FISCAL YEAR ENDS – MAY
MOST RECENT QUARTER – FEB ’22
MOST RECENT CONFERENCE CALL TRANSCRIPT
MOST RECENT CONFERENCE CALL SLIDE PRESENTATION
FISCAL YEAR ENDS – MAY
MOST RECENT QUARTER – FEB ’22
MOST RECENT CONFERENCE CALL TRANSCRIPT
MOST RECENT CONFERENCE CALL SLIDE PRESENTATION
THE WEEK THAT WAS, ENDING 3-25 – ANALYSTS ALREADY LIKED WINGSTOP, WENDY’S, FIRST WATCH, DARDEN, ONE COMPANY UPGRADED, WHICH WE WROTE UP A MONTH AGO
FIRST WATCH (FWRG) AND DARDEN (DRI) PROVIDE GOOD REPORTS, HARD NOT TO LIKE THEM. ARCO DORADOS (ARCO) GETS UPGRADED
RE: First Watch (FWRG), ANDY BARISH, JEFFREY BERNSTEIN, GOLDMAN SACHS, continue to like it. ANDREW CHARLES wants to see more (I guess).
RE: Darden (DRI), BRIAN VACCARO, LAUREN SILBERMAN, JAMES RUTHERFORD, JEFFREY BERNSTEIN, analysts at Morgan Stanley all continue to like it. NICK SETYAN wants to see more (I guess).
RE: Wingstop (WING), NICK SETYAN likes it, in spite of Charlie Morrison leaving.
RE: Wendy’s (WEN), IVAN FEINSETH likes it.
RE: Arcos Dorados (ARCO), ROBERT FORD upgrades to BUY.
RELEVANT TRANSCRIPTS FROM MOST RECENT CONFERENCE CALLS.
THE SEARCH FOR VALUE CAN START WITH OUR “CORPORATE DESCRIPTIONS” – SIX FRESH WRITEUPS HERE: NOODLES, DARDEN, ARK, GOOD TIMES, RCI HOSPITALITY, FLANIGAN’S – this website contains similar writeups on every publicly held restaurant company.
Jack in the Box added to Jefferies Conference – 1:30PM today, link below
Ark Restaurants (ARKR)
Good Times Restaurants (GTIM)
RCI Hospitality (RICK)
Jack in the Box Presentation at Jefferies Conference: 1:30pm EST – link below
DARDEN (DRI) REPORTS STRONG AUGUST QUARTER, DRIVES STOCK TO ALL TIME HIGH, SUPPORTS FULL SERVICE CASUAL DINING SECTOR
Darden (DRI) reported a strong quarter, driving its stock up 6.1% today to an all time high of $159. The “pin action”, as this is written, has moved Bloomin’ Brands up 5.25%, BJ’s up 4.3%, Cracker Barrel up 4.0%, Brinker up 6.3%, Ruth’s Chris up 4.1%, Red Robin up 7.1%, and Texas Roadhouse up 2.5%.
We consider Darden management, led by CEO Gene Lee, to be “best of breed” among full service dining companies, and their conference call commentary is uniquely candid and invariably instructive. The following is a summary of the results and their conference call discussion. We have underlined what we consider the most insightful of their remarks.
Q1’22, ending 8/29/21, in which the Company bought back $186M of stock, showed EBITDA of $370M, and diluted EPS from continuing operations of $1.76/share. That compares to 8/25/19 when EBITDA was about $288M and EPS was $1.38. Over the same two year period consolidated comp sales were up 4.8%, including Olive Garden (OG) down 1.5%, Longhorn Steakhouse (LH) up 20.9%, Fine Dining (FD) up 12.6%, and Other Business Virtually Flat.
MARGIN AND SALES DISCUSSION
The two year comparison, from Aug’19 to Aug’21 showed: CGS 150 bp higher with investments in food quality and pricing below inflation, labor 110 bp lower due to efficiencies from operational simplification, including a narrower menu at OG, (partially offset by higher wages), Other Operational expenses 110 bp lower due to sales leverage, and marketing 220 bp lower. Consolidated restaurant level EBITDA at DRI was 290 bp better at 20.9%, and G&A was 30 bp higher (mostly stock compensation). Q1 at OG showed flat sales (because two years ago included “Buy One, Take One”) with segment profit margin up 220 bp. LH showed sales up 26% with profit margin up 250bp. Helping at LH is the 40% fewer crew members than at OG and relatively heavy geographical concentration in states such as GA and FL. Fine Dining sales were up 24% with profit margin up 490bp, as pent up demand and increased Sunday dining have helped. The digital platform continued to grow, representing 60% of all off-premise sales, and off-premise sales were 27% at OG, 15% at LH. They had previously used PayPal (used for 25% of mobile app transactions) and added Apple Pay and Google Pay during the quarter.
INTRA-QUARTER SALES TRENDS, SEPTEMBER SO FAR
Q1 sales started strong in June, strengthened further and peaked in July, slowed in August with the Delta Variant, finishing Q1 at +4.8% cumulatively. Company comps are up 7% first three weeks of September. There have been some cancellations of large parties inside Fine Dining, but management still expects a strong holiday season.
STAFFING & SUPPLY CHAIN COMMENTARY
Top priority in Q1 was staffing of restaurants. Introduced was a new talent acquisition program that allows applicants to apply and schedule an interview within 5 minutes or less. Social media and a digital platform is netting more than 1,000 new team members per week, and staffing is now 90% of pre-Covid levels. The success of this enhanced recruiting effort has been more important, one way or another, than the ending of supplemental unemployment benefits. Staffing has been complicated by the contract tracing and quarantining requirements when an employee has been exposed to one of the Covids. While stores are not 100% staffed, management does not believe they will need as many as previously due to productivity improvements during Covid. Hoping to hang on to current margins, as sales and operations normalize. (“no reason why we can’t hang on to these margins”).
Another important influence during Q1 was the supply chain challenge, as shortages and higher freight costs are now leading to 4% cost inflation and a planned 2% menu price increase.
Guidance versus the pre-Covid year ending 5/20 includes total sales growth up 7-9% over the two years. Total cost Inflation is expected to be about 4%, with commodities up 4.5% and total restaurant labor up 5.5%, including hourly inflation of about 7%. For the year ending 5/22, management expects EBITDA of $1.54B to $1.6B, with diluted EPS of $7.25 to $7.60 on $9.4B of sales. Have to go back to the year ending 5/19 to get a full year’s normalized comparison, which was $8.5B of revenues and $5.73/share of earnings from continued operations. Over three years, therefore, from 5/19 through 5/22 sales would be up about 10% and EPS (at the ’22 midpoint of $7.43) would be up about 30%.
OFF PREMISE, INCLUDING DELIVERY
They are not going to promote delivery, and don’t want to go too aggressively after off-premise in general (“on the weekends, we have to throttle the off premise business”) because they don’t want to affect dine-in operations. A modest catering effort is improving but is not significant to the total.
There is very little couponing now, only about 1% of sales, and the check increase has only been about 2.5% over the last two years, less than the industry average of about 5%. The sales strength at LH can be attributed to its geographical footprint in states like Fl and GA. Fine Dining sales trends are still lackluster in major cities like NYC (down 40%) and others, but there has been an uptick in Suburbia, apparently from pent up demand and better Sunday activity. “Last 6-8 weeks have felt some pressure in Georgia and Florida….Texas in a world of its own, Northeast is performing OK but has never really come back, have felt the Variant to varying degrees in Tennessee, KY, West Va…..Doesn’t make sense to advertise aggressively when restaurants are still not 100% staffed…we’re not going to know what the full potential at equilibrium is for a while…we don’t want to be discounting off a value platform……we’ve got to figure that out….we need to see what the competitive environment is…..and see what the economic backdrop is. Darden has not been pushing the Loyalty program during Covid, considering it a form of discounting (to highest use consumers)… “we were seeing positive trends in our loyalty program, a point based discount program, but we don’t think that is the right way, in the long run, to do loyalty in the restaurant business”.
FULL SERVICE CASUAL DINING – WE GO TO SCHOOL WITH GENE LEE, CEO OF DARDEN (DRI)
Gene Lee, and his management team at Darden (DRI), provide about the most candid description of current fundamentals among the publicly held full service casual dining companies. Not only are their reported results about the best in the industry, but they describe, on their quarterly conference call, how and why. Our summary below is of “best practices”, as produced by Darden, and the outlook as presented within their conference call on June 24th.
Darden’s most recent reporting period was their fourth quarter, ending at the end of May. Their two largest chains are Olive Garden and Longhorn Steakhouse. Important, but less material, are Cheddar’s Scratch Kitchen, Yard House, The Capital Grille, Season’s 52, Bahama Breeze and Eddie V’s.
GENE LEE’S SCRIPTED COMMENTARY
Gene Lee, CEO, commented that they have begun to see demand come back strongly. They are relying on Technomic for industry data, which quantifies the casual dining industry at $189B in 2020, down from $222B in 2019. Though the industry has shrunk by 10% in units during the pandemic, Darden believes the industry will at least regain the 2019 level, implying that AUVs could be higher than before. Not mentioned was “price”, but that would obviously contribute to higher nominal sales.
Lee considers that the Darden business model has improved over the last year. “We’ve invested in food quality and portion size….made investments in our team members to ensure our employment proposition…..and we invest in technology, particularly within our to-go capabilities, to meet our guests growing need for …the off premise experience.”
RICARDO CARDENAS’ (COO) SCRIPTED COMMENTARY
Ricardo Cardenas, President and COO, described the operational simplification effort, which has improved execution and strengthened margins. Even as dining rooms have reopened, off-premise sales have remained strong, proving to be “stickier” than expected. During Q4 off-premise was 33% of sales at Olive Garden, 16% at Cheddar’s and 19% at Longhorn. Technology within online ordering has improved to-go capacity management and curbside delivery. During the quarter 64% of Olive Garden’s to-go orders were placed online and 14% of Darden’s total sales were digital transactions. Nearly half of all guest checks were settled digitally, either online or on tabletop tablets or via mobile pay. Cardenas described the effort to recruit and retain operational talent, claiming no systemic issues. Supply chain issues have also been largely avoided.
RAJESH VENNAM’ (CFO) SCRIPTED COMMENTARY
Rajesh Vennam, CFO, described how SSS compared to pre-Covid (2019), improved from negative 4.1% in March to positive 2.4% in May and positive 2.5% in the first three weeks of June. Though to-go sales have seen a gradual decline, this has been more than offset by in-store dining. In the fourth quarter, CGS was 90bp higher (investments in food quality and pricing below inflation), labor was 190bp lower (320 bp of simplification efforts, partially offset by wage pressures). Marketing was 200 bp lower. Restaurant EBITDA margin was at a record EBITDA of 22.6%, 310bp higher than pre-Covid. CGS inflation is expected to be about 2.5% and hourly labor inflation at about 6%.
QUESTION AND ANSWER DISCUSSION
Gene Lee talked further about the “employment proposition”. The store level margin allows for adequate wages, along with promotion of a thousand team members per year into management. When questioned about store level margin expectation, CFO Vennam indicated that store level EBITDA in the short term is expected to be 200-250 bp better than in 2019, with pricing of 1-2%, lower than CPI inflation of about 3%, but full year margin (ending 5/22) has yet to play out. Commodity inflation of 2.5% for the year will be 3.5-4.0% in the first half, expected to tail off to roughly flat by Q4. Chicken and seafood are elevated, also cooking oil and packaging, a little bit in dairy.
Lee feels that the throughput improvements, including menu simplification, allow for more sales capacity from this level. Mother’s Day sales were a record and mid-week capacity is not fully utilized. Consumer behavior is not yet normalized, so the mix between dine-in and off-premise is still uncertain.
When questioned about the sales improvement “flattening” in May and June, CFO Vennam pointed out that promotional levels are not as heavy now as in ’19, obviously helping the operating margins even with sales just modestly higher. Gene Lee commented later that the current advertising is generic, removing all incentives and discounts, with record operating margins, so marketing decisions going forward will obviously be carefully considered. Later in the call, Gene Lee talked about the Fine Dining segment also improving (a little later than Olive Garden and Longhorn) from down 12 in March to down 6 in May.
COO Cardenas described how technology is reducing “friction” in the guest experience, as well as for team members, making ordering and pickup easier. To further improve the process within the restaurant, a revamp of the point of sales system is planned.
Gene Lee talked about the potential to improve direct marketing to new digital customers, especially with the newly acquired ordering preferences. Lee emphasized the effort to improve the craveability of the menu, at the same time simplifying and improving the core items.
Relative to the addition of additional brands, Lee expressed great satisfaction with the improved returns within the existing portfolio. While not ruling anything out, he seemed to feel that there is substantial opportunity to profitably invest internally.
GENE LEE OPENS UP A LITTLE FURTHER
When pushed about why the sales recovery within Darden is not as fast as elsewhere, Gene Lee’s response was telling. “Because we’re not participating giving away food to third-party channels…not discounting heavily….not discounting cash through selling gift cards….we put up 25% fourth quarter restaurant margins….that’s what we’re focused on. A lot has changed…..virtual brands….guys, you got to get off this……this (Darden’s portfolio of brands) is the best business in casual dining, not even by a little bit anymore…..our guests are loving the experience ….they love the changes that we made….but we’re not chasing an index and we’re not chasing where we were in the past. We love our position today.”
Lastly, when questioned about what the new normal will look like, Gene Lee summarized by saying: “I think we’ve still got another six to nine months to understand (if we don’t have any more problems with Covid) what are going to be the normal behaviors….and then you start developing your market plans and you get tactical on how to get these folks into your restaurant or use you as an off-premise occasion.”
DARDEN (DRI) REPORTS SECOND QUARTER – WHAT CAN WE LEARN FROM THE BEST ?
We continue to look for data points and operational discussions from the best operators we can find. This allows our readers who are restaurant operators to consider “best practices”, and our financially driven followers to make more informed judgements about the future. (As Yogi Berra said: “Predictions are always difficult, especially about the future.”)
There is no better operator, among publicly held full service casual dining companies, than Darden, and we view CEO, Gene Lee, as not only one of the most effective leaders in the industry but probably the most candid in terms of what is really happening out there. We therefore report briefly below the financial results (which you can read about in more detail elsewhere), but we like to provide our readers with the “color” that might not be as widely disseminated as the hard numbers.
The second fiscal quarter ending 11/29/20 showed same store sales down 20.6% on a blended basis, which included; down 19.9% at Olive Garden, down 11.1% at Longhorn Steakhouse, down 31.0% in the Fine Dining group, and down 28.6% in Other Business. Though diluted net earnings per share was down to $0.74/sh vs. adjusted EPS of $1.12, don’t worry about Darden. They had net earnings from continuing operations of $97M and EBITDA of$206M. All four segments of the business were profitable, from a low of $50.7M at Fine Dining to a high of $419M at Olive Garden. Relative to current guidance, management guided only to the current (third) quarter, including diluted EPS of $.50-.75/sh and EBITDA of $170-210M.
The most interesting part of the formal report was the sales trend over the last month or so. On a blended basis, comps declined from a negative 23.4% in the W/E 11/8 to a negative 36.9% for the W/E 12/13. Olive Garden fell from down 21.9% to down 32.6%. Longhorn declined from down 12.0% to down 23.3%. The falloff was largely due to fewer restaurants open with at least limited dining room capacity, going companywide from 92% open to 75.4%.
CONFERENCE CALL HIGHLIGHTS
Gene Lee started the call by describing how operations and menus have been streamlined and simplified, all designed to improve the guest experience. 25 million email addresses are now in the database and will be increasingly useful to drive sales. More than 55% of off-premise sales were digitally ordered and paid for, representing 20% of Darden’s total sales for the quarter. Curbside pickup was rolled out during the quarter. Now provided, and apparently important to the guest, is waitlist visibility, whether ordering online or in person.
At Olive Garden, sales were limited by capacity restrictions, but operational efficiencies, the simplified menu and the elimination of promotion discounts strengthened margins. The marketing spend was directed to showcasing the off-premise experience and compelling menu items, rather than promotions. Off premise sales grew 83% in Q1 and represented 39% of sales.
Longhorn concentrated on increasing the quality of the guest experience and simplifying operations. Off premise sales increased by more than 175% and represented 22% of total sales.
Newly named President and COO, Rick Cardenas, described operating details including a reduction in marketing spend of almost $50M in the quarter, down 210 bp YTY. Restaurant level EBITDA margin was 17.9%, up 140 bp YTY. As of the moment, 77% of the restaurants have at least partial dining room capacity, versus a peak of 97% in the middle of Q2. Guidance in the current quarter included EPS of $0.50-0.75/sh, EBITDA of $170-210M and sales down 25-30% YTY. The broad range of Q3 expectations and the lack of further guidance are a function of the general uncertainties affecting the industry and the broad economy. Comp sales are down about 26%, blended, in the third quarter to date, ending last Sunday.
Gene Lee started his further commentary by describing the emergency pay program which provides three weeks of compensation to team members furloughed from dining room closures.
Lee talked about no definitive plans to gear up marketing in the near term. Development of new restaurants is also up in the air, openings on hold until 50% occupancy is a reality. The business model from the cost side is much stronger than it was pre-pandemic, so cannibalization can be less of a factor. Technology is a key going forward, and Lee described “clarity that this is going to be a curbside business.”
The Q&A session described how the cash contribution of marginal sales right now is 50%, used to be closer to 40% and some of those costs will come back as the sales mix stabilize. Going forward, cost of goods could be a bit lower and labor a little higher ($15 minimum wage spreading) so overall store level margin will be basically back in the same place.
Gene Lee, responding to a question about the potential of ghost kitchens, said Darden is an on-premise restaurant company. He expects the on-premise sales to come back stronger than ever, accompanied by some reduction of the off-premise side. Off-premise will be auxiliary, presumably higher than at pre-pandemic levels. Importantly, his view regarding delivery remains: “Logistics of moving that last mile….really cuts into the profitability and something that we don’t want to be involved in”. He also said that the guests don’t like to look at menus on the phone and the waitlist visibility now in place is important. Technology can be further improved off-premise but he doesn’t see a great deal of technological advances in-store. Regarding “virtual brands”: Lee wants to stay focused on running the brands that they have spent years building, rather than diluting the operational effort.
There is a strong focus currently on ensuring the appearance and quality of the food 30-50 minutes after it has left the restaurant. Streamlining the menu has helped to improve the quality of the remaining items. Family packs are an increasing emphasis within the off-premise effort. Regarding the use of handheld devices and other technology advances, Lee views these developments as more important to speed and satisfaction of the guest than cost savings. The company is committed to keeping service levels high, viewed as an important differentiator for the various Darden brands.
DARDEN RESTAURANTS, INC. (DRI) REPORTS Q4 – ALWAYS A LOT TO LEARN!
Darden Restaurants, Inc. (DRI) reported fourth quarter and yearend, 5/31/20 results late last week. The fourth quarter was predictably dismal, with total sales down 43.0% to $1.27 billion, obviously as a result of the coronavirus pandemic that directly affected March, April and May. Same store sales were down 39.2% at Olive Garden, down 45.3% at Longhorn Steakhouse, down 63.1% at Fine Dining (62.5% at The Capital Grille and 65.25 at Eddie V’s) and 65.4% for Other Businesses (58.5% at Cheddar’s, 70.7% at Yard House, 69.9% at Season’s 52, my favorite, and 66.1% at Bahama Breeze).
The Company lost $1.24 per share ($154.6M), after excluding non-cash items of $2.61 per share primarily relating to goodwill, trademark, and restaurant level impairments.
It’s no surprise that Darden lost a fortune in Q4 ending May, reducing operating costs wherever possible, focusing on off-premise sales activity to minimize losses, etc. We consider Darden to be one of the premier multi-concept full service casual dining operators on the planet, admirably transparent in disclosure and commentary. Rather than rehash the financials, which our readers can access elsewhere, we prefer to discuss the highlights of the conference call. Many of our readers are full time restaurant operators. For their purposes, it’s more convenient and less expensive to listen carefully to CEO, Gene Lee and his capable team than to retain highly paid, and, probably less qualified, consultants.
To start with, sales after firming from the lows of late March through April and May, continued increasing the last week three weeks into June.
THE BUSINESS STRUCTURE HAS EVOLVED
Online ordering has increased more than 300% at Olive Garden, more than 400% at Longhorn, 58% and 49% of which is TO GO, respectively. Off-premise is obviously a major ongoing emphasis, in the hope that an important part of it can be retained after dining room activity has been rebuilt. It was disclosed that 10-15% of the restaurants are already comping positively, where there was a solid off-premise business, mid-week and mid-day business.
Darden has transitioned to accepting delivery orders as small as $50 (averaging well above that), ordered by 5pm the day before, delivered by third parties. The pandemic accelerated the consumers’ desire for convenience, in particular through digital engagement and Darden focused on helping the guest easily order both in and out of the restaurant, improving the wait to be seated, streamlining the order pickup and payment process . Contactless curbside pickup creates almost a “drive through in our parking lots”, and may be the future core of off-premise consumption.
Menus have been streamlined. Advertising and promotions have been reduced, because (as we interpret it) customers are more interested, for the moment, in convenience than “value”. As the business remains in a major state of flux, Darden will go slow in reintroducing their loyalty program, adding back menu items or re-engaging with the extreme value oriented customer. As they put it: “we’ve improved productivity in our restaurants through more streamlined menus. We’ve got to really go through that discovery process. I think the big work that needs to be done is to think about what we need to do inside the box to better support and stage curbside if it’s going to be that big part of our business….right now we don’t think it’s prudent to be promoting people into our restaurants ….. long waits to get into the dining rooms…. would just be creating more frustration for our guests to get in…..taking this opportunity to cleanse our marketing spend to understand as we put it back in what works better, what gets us the highest return on investment……don’t think this is the right time to be advertising. We think this is the right time to pull it back….then we’ll start to layer some advertising back in and promotion back in….the most significant thing we’ve done is streamline the menus and our processes and procedures and that’s forever.”
THE Q4 PANDEMIC RELATED COSTS WERE SUBSTANTIAL
The pandemic related expenses were discussed at length. New labor related expenses include permanent sick leave, emergency pay, child care costs, pay and benefits for furloughed employees, as well as previous Q4 targeted store manager bonuses. Health and safety programs for team members include health checks, personal protective equipment, enhanced sanitation processes, social distancing and frequent hand-washing. Frequent paid sick leave is provided at the same time that guests are cautioned to not enter the restaurants if they are symptomatic. In addition to the permanent paid sick leave, a three-week emergency pay program provided nearly $75 million during the fourth quarter to hourly team members who could not work.
THE RE-OPENING PROCEEDS (HOPEFULLY)
Management commented on the call that, as the opening phases progress, the 6 foot social distancing comes into play more than whether the restaurant is 50%, 75% or 100% “open” for inside dining. Different seating configurations are being evaluated for maximum efficiency, including partition erection. At the current time, Hourly Labor and Cost of Goods combined are better than a year ago, but the occupancy expense burden is yet to be determined based on seating and the off-premise vs. inside dining breakdown, and the Store Level Management cost will deleverage while sales are lower.
Q1’21, ending AUGUST’20, AND BEYOND
As Yogi Berra put it: “Predictions are always difficult, especially about the future”.
Management is optimistic about getting back to 2-3% unit growth and the possibility of better real estate deals as competitors fall by the wayside. They stated that the Company is currently Operating Cash Flow positive, as of last week, with sales down 30%. Guidance was only provided for the current quarter, at approximately breakeven, with $75M of EBITDA. Just too many uncertainties beyond the next couple of months. They reiterated the planned $250-300M of total capex in the current year, which includes $100-120M of maintenance capex and 35-40 new locations. As we have often pointed out, D&A is not free cash flow.
There’s nobody better than Darden. We look forward to the next installment of “Dining with Gene”.
DINING ROOMS ARE OPENING – WHAT CAN WE LEARN ? + OPERATING COST TRENDS
Darden Restaurants provided an update this morning on sales trends. Darden is a premier operator in the full service casual dining sector so their sales report provides us with an early look into sales and profitability trends. Below is a table showing sales trends, in total and indicating the To-Go portion of Revenues.
We’ve spoken before about the unknown equation, once dining rooms are opened, between how much of the off premise sales are retained as the dining room revenues build. The positive possibility is that a good portion of the off premise increase can be retained even after the dining room revenues have returned close to pre-pandemic levels. We won’t know the answer to this question for a while however, probably not until after a vaccine has allowed dining rooms to operate close to full capacity. In the meantime, we are all interested in cues as to what to expect. It is a given that full service restaurants cannot be cash flow positive with restaurants operating at even 50% of capacity. At 75%, perhaps, if the off-premise portion can be largely retained, but even that is questionable, considering higher labor (and other ) costs.
You can see from the table above that dining rooms contributed about $23.7k of average weekly sales at Olive Garden in the week ending 5/17 out of the $69.6k total (for the 398 or 47% of the system with dining rooms opened). That was accompanied by a decline (from 4/26 to 5/17) in average weekly To-Go sales of $4.7K on the total system. Since only about half the system had opened dining rooms, it is implied that about about 9.4k of To-Go sales per store in the total system was cannibalized, or 40% of the total gain. At LongHorn, it is implied that the 275 units (52% of the system) added about 26k the week ending 5/17 but To-Go sales declined 6.4k in those stores with open dining rooms from 4/26 to 5/17, which amounts to about $13k/store for the entire system, 50% of the overall gain. For our purposes, we figure 50% is an adequate approximation.
We can’t know whether this pattern will prevail, but let’s look at the following simplistic theoretical model. The pre-pandemic model is $5.0M of sales, consisting of $4.5M dine-in and $500k To-Go. The pandemic hits and Dine-In goes away but To-Go becomes an impressive 40% of previous levels or $2M annualized. The pandemic ends. Total Sales go from $2M to $3M, up by $1M, but $500k of To-Go slips away so total sales are $3M-500k or $2.5M (still down 50% YTY). Sales go up another $1M to $4M but we lose another $500k of To-GO (to $1.0M), now doing $3.5M overall (still down 30% YTY). Sales go back to $5M, same as Pre-Pandemic, we lose another $500k of To-GO (to $0.5M) and we’re back where we started. Problem is: in today’s environment costs will be higher so our cash flow and profit margins will be lower. The hope therefore, based on this simplistic model, is that something less than 50% of the overall gain in sales will come from a reduction in To-Go sales, and also that costs won’t escalate.
MARGINS TO BE EXPECTED
It is relevant to the discussion above, as we try to anticipate what the sales recovery (which will happen ) will look like is that costs are inevitably going to be higher. We’ve written before that unintended consequences of the government stimuli will emerge over time. We’ve suggested that supply chain inefficiencies could cause commodity prices to move higher and it was in the news today that egg prices are currently up 38% YTY, ground chuck is up 11% and pork is up 10%. Cheese is much lower, so pizza purveyors can further celebrate.
Labor continues to emerge as the biggest single harmful variable. Crew members that have stayed on the job are receiving hazardous duty pay. Laid off employees are making more staying home than they were at the job so must be lured back with some sort of signing bonus. This trend will not change. If somebody knows where the efficiencies will come from, other than possibly leveraging higher sales someday, we would like to hear about it.
DARDEN’S CASH BREAK EVEN POINT
Darden pointed out today that their current overall corporate cash burn is $10M per week, so that’s a rate of something over $500M per year at the current rate of sales. Darden is a company that has “normalized” revenues of about $8 billion per year, so cash flow is negative by about 6% of the previous level but 12% of the current $4 billion run rate. If we figure that 40% of incremental revenues flows through to cash flow (100%-28% food cost – 16% variable (half the 32% total) labor – 16% variable operating expenses such as marketing, utilities, waste removal, etc.etc.), that would require $1.25B of higher sales from current levels to get to cash breakeven, up 31% from here. GAAP breakeven, covering $336M of last year’s D&A to would require another $840M of annualized sales or 21% on the current sales base, so Darden needs something like a 52% gain in sales from here to achieve break even on a GAAP basis. That assumes that costs haven’t changed. This calculation is not supposed to be precise, but we believe the order of magnitude is instructive. We’re happy to entertain a discussion from the Company, analysts and/or investors, and adjust our analysis if justified.
The above discussion is not intended to single out Darden as a poor investment. We are neither long nor short DRI, and this Company is actually the best managed diversified full service publicly held casual dining operator in the world, as far as we are concerned. It is only because they are so well managed and so consistently candid in their disclosures that we focus on their results. DRI has a lot of wood to chop to get back to where they want to be, and their competitors undoubtedly have at least as much ground to travel.
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.