. Corporate EBITDA margin was an impressive 16.6%, 170 bp better than pre-COVID. Staffing levels essentially are back at pre-COVID levels. Hourly wage inflation is currently about 8%, total labor (including store management) up about 6%, embedded in guidance.
CONFERENCE CALL “COLOR”
On the conference call, management elaborated regarding sales trends intra-quarter, as well as short term expectations. Comps built from March to April and into May, with a “not dramatic”…“check management” at the modestly priced Cheddar’s. Olive Garden “to-go” is above 25%, Long Horn around 15% of sales, much higher than pre-Covid. 60% of to-go is digital, which is 10-12% of total sales. Darden has not embraced delivery, so the increase in to-go business is a result of investments made to reduce the friction in ordering, paying, and picking up. The much stronger comps at Long Horn, compared to Olive Garden is a result of Long Horn’s pre-Covid “refresh” of its concept.
Reference was made to industry wide sales, including DRI, that have softened in June, but it was suggested that it could be seasonality that didn’t take place last year. On the other hand, management’s reference to current consumer “uncertainty” (as evidenced by horribly weak sentiment surveys), especially visible at the lower priced Cheddar’s, indicates a justifiable reluctance for management to be aggressive with guidance. On the positive side, cost of goods, including chicken and wheat and dairy, in particular, seems to have peaked and is expected to retreat. We suggest that the “2nd derivative” of wage increases (i.e. a change in the rate of increase) may have peaked as well, so, along with recently imposed higher menu prices, there could be further improvement of store level margins. Other than reiterating that store level margins should remain above pre-Covid levels, management did not go as far as we are suggesting. A further indication of management’s optimism is the increase in store openings, 55-60 in the current year, up from 37 in the year just ended.
Readers should review the operating statistics as presented in the “Corporate Descriptions” portion of this website. Below: (These Descriptions are current for every publicly held restaurant company.)
Best of Breed DRI has only rarely traded with an Enterprise Value less than the current 10.3X trailing twelve month EBITDA and equity value about 16x next twelve month EPS. With a secure dividend that was just increased to yield about 4% annually, and a $1B stock buyback in place, DRI represents an attractive long term participation in the casual dining industry. Recession or not, people have to eat and they have lots of options within Darden’s portfolio of well managed brands.