Darden Gains From Cheddar's Acquisition, But Competition Is Rife

Darden Restaurants, Inc. DRI's effective sales-boosting initiatives, Brand Renaissance Plan and synergies from Cheddar's acquisition put the company on growth trajectory. However, high costs related to restaurant operations and stiff competition in the industry remain major concerns.

Last month, Darden posted mixed third-quarter fiscal 2018 results, wherein earnings surpassed the Zacks Consensus Estimate while revenues lagged the same. Also, both earnings and revenues in the last reported quarter grew 29.5% and 13.3%, respectively, from the prior-year quarter.

The company's relentless efforts in improving the basic operating factors of the business — food, service and atmosphere — remain the key growth driver.

Cheddar's Acquisition Drives Top Line

Darden's acquisition of small restaurant chain, Cheddar's Scratch Kitchen (Cheddar's), in April 2017, added an undisputed casual dining value to the company's portfolio of differentiated brands. It also helped Darden to further enhance its scale.

In the fiscal third quarter, total sales were favored by 11.3% from the addition of 154 Cheddar's and 34 other new restaurants. Segmental sales also improved owing to Cheddar's integration in the Other Business segment, which jumped 71.4% year over year to $438 million in the last reported quarter.

Brand Renaissance Plan for Olive Garden & Other Sales-Building Efforts Boost Comps

Darden implemented a set of initiatives under its Brand Renaissance Plan to boost the performance of the Olive Garden brand. These include simplifying kitchen systems, improving sales planning and scheduling, operational excellence to improve guest experience, developing new core menu items, allowing customization and making smarter promotional investments.

Also, the brand is focusing on remodeling and bar refreshes. The revamped restaurants are already generating high same-restaurant sales and returns. In fact, the remodeling program has gained momentum in the last couple of quarters and the company intends to continue investing in remodeling for optimal returns. In fact, supported by these initiatives, Olive Garden posted the 14^th consecutive quarter of positive comps in third-quarter fiscal 2018.

Meanwhile, Darden is also focusing on technology-driven initiatives like the system-wide rollout of tablets, in order to capitalize on the digital wave that has hit the U.S. fast-casual restaurant sector. This initiative has boosted sales for the past few quarters. Sales of the company have also picked up momentum with the launch of mobile ordering in November 2014.

High Costs Pose Concern

Higher labor costs due to increased wages and those incurred on implementation of the Affordable Care Act are expected to continue keeping Darden's profits under pressure.

Further, the non-franchised model makes the company susceptible to increased expenses. Since all the restaurants are owned and operated by Darden, so instead of signing franchise agreements and putting the burden of costs on the franchisee, the company is solely responsible for the expenses of operating the business.

In fact, in the first nine months of fiscal 2018, total operating costs and expenses increased 14.4% year over year.

Competitive Industry Puts Pressure on Darden

Darden operates in the retail restaurant space that is highly dependent on consumer discretionary spending. Although higher disposable income and increased wages are favoring the industry right now, it can change with the slightest disruption in the economy. Darden, therefore, is highly vulnerable to the inconsistent nature of consumer discretionary spending. If the company does not make pragmatic use of advanced technologies to innovate across value chains, it has high chances of fading out like many other retailers. In fact, for the restaurant industry as a whole, the fourth quarter comps were up by a meager 0.4% after seven consecutive quarter of declining comps.

Moreover, the retail restaurant space is highly competitive as numerous restaurant operators are adapting advanced and prudent strategies to increase their sales. These initiatives involve high costs. Darden also is bearing the brunt of higher operating cost from these sales building initiatives. In fact, in the first nine months of fiscal 2018, total operating costs and expenses increased 14.4% year-over-year. Amid such stiff competition, Darden is also missing out on international presence that other restaurant chains like McDonald's MCD, Domino's DPZ and Yum! Brands YUM are aggressively pursuing.

We believe that the company needs to expand its presence beyond the United States in order to offset the impact of cut-throat competition in the saturated domestic market.

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