Darden Gains From Cheddar's Acquisition Amid High Expenses

Zacks Equity Research

Darden Restaurants, Inc. DRI continues to gain from Cheddar’s acquisition, various sales-boosting initiatives and cost-saving efforts. However, high costs remain a potential concern for the company.

Shares of the company have gained 24.7% so far this year, outperforming the industry’s 18% rally. We are further encouraged by Darden’s fourth-quarter fiscal 2019 results, wherein earnings surpassed the Zacks Consensus and also increased on a year-over-year basis.

Notably, the company’s earnings met/surpassed the Zacks Consensus Estimate for 19 straight quarters. In fiscal 2020, Darden’s earnings per share are anticipated to be $6.30-$6.45. The Zacks Consensus Estimate for its earnings for the fiscal year is pegged at $6.39, higher than the midpoint of the company’s guided range.

 

Sales-Building Initiatives Aid

Darden’s acquisition of the 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. The chain’s total sales increased 0.6% in the fourth quarter of fiscal 2019. Further, management made significant operational readjustment to the brand, which is expected to reap long-term benefits.

Meanwhile, in order to boost performance of the Olive Garden brand, the company implemented a set of initiatives under its Brand Renaissance Plan. These included 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 the fourth quarter of fiscal 2019, Olive Garden's off-premise business grew 9% and represented 15% of total sales. Also, the brand posted the 19th consecutive quarter of positive comps in fourth-quarter fiscal 2019.

At LongHorn, the company strives to attract guests by focusing on core menu, culinary innovation and providing regional flavors. It is also working on its marketing strategy to improve execution, customer relationship management and digital advertising as well as strong promotional pipeline that leverage the segment’s expertise. Further, the company continues to focus on strengthening its in-restaurant execution through investments in quality and simplification of operations to augment guest experience. Owing to these efforts, segmental comps registered growth for 25 consecutive quarters.

Concerns

Higher labor costs due to increased wages continue to keep 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, instead of signing franchise agreements and putting the cost burden on the franchise, the company is solely responsible for expenses of operating the business.

Total operating costs and expenses increased 4.8% year over year in fiscal 2019. This downturn can be attributed to an overall increase in food and beverage costs, restaurant labor and expenses, and marketing costs. Increase in expenses might hurt the company’s margin in the coming quarters.

Meanwhile, Darden’s restaurants are located in the United States and Canada, and it has no exposure in international markets. While several other fast casual restaurateurs like McDonald’s MCD, YUM! Brands YUM and Domino’s DPZ are capitalizing on the emerging market potential, Darden seems to be slow on this front. We believe that the company needs to expand its presence beyond the United States to offset the impact of cutthroat competition in the saturated domestic market.

Darden currently has a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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