Darden Restaurants, Inc. (NYSE:DRI), the parent company of Olive Garden, Red Lobster and LongHorn Steakhouse, has stalled out over the past three years, despite bouncing back strongly from the depths of the recession. Once a strong growth stock in the 1990s, Darden’s full-service diners are now being abandoned in favor of fast growth bistro chains such as Chipotle Mexican Grill, Inc. (NYSE:CMG) and Panera Bread Co (NASDAQ:PNRA), which provide high quality fast food at a cheaper price.
Although Darden’s third quarter earnings topped Wall Street estimates, the company is still struggling to stave off negative same-store sales growth and declining profits. Should investors abandon this former icon of the American restaurant industry for moreprofitable restaurants instead?
Third Quarter Earnings
For its third quarter, Darden Restaurants, Inc. (NYSE:DRI) earned $1.02 per share, or $134.4 million, an 18% decline from the $1.25 per share, or $164.1 million, it earned the previous year – but it topped the analyst estimate by a penny.
Revenue grew 5% from $2.16 billion to $2.26 million, matching the consensus estimate.
Sales Growth
Darden’s combined same-store sales, primarily generated by its three flagship restaurants, slid 4.6%. Darden Restaurants, Inc. (NYSE:DRI) attributed the drop to adverse winter weather conditions in December and February. The company’s same-store sales drop of 9% in February, accompanied by a 7% decline in store traffic, was its steepest monthly loss during the quarter. As a result, same-store sales dropped at all three brands.
Longhorn Steakhouse’s revenue rose 6.9% to $332 million, due to the addition of 42 new locations. Same-store sales dropped 1.6%.
Meanwhile, Olive Garden’s revenue edged up 0.6% year-over-year to $962 million. Darden added 42 new Olive Garden restaurants, which contributed to the positive sales growth, a reversal of its decline over previous quarters. However, same-store sales still slid 4.1%.
Red Lobster fared the worst, logging a 6.0% drop in revenue to $669 million, while same-store sales plunged 6.6%. Darden only added three new Red Lobster restaurants during the quarter.
However, Darden’s specialty restaurants – which include Yard House, Bahama Breeze, Seasons 52, Eddie V’s and The Capital Grille – posted the strongest growth, with revenue soaring 61% to $287 million. During the quarter, Darden added 43 Yard House, five Bahama Breeze, seven Season 52 and three The Capital Grille locations. All of its specialty restaurants posted positive same-store sales growth, except for Bahama Breeze, which declined -0.3%.
Although Darden’s rapid expansion has kept revenue flowing in, there are some problems with the company’s key financial metrics.
Since the end of the recession, expenses and debt have risen, while free cash flow and cash have decreased. Therefore, it might not be prudent to continue expanding simply to generate more revenue while these metrics are all apparently headed in the wrong directions.
Being everywhere is not a good thing
The main problem with Darden Restaurants is the public perception of its three flagship brands. Driving around any town in America, two of the brands – Olive Garden and Red Lobster – seem to be next to every strip mall or interstate highway. Simply put, they are as common a sight as McDonald’s or Taco Bell, but more expensive.
That’s why we’re seeing stronger growth from its specialty restaurants, as well as softer declines from LongHorn Steakhouse, which is smaller and has less saturation than Olive Garden or Red Lobster.
Shifting trends in dining
Two companies have changed the American perception of dining more than any others: Chipotle Mexican Grill, Inc. (NYSE:CMG) and Panera Bread (NASDAQ:PNRA). Prior to the arrival of these two brands, restaurants were generally classified as ‘fast food’ – like McDonald’s – or ‘full service’ – like Olive Garden.
Chipotle, which serves organic Mexican food, and Panera, which sells sandwiches, soup and salads, have blurred the lines between the two classifications and disrupted the market with a no-frills bistro dining experience. In other words, customers are getting higher quality food for a lower price without having to pay tips for the full dining experience.
A quick comparison of the top and bottom line growth of Chipotle Mexican Grill, Inc. (NYSE:CMG), Panera, McDonald’s, Yum! Brands, Inc. (NYSE:YUM) and Darden reveals the obvious shift in dining trends.
Simply put, people like the ‘pay at the counter’ approach to purchasing reasonably priced, healthier food – but it’s not a trend that Darden is completely oblivious to. Darden recently announced that it was testing the “Seaside Express” format at two Red Lobster locations, which use a ‘pay at the counter’ approach similar to its bistro rivals.
Although the concept is still experimental, it raises some interesting questions. Can Red Lobster re-brand itself as a no-frills bistro experience?
I believe the market has room for an affordable seafood bistro, which could offer unique fare such as seafood sandwiches, soups and salads. However, Darden also runs a high risk of cheapening its own brand and turning Red Lobster into the next Long John Silver’s.
However, investors shouldn’t get too excited about these baby steps. Although the company’s specialty restaurants show promise, its three main brands are simply losing their appeal in mainstream America.
Right now, Panera and Chipotle – which were built from the ground up to be disruptive – are winning the battle, as seen in the following fundamental comparison.
Although Darden appears to be a fairly undervalued stock at current levels, Chipotle and Panera are landing the blows where it counts – in margin growth and same-store sales. Although Chipotle Mexican Grill, Inc. (NYSE:CMG) and Panera are considered more expensive stocks, they deserve to trade at a premium due to more robust top and bottom line growth.
The Foolish Bottom Line
In fiscal 2013, Darden expects to earn $3.06 to $3.22 per share, in line with the analyst estimate for $3.16 per share. It forecasts revenue to rise 6% to 7% to $8.48 billion to $8.56 billion, also in line with the consensus estimate of $8.51 billion. In other words, it expects bland growth for the year ahead. However, bland and boring might be good for an income stock – Darden pays a quarterly dividend of $0.50 per share, a 4% yield at current prices.
In conclusion, there are simply better restaurant stocks out there than Darden. Darden is still trying to find itself, and it is heavily weighed down by the saturation of its three main brands. Customers in 2013 desire a more unique dining experience than a night at the Olive Garden – and that’s why the company will continue struggling in the foreseeable future.
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