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DARDEN (DRI) REPORTS EXCELLENT QUARTER WITHIN TOUGH ENVIRONMENT, WHAT’S COOKING?

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DARDEN (DRI) HAS EXCELLENT QUARTER IN STILL TOUGH ENVIRONMENT, WHAT’S COOKING?

Darden Restaurants, Inc. (DRI) has just proved to be the exception to the recent rule among restaurant operators. They reported an excellent quarter, with blended same store sales up 3.3%, and traffic up a bit (which hardly anybody else is accomplishing).

Having just listened to the conference call with analysts, we consider the dialogue to be a short tutorial on “best practices” within the casual dining industry. For the sake, among our readers, of operating executives, we think the blocking and tackling fundamentals that are driving the results, as described by Gene Lee, CEO, are worth paying attention to.  As Gene pointed out, perhaps echoing Nick Saban, the world class coach of The Crimson Tide football team, it’s “all about the process”.

Summarizing the numbers, DRI beat the estimates for same store sales (a blended 3.3%) and EPS, improved store level EBITDA margins slightly (which is a rarity these days) and raised SSS and EPS guidance for the year slightly. The rise in EPS guidance was mostly a function of the very low tax rate just reported. As impressive as  anything else was the traffic improvement in the quarter, accompanied by slightly better store level EBITDA, better than almost anybody else in Casual Dining.

The most pertinent operating details include:

Olive Garden’s 5.3% comp was accomplished with an emphasis on value and convenience, and a 13% improvement in off premise sales, bringing that portion of the business to 13%. (More on this “opportunity” later.) Longhorn had a 3.1% positive comp, guest counts were up 0.3%, had only one price promotion in the quarter, versus two a year ago, trying to move to more full pricing, and menu mix was positive by 1.8%. Off premise at LH was also positive but no number was given.  Cheddar’s had SSS of negative 4.4%, still rebuilding operational standards. The original company operated Cheddar’s stores were down 2.3%, reacquired stores were down 6.7%, with obviously more work to do. The new President at Cheddar’s has been previously with DRI’s Bahama Breeze, obviously well thought of. Food and beverage costs were positive by 20 bp (pretty good these days), labor costs unfavorable by 70 bp (wage inflation of 5%, expected to continue), other restaurant expenses favorable by 20 bp, EBITDA at store level impressively improved 20 bp to 18.2%. G&A expense better by 30 bp. The tax rate in the quarter was only 4%, and was the primary reason they beat analyst estimates by about $0.10. The normal tax rate these days would be about 12%. In terms of guidance, total sales for the year are expected to be up 5-5.5%, SSS up 2-2.5%, diluted EPS $5.52 to $5.65, all up slightly.

Of more interest to us, and we think to operators among you, was the qualitative discussion. We urge you to read the full transcript, which we will be happy to forward to you upon request, and the highlights were as follows:

Casual dining, and QSR are in a “war for talent”. Consumer confidence may be at a high, but not all boats are rising. Only those restaurants adequately staffed and properly trained, can deliver against the potential increased demand. The 5% reported increase in labor costs, which is expected to continue, is not a result of management “reinvesting tax savings”, but a necessity in a tighter labor environment. Parenthetically Gene Lee added that is is “hard for lower volume businesses to attract great team members”, and that is obviously a competitive advantage for DRI. Broadly speaking, DRI management considers that their chains “cannot grow rapidly without strong management retention, the key to successful and sustainable growth”.

dCheddar’s is improving steadily, indications are positive, a result of intensive attention, leadership, organizational structure, working on process, simplifying and standardizing operations, increased accountability.  They are expecting and monitoring day to day and week to week improvement, and “it will happen”. Only when operational standards are being met will unit expansion take place, the objective being 7-10% unit growth, with a backfill strategy, considered the top of the growth range that allows operational standards to be maintained. (An interesting commentary from this excellent operator, juxtaposed against the 35% unit growth at Shake Shack (SHAK), about which we have cautioned) Applied more broadly to all  DRI’s concepts, restaurant chains  “cannot grow rapidly without strong management retention, the key to driving sustainable growth.”

The improvement at Olive Garden is a function of a healthier consumer, four years of focus on the core consumer, putting value back into the menu, continuously searching for new ways to improve the value proposition, staying engaged and relevant to the customers while staying “true to who we are”, especially trying to appeal to Millennials.

Size and scale is one of DRI’s core strengths.  It helps to improve the employment proposition, which supports the consumer proposition.  This ties into attracting, hiring, and retaining key employees. DRI is continuously trying to become more efficient at non-consumer facing functions, allowing for more investment at the store level.

There was very strong reaction by Gene Lee when discussing third party delivery. While there is a strong focus at DRI on off-premise, 13% of sales at OG and growing at 13%, with an objective of getting to 20% of sales, third party delivery tests are not encouraging. They are not happy with the economics of third party delivery, they doubt it will “enhance the brand” with “how it is executed”, and aren’t confident it “can enhance growth with scale”. They want to protect the current profitability of the current off premise business. A bit of detail was provided regarding DRI’s off premise activity. They cater with an order of at least $100, ordered 24 hours in advance. They have no interest in delivering a $10 meal. They are very proud of the “packaging and process” within OG’s off premise activity.  Their goal is to be “on-time and correct”, and creation of a compelling experience in this regard. In summary, Gene Lee said “I do not expect to go with a third party, I really don’t like that business”. My take: Never say never, but those are his words as if this morning.

Lots of lessons here.

Roger Lipton

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DARDEN RESTAURANTS

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 COMPANY OVERVIEW (2018 10-K):

Darden Restaurants, Inc. is a full-service restaurant company based in Orlando, FL As of May 2018, the Company owned a total restaurant count of 1,746 divided among two Fine Dining restaurant chains: Eddie V’s Prime Seafood and the Capital Grille; and six Casual Dining restaurant chains: Olive Garden, Longhorn Steakhouse, Bahama Breeze, Season’s 52, Yard House and Cheddar’s Scratch Kitchen (the latter having been acquired on April 24, 2017).

As of May 28, 2018, Darden also has 71 restaurants operated by independent third-parties pursuant to area development and franchise agreements (franchise locations listed below).

The following table details the number of Darden owned and operated restaurants as well as those operated under franchise agreements as of May 28, 2018.

Combined the Company generated $8.1 Billion in revenue in FY-2018 (ending May 2018) (see Annual Segment Breakdown).

The restaurants are organized into four segments: Olive Garden, Longhorn Steakhouse, Fine Dining (The Capital Grille and Eddie V’s) and Other Businesses (Yard House, Seasons 52, Bahama Breeze and Cheddar’s Scratch Kitchen).

 RESTAURANT BRANDS:

Olive Garden – The largest full-service dining Italian restaurant operator in the United States and is the largest and most mature of Darden’s concepts. It offers a variety of Italian fare, including: Classic Tuscan favorites and a broad selection of Italian wines; all presented simply with a focus on flavor and quality.

Most dinner entrees’ prices range from $10-$20, lunch entrees’ range from $7-$15. During FY-2017 check average was $17.50 (up 50¢ YOY) of which 6.8% was for alcoholic beverages.

Longhorn Steakhouse – Restaurants are located primarily in the eastern United States. Operating in an atmosphere inspired by the American West and features a variety of menu items including: Signature Steaks, as well as Chicken, salmon, shrimp, ribs, pork chops, burgers and prime rib.

The price range of dinner entrees is $12-$25; lunch entrees range from $7.50-$15.50. The average check in Longhorn’s restaurants in FY-2017 was $20.50 (up 50¢ YOY) of which 9.6% was for alcoholic beverages.

Fine Dining Segment:

The Capital Grille – Fine dining restaurants with locations in major metropolitan cities featuring relaxed elegance and style in a private club-like setting. It specializes in nationally acclaimed dry-aged on premises steaks. The Capital Grille is also known for fresh seafood flown in daily and culinary specials created by its chefs. The restaurants feature an award-winning wine list offering over 350 selections. Dinner entrees range in price from $10-$62; lunch entrees range from $12-$39. The average check in The Capital Grille restaurants in FY-2017 was $77 (up $2 YOY; includes one Capital Grille Burger Restaurant in fiscal 2018 opened in March 2018 in Washington D.C.) of which 29.1% was for alcoholic beverages.

Eddie V’s – Also a fine dining restaurant located in major metropolitan areas with a sophisticated and contemporary ambiance featuring live nightly music in the V-Lounge. Eddie V’s is the only Darden concept that does not offer a lunch day part. The menu is inspired by the great classic restaurants of New Orleans, San Francisco and Boston emphasizing prime seafood flown in daily from around the world, USDA prime beef and chops, and fresh Oyster Bar selections, Dinner entrees price range from $20-$61. The average check in FY-2017 was $91 (up $1 YOY) of which 31.2% was alcoholic beverages.

Other Business Segment:

Seasons 52 – A sophisticated casual fresh grill and wine bar concept operating primarily in the eastern United States. It offers a seasonally changing menu inspired by the appeal of a local farmer’s market. The menu includes an international collection of more than 100 wines with 52 available by the glass. Most dinner entrees are priced between $14-$32 and most lunch entrees range in price from $10-$32. During FY-2017 the average check was approximately $45 with alcoholic beverages accounting for 25.2%. Season 52 maintains different menus across its trade areas to reflect geographic differences and customer preferences.

Bahama Breeze – A full service concept operating primarily in the eastern United States that offers guests the feeling of a Caribbean escape with food and drinks and atmosphere found in the islands. The menu features distinctive Caribbean inspired fresh seafood, chicken and steaks as well as handcrafted tropical cocktails. Most lunch and dinner menu entrees are priced between $7.50-$30. During FY-2017 the average check was $28.50 with alcoholic beverages accounting for 23.8%.

Yard House – A full service restaurant designed to be a gathering place for lunch, happy hour, dinner and late night for a younger crowd offering a classic “Rock” ambiance. It operates in major metropolitan areas across the United States with an American menu that includes 100 chef driven items, along with a wide range of appetizers, snacks, burgers, steaks, street tacos, salads, sandwiches, fresh fish and a wide selection of beers. Lunch and dinner entrees prices range from $9-$33. The average check for Yard House in FY-2017 was $31.50 of which 37.3% was alcoholic beverages.

Cheddar’s Scratch Kitchen – DRI’s newest acquisition that was completed April 24, 2017 is located primarily in the South and East United States. The casual dining menu features modern classics and American favorites cooked from scratch. Most lunch and dinner menu entrees’ prices range from $5.99-$19.99. Of its 165 locations, 25 are franchised. Historically, DRI has declined to franchise its brands domestically; but, management has not detailed its franchising plans for Cheddar’s.

Internationally, the Company franchises Olive Garden, The Capital Grille and Longhorn Steakhouse. Currently, there are approximately 40 locations with Area Development Agreements for about 150 in such countries as Puerto Rico, Malaysia, Mexico and Qatar.

COMPANY STRATEGIES (Source 10-K):

Darden believes they are capable operators of strong multi-unit brands and that the breadth and depth of their experience and expertise sets them apart in the food service industry. Aside from the obviously required restaurant operating expertise, included in the specifics of this is brand management, maintaining strong supply chain, and information technology. With this philosophy as a backdrop, Darden’s strategy is focusing on by providing an outstanding guest experience rooted in their culinary inheritance and innovation, attentive service, engaging atmosphere and integrated marketing.

To achieve these objectives, Darden’s strategic goals, as they state them, are:

Growing Same Store Sales:  They are focused on improving culinary innovation and execution inside each of their brands, delivering attentive service to each and every one of their guests, and creating an inviting and engaging atmosphere inside the restaurants. Darden supports these priorities with smart and relevant integrated marketing programs that resonate with their guests. By delivering on these operational and brand-building imperatives, they expect to increase their market share through new restaurant and same-restaurant sales growth and deliver best-in-class profitability.

The Darden Support Structure helps in (1) driving advantages in supply chain and general and administrative support; (2) applying insights collected from their  significant guest and transactional databases to enhance guest relationships and identify new opportunities to drive sales growth; (3) driving operating efficiencies and continuous improvement, operating with a sense of urgency and inspiring a performance-driven culture; and (4) their commitment to rigorous strategic planning.

Darden Seeks to Increase Profits by: leveraging their fixed and semi-fixed costs with sales from new restaurants and increased guest traffic and sales at existing restaurants. To evaluate operations and assess financial performance, Darden monitors a number of operating measures, with a special focus on two key factors:

  • Same restaurant sales – which is a year-over-year 52-week comparison of each period’s sales volumes for restaurants open at least 16 months, including recently acquired restaurants, regardless of when the restaurants were acquired; and
  • Segment profit – which is restaurant sales, less food and beverage costs, restaurant labor costs, restaurant expenses and marketing expenses (sometimes referred to as restaurant-level earnings.

DARDEN’S RETURNS TO SHAREHOLDERS

The current dividend yields 2.68% to shareholders at this price. The Company has consistently bought back shares in recent years, $27M in Q4’18 and $235M for all of ’18, and a new $500M program has just been implemented. In fiscal ’18, $550M was “returned to shareholders” between dividends and share repurchases, $1.5B over the past three years. Though the stock has gone through periods of lackluster performance over the more than twenty years it has been publicly held, it has done exceptionally well over the long term. DRI is up close to 40% in the last twelve months, up around 250% in the last five years, more than quadrupling since its lows of ’08-’09.

 RECENT DEVELOPMENTS (Per Q4’18 and Y/E’18 Reports, Q4 Conf. Call)

 Darden continued its strong performance, especially relative to its peers, in Q4 and the full fiscal year ending 5/18. Same store sales were up for almost all brands in both periods, the consistent results especially impressive considering the broad portfolio of brands. All but Cheddar’s performed about the same for Q4 as for the full year. The two most important concepts, Olive Garden and Longhorn Steakhouse were up about 2.5%. Capital Grille was up in the high 2s. Eddie V’s was up about 4%, Yard House was up a little more than 1%, Seasons 52 (my favorite) was flat. Only the recently acquired Cheddar’s was down, 4.7% in Q4 and 2.0% for the year.

On the conference call, management discussed their operating initiatives brand by brand.

Olive Garden is targeting their marketing, simplifying operations and the promotional calendar, emphasizing a weekday lunch offering. Dinner offerings included Giant Stuffed Fettuccini and Giant Meatball. Off premise sales grew 9% to 13.8% of total sales for the quarter. Discussion about Delivery as a long term opportunity to build on that number were set aside by management as an area that still requires a great deal of evaluation, in terms of satisfactory representation of the brand, the margin on the business, and the ownership of the names and data. Longhorn had their 21st consecutive quarter of SSS growth. Efforts included menu simplification, reducing operational complexity. The Fine Dining brands, Capital Grille and Eddie V’s continued to do well. Capital Grille is increasing capacity in certain units. Yard House is also simplifying operations, which has improved cost of goods and labor productivity. The concept has four productive dayparts, so there are lots of opportunities to build sales. Bahama Breeze had the 14th consecutive quarter of SSS growth. Seasons 52, with SSS up just modestly, improved traffic by 2.1% in Q4, improving the value perception with a 3-course offering that includes a starter, an entrée, and an indulgence. Cheddar’s is being “integrated”, including a transition to Darden’s proprietary POS system. While this was happening, marketing activities were suspended, no doubt affecting SSS comparisons, especially since Q4 a year ago was heavily promotional. With the integration complete at Cheddar’s, attention is being shifted to the “operational foundation”.

Relative to the Q4 P&L, Cost of Goods was favorable by 60 bp, labor unfavorable by 90 bp. The tax rate was 290 bp lower in Q4 versus last year.

Looking forward, management expects total sales to be up 4-5% in fiscal 2019, ending May. SSS are guided to 1-2% and there will be 45-50 new restaurants, costing $425-475M. Commodity inflation will be 0-1% and Labor inflation 3.5-4.5%. The earnings guidance in the range of $5.50-$5.56 per share includes incremental synergies from the Cheddar’s acquisition of about $13M, an effective tax rate of 11-12%, and approximately 125M average shares outstanding, just slightly less than 126M fully diluted in ’18. The number of shares repurchased could obviously be somewhat accretive.

 

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