Economies of scale in sourcing and distribution
Darden Restaurants, Inc. (NYSE:DRI) has delivered consistent operating margins within a narrow range of 8%-10% in every single year for the past decade. This is the result of significant economies of scale.
In terms of sourcing, Darden Restaurants, Inc. (NYSE:DRI) makes more than $2 billion in purchases annually from approximately 1,500 suppliers based in 20 countries. Its diversity in sourcing helps to ensure that the prices of food supplies remain competitive and reduce over-dependence on any particular supply source.
With respect to distribution, the timeliness of delivery is a function of a restaurant’s scale. Many chefs will admit that the freshness of seafood plays a bigger part in the superior taste of their masterpieces, than their culinary skills. With its extensive network comprising 11 distribution centers operated by three distribution partners in the U.S. and Canada, Darden Restaurants, Inc. (NYSE:DRI) is able to deliver food supplies to its restaurants in an effective and efficient manner.
Brand improvement initiatives to address decline in restaurant industry traffic
Weak consumer sentiment and high unemployment rates have contributed to reduced affordability and consequently, lower restaurant traffic in the past few years. Darden has experienced declining same-restaurant traffic of about 7% from fiscal 2008 to fiscal 2012.
Darden has implemented new initiatives over the past year, with the aim of revitalizing its brands and improving consumer affordability. For its Olive Garden Italian restaurant chain, it increased its food variety to appeal to a wider range of guests, particularly focusing on healthier food choices, such as new dishes Lasagna Primavera with Grilled Chicken and Seafood Brodetto, which are below 500 calories.
Also, new core menu additions and value combos such as the $12.95 Chicken Toscano and the 2 for $25 Italian Dinner will help attract more price sensitive customers. With respect to its LongHorn Steakhouse business, Darden launched advertising campaigns emphasizing on the quality and freshness of its beef.
Outlook
While Darden registered a 12% year-on-year decline in quarterly diluted net earnings per share from continuing operations of $1.01 for the fourth quarter of fiscal 2013, there were positive operating trends observed. U.S. same-restaurant sales at LongHorn Steakhouse, Red Lobster, and Olive Garden increased 3.5%, 3.2%, and 1.1%, respectively, in the quarter. In addition, Darden increased its quarterly dividend per share by 10% to $0.55, and currently sports a 4.50% forward dividend yield.
I expect Darden to fully realize the benefits from its brand improvement initiatives in fiscal 2014, with a positive impact on public perception, restaurant traffic, and sales. Management guided for fiscal 2014 sales growth to be between 6% and 8%.
Peer comparison
Darden’s peers in the casual dining space include Brinker International, Inc. (NYSE:EAT) and Buffalo Wild Wings (NASDAQ:BWLD).
Brinker International, Inc. (NYSE:EAT) either operates or franchises close to 1,600 restaurants under the names Chili’s Grill & Bar (representing the bulk of restaurants) and Maggiano’s Little Italy. Brinker International, Inc. (NYSE:EAT) delivered a good set of results in the third quarter of fiscal 2013, increasing operating margin by approximately 70 basis points to 17.9% and earnings per diluted share, excluding special items, by 20% to $0.72 per share. Despite this, Brinker International, Inc. (NYSE:EAT) saw quarterly traffic at its restaurants Chili’s and Maggiano’s fall 3.2% and 1%, respectively.
I expect Brinker International, Inc. (NYSE:EAT) to concede more market share to its competitors in the near-term, as a result of more aggressive promotional activities by its competitors such as Darden. I prefer Darden over Brinker, because of its diversification across multiple concepts in its restaurant portfolio and its high dividend yield. Brinker International, Inc. (NYSE:EAT)’s 2% dividend yield pales in comparison with the 4.5% yield for Darden.
Buffalo Wild Wings (NASDAQ:BWLD) is differentiated from Darden and Brinker with its specialized niche. It is the largest sports bar restaurant chain in the U.S. and is known for its namesake Buffalo Wild Wings (NASDAQ:BWLD), New York-style chicken wings. It reported a 27.8% and 41.4% increase in quarterly revenue and net earnings to $285.4 million and $16.5 million, respectively. Going forward, management has guided for 17% growth in net earnings for full year 2013.
It has outlined plans to leverage on strong domestic growth prospects, through almost doubling its current locations in the U.S. from 900 to 1,700. However, this superior growth profile has been largely factored into Buffalo Wild Wings (NASDAQ:BWLD)’ valuation, with it trading at a significant premium to its peers with a forward P/E of 22. In comparison, Darden and Brinker are valued by the market at about 15 times forward P/E. Furthermore, Buffalo Wild Wings (NASDAQ:BWLD) does not pay a dividend, unlike its peers.
Conclusion
I am positive on Darden for its economies of scale, multiple concept restaurant brand portfolio, and strong brand names. Its brand improvement initiatives should see positive results in the new fiscal year 2014, with Darden gaining market share at the expense of competitors with its new value-for-money product offerings. Moreover, Darden is reasonably valued at 15 times forward P/E with a juicy 4.5% dividend yield, making it a buy in my books.
The article This Company’s Scale Ensures the Freshness of Its Products originally appeared on Fool.com and is written by Mark Lin.
Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Buffalo Wild Wings. The Motley Fool owns shares of Buffalo Wild Wings and Darden Restaurants. Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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