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WEEKDAY TRADER - Barrons.com Jan. 6, 2010
Darden Shares Should Be on the Menu
By MIRIAM GOTTFRIED

The operator of Red Lobster and Olive Garden is better positioned than its peers to deliver market-beating returns.

CASH-STRAPPED CONSUMERS have been avoiding restaurants. But an improving economy is gradually bringing them back to the table.

Darden Restaurants (ticker: DRI), the owner of Olive Garden, Red Lobster, and LongHorn Steakhouse restaurants, should get a boost as its well-priced pastas, porterhouse steaks and steamed Maine lobsters make their way back into household budgets.

The stock has risen 18% over the past year, outperforming the 11% gain for restaurant stocks, but sharply underperforming the Standard & Poor’s 500 as a whole.

At a Glance
Darden Restaurants (DRI)

Stock Price: $34.39
52-Wk High: $41.21
52-Wk Low: $23.32
Market Cap: $4.8 billion
Est. FY 2010 EPS:* $2.74
FY 2010 P/E: 13
Est. Long-Term EPS Growth:** 12%
Est. (FY’11/FY’10) EPS Growth: 10%
Revenue (trailing 12 months): $7.2 billion
Dividend Yield: 2.9%
CEO: Clarence Otis Jr.
Headquarters: Orlando, Fla.
*Darden Restaurants’ 2010 fiscal year ends May 30, 2010.

**Based on analyst estimates looking ahead three to five years.

Source: Thomson Reuters
But Darden is poised to outperform the broader market, along with its peers. It has avoided the deep discounts of other casual chains, and though sales in restaurants open at least a year remain negative, the company’s sales continue to beat peers’.

Darden’s core concepts — Olive Garden (Italian) and Red Lobster (seafood) — dominate their respective niches nationwide, unlike the crowded bar-and-grill category.

To be sure, betting on a restaurant recovery in an economy that’s improving in fits and starts has risks. But Darden is well-managed and has built-in defenses.

Analysts say same-restaurant sales will be flat in the second half of fiscal 2010 — which ends May 30 of this year — and should start to creep back into positive territory in fiscal 2011. Year-over-year comparisons will start to ease, and sales are already showing sequential improvement.

Darden trades at 13 times analysts’ estimates for fiscal 2010 earnings and 11 times estimated fiscal 2011 earnings. The stock also boasts a dividend of 2.9%. Analysts are projecting price appreciation of 15% to 30% over the next year.

“There’s generally a lot of cash flow,” says Stephen Anderson of MKM Partners. “They have the flexibility to pay down debt and build new restaurants. I think that now they’re gaining more confidence in the economy and share buybacks are on the horizon within the next 12 months.”

Analysts agree the task for Darden will be getting customers through the door. Combined sales at Olive Garden, Red Lobster and LongHorn locations open at least a year were down 3.9% in the second quarter, which ended Nov. 29. That compares with a decline of 5.9% in the Knapp-Track benchmark of U.S. same-restaurant sales (excluding Darden), but it leaves much to be desired.

Competitors have used discounting to try to boost traffic, but MKM’s Anderson says Darden’s resistance to across-the-board price cuts has helped it stay ahead of companies like Brinker International (EAT), which owns Chili’s; DineEquity (DIN), owner of Applebee’s; and privately held Outback Steakhouse.

Many of these companies have resorted to discounts that don’t typically bring in enough volume to make up for the decline in the average meal tab, he says.

Darden has used promotions in a more targeted way. This week, for example, the company introduced a “$29.99 seafood dinner for two” at Red Lobster to boost post-holiday sales. The promotion amounts to a 12% discount, compared to the 25% to 35% discounts offered at some bar-and-grill chains.

“They may lose some short-term sales [by not discounting as heavily], but this management is successful because they’re able to have a long-term view,” says Jamie O’Neil, a partner at Cooke & Bieler Investment Counsel, whose firm owns Darden shares.

O’Neil says Darden’s nuanced promotional strategy exemplifies its superior management. Many top Darden executives come from General Mills (GIS), which spun off Darden in 1995.

To do that, Darden advertises heavily, outspending competitors by three to five times, says Larry Miller, an analyst with RBC Capital Markets. Darden spent about $310 million on advertising in the last fiscal year, compared to $113 million for Brinker.

Darden’s management is also skilled at capitalizing on the efficiencies that come with scale, continually working on cost-reduction programs. A new automated monitoring system brought inventories down more than 22% in the fiscal 2010 second quarter, compared to the second quarter of fiscal 2009, amounting to less waste.

Robert W. Baird analyst David Tarantino says the company has a natural defensive hedge. Lack of demand from restaurants and food processors has kept many of Darden’s primary commodity costs low throughout the recession, a trend that will only be reversed when customers return and margins can be met with top-line growth.

Darden has extended that security by forward contracting more than 75% of its food costs for the remainder of the fiscal year. Even margins for pricier Red Lobster menu items like lobster and shrimp have been helped by demand-related price drops.

While the company tempered its expansion plans when the recession struck, it has continued to open new outposts. Darden is hoping a larger portion of its growth will come from the expansion of LongHorn, purchased in 2007, and about half the size of Olive Garden.

The company plans to open 15 new LongHorns in fiscal 2010, ramping up to 30 per year as economic conditions normalize.

If Darden’s team of brand experts gets it right again, the company could soon have another go-to restaurant on its hands.

Darden shares finished at $35.15 on the Jan. 15, 2010 expiration date for the recommended buy/write. The shares went up by 10.4% from the June 26, 2009 posting date.

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