Market Overview

A Closer Look at Darden Restaurants

Darden Restaurants (NASDAQ: DRI) is the world's largest full-service restaurant company. It operates the restaurant chains Red Lobster, Olive Garden, LongHorn Steakhouse, The Capital Grille, Bahama Breeze, and Seasons 52.

Darden's annual revenue is projected to grow $3-4 billion in the next five years from the $7.53 billion generated in fiscal year 2011, according to company officials. Officials also expect Darden's total unit count to rise by 520 restaurants, from 1,894 units in 2011 to 2,414 in 2016. Darden plans to expand in the following three ways:

1. Expansion of “Synergy” Sites

Darden has begun co-branding Red Lobster and Olive Garden. In the new co-branded stores, the two famous chains will share one roof and kitchen. “Darden plans to open two more [co-branded stores] in early 2012. We're looking at markets where that fits that general bill, and where we couldn't have a stand-alone Red Lobster or a stand-alone Olive Garden. So far we've been pleased [with the synergy model],” says Rich Jeffers, Darden's spokesman.

2. International Expansion

In August 2011, Darden entered into a formal area development agreement with CMR to develop and operate Darden's Red Lobster, Olive Garden and The Capital Grille brands in Mexico. The agreement calls for CMR, which is Mexico's leading casual dining company, to develop a minimum of 37 restaurants in Mexico over the next five years.

3. Acquisitions

In November 2011, Darden acquired eight Eddie V's Prime Seafood and three Wildfish Seafood Grille restaurants for $59 million. The two chains will become part of Darden's Specialty Restaurant Group, which includes The Seasons 52, Bahama Breeze and Capital Grille brands. Darden believes this will help it capture a broader audience.

Going forward, Darden says it will continue to focus on adding brands that complement those it currently owns. More acquisitions are expected in 2012.

Below is a list of the pros and cons surrounding Darden:

Pros:

1. Amid growing calls for healthier options for young people, Darden has targeted a 20% reduction in calories and sodium in its meals for children over the next decade. Darden, which owns 1,900 restaurants in 49 states, is the latest US restaurant operator to offer healthier meals to children, following similar moves by McDonald's and Burger King.

2. From the financial statistics below, we can see that Darden generally performs better than the industry average. Its P/E and PEG indicate that its priced reasonably right now.

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Cons:

1. Costs for Darden are noticeably higher than before.

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From looking at the ratio of operating expenses divided by gross profit – as seen in the above quarterly income statement – it becomes apparent that costs have become much higher, having increased every quarter of 2011. It's perhaps necessary to ask whether this is a temporary phenomenon that can be offset by the good cash flows in the future, or if there are long-term administrative problems because of the company's aggressive multi-pronged expansion plan.

2. Olive Garden is the core brand for Darden. For the quarter ending on November 27, 2011, Olive Garden's U.S. same-store sales fell 2.5%. Meanwhile, sales increased at Red Lobster and LongHorn. Olive Garden's disappointing sales, along with increased commodity costs, contributed to a 28% drop in Darden's profits from the same quarter last year.

3. Zacks Investment Research downgraded Darden from a Neutral rating to an Underperform rating. Analysts at Zacks wrote, “Although Darden Restaurants, Inc. registered improving blended comparable restaurant sales for the last few quarters, recent woes at Olive Garden continue to nag Darden. Stiff competition resulting in higher discounting rates and promotional offers, increasing food costs for the upcoming quarter and cautious consumer spending add further woes to the worry.“

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