Breakout

Red Lobster May Not Be Worth Saving Says Restaurant Analyst

Breakout

End the “Endless Shrimp” to concentrate on the “Never Ending Pasta Bowl”?

This, in effect, is what an outspoken longtime restaurant analyst thinks Darden Restaurants Inc. (DRI) ought to do: Throw the Red Lobster overboard in order to hunker down in the Olive Garden.

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Darden - the parent company of those huge casual-dining chains along with Longhorn Steakhouse, Capital Grille, Bahama Breeze and others – has struggled in recent years with sluggish customer traffic, subpar profit margins and a lagging stock price.

Sales are on track to slide almost 8% this year, compared to an average 13% gain by industry peers. Shares of Orlando, Fla.-based Darden have trudged higher by less than 10% the past two years, compared to a 40% gain in the broad stock market and a 100% surge in close rival Brinker International Inc. (EAT).

This sluggish performance has drawn an aggressive approach by “activist” investment firm Barington Capital, which last month reported owning the stock and urged Darden management to break the company up. They propose creating two companies, one to house the mature Olive Garden and Red Lobster and the other for the smaller, nimbler brands, while also hiving off its real-estate holdings.


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Brinker, for instance, has sold several brands such as Macaroni Grill to focus on its core Maggiano’s Little Italy and Chili’s chains, increasing efficiency and boosting its stock price.

Yet Howard Penney, analyst at Hedgeye Risk Management, tells Breakout in the attached video that such a proposed maneuver isn’t radical enough. “A lot of inefficiencies have been created by putting this portfolio of brands together,” he says. “I think that’s fairly evident when you break down the numbers on the income statement,” which show, for example, much higher corporate overhead costs than its competitors.

Darden, he says, “needs to undo what the CEO Clarence Otis has done over the last eight years or so.” Of the idea simply to bust Darden into two pieces, Penney says:

“I don’t think it makes much sense. The smaller, faster-growing brands are not really growing very fast and there’s really not much growth opportunity for them. What I’d like to see is for the company to just get whittled down to what I call the crown jewel, which is Olive Garden.”

And the chances of this happening?

“Zero.”

CEO Otis has hewed to his collection-of-concepts strategy and is unlikely to deviate any time soon.

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Aside from an inefficient corporate structure, Darden is up against the same challenges facing other big casual sit-down restaurant companies: still-high unemployment, stagnant wage growth and simply too many restaurants vying for the family dinner dollar. The rise of “fast casual” players such as Chipotle Mexican Grill Inc. (CMG) and Panera Bread Co. (PNRA) has squeezed full-service chains, with their slightly higher meal prices and reliance on alcohol sales.

Ironically, even though business isn’t great across the industry, Penney says the sector’s stocks are in a “casual dining bubble,” with valuations near all-time highs for most leading stocks. No doubt, the stocks have become caught up in the investor enthusiasm for plays on the domestic housing and consumer recovery story.

While some companies such as Brinker’s Chili’s are performing well, in general Penney figures its time for investors in these stocks to push away from the table.

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