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Darden: Where Low Expectations And Mediocre Performance Meet

Posted: Sep 19, 2008 10:05 AM by Stephen Simpson

Tickers in this Article: DRI, EAT, CAKE, SYY

All things considered, I guess Darden Restaurants (NYSE:DRI) did OK by its investors in its most recent quarter. After all, the operator of Olive Garden and Red Lobster outperformed the market. Of course, that is a pretty low hurdle these days. (If you're interested in the restaurant business, check out Sinking Your Teeth Into Restaurant Stocks.)

Investors Didn't Expect Much, And Darden Delivered
Darden actually pre-announced the quarterly numbers back in August, so there were not any big surprises in Tuesday's announcement. Same-store sales were down about 1%, operating margins contracted and earnings were down by double-digits. What's more, management didn't really say anything terribly new in regards to future estimates. (Want to understand a bit more about what goes on between the lines? Then check out Analyzing Operating Margins.)

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I'm still a little surprised at the internal details of some of the numbers, however. For starters, the company paid about $1.4 billion to acquire RARE Hospitality about a year ago … but LongHorn Steakhouse and Capital Grille are the company's worst performing concepts right now, and don't look poised for a quick turnaround. Now, is this because the company underestimated the competition, or is just because there hasn't been sufficient time for these two concepts to become fully "Darden-ized"?

On a more positive note, the company's Olive Garden chain has now posted 56 straight quarters of positive same-store sales. When you think about all of the competition out there - whether Brinker International's (NYSE:EAT) Maggiano's Little Italy or Cheesecake Factory (Nasdaq:CAKE) or the host of Tipsy McStagger's look-alikes - that's an incredible accomplishment.

All Aboard the Pain Train
When thinking about what Darden Restaurants is likely to experience over the next year, I'm reminded of the Clubber Lang quote from "Rocky 3": "My prediction… Pain!".

The company's management is admittedly not looking for robust same-store growth (flat to up 1%), but even that may be tricky. What's more, the company's prediction of low single-digit net cost inflation next year might prove to be optimistic. All sorts of agricultural commodities have traded higher and nobody, from farmers to suppliers like Sysco (NYSE:SYY), are going to just surrender their margins to help out their old buddy Darden.

Bottom Line
Now here's the part of investing that makes you go gray just a little faster. The fact is that this is usually the time you want to think about buying high-quality stocks like Darden Restaurants. Current valuations are pretty attractive relative to past levels, and I don't see anything about the company's performance that suggests the business won't rebound when consumers come back out of their bunkers.

That isn't to say that the stock couldn't fall from here (perhaps by a lot) and give investors a sour stomach for a while, but that's the inherent paradox of skillful investing - the best time to buy is often the time when everybody is trotting out the bear case and you feel like a fool for buying. The good news/bad news of this current malaise, however, is that investors probably have a fair bit of time to mull over decisions like this.

For related reading, see Buy When There's Blood In The Streets.

By Stephen Simpson

Stephen Simpson, CFA, has worked as an equity analyst for both sell-side and buy-side investment companies, and presently works as a sell-side equity research analyst. He has worked as a consultant for the healthcare sector, and has written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson is the editor of Kratisto Investing, a website devoted to financial analysis and personal commentary.

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