Is Darden Headed for a Split?

Zacks

Hedge fund Barington Capital Group LP reportedly acquired a 2.8% stake in Darden Restaurants Inc. (DRI). According to Reuters, this stake acquisition makes Barington Capital Darden's fifth largest shareholder. Soon after acquiring the stake, Barington Capital proposed a break-up of the company amid growing concerns about Darden's performance. Darden confirmed receiving the firm’s suggestion and looks forward to evaluate it.

The news was received positively by investors and pushed up the company’s shares by 7.11% to $49.57 per share as of Oct 9, 2013, the highest increase in more than two years.

Based in Orlando, Fla., Darden owns and operates more than 2100 restaurant, primarily under the names of Red Lobster, Olive Garden, LongHorn Steakhouse and the Specialty Restaurant Group (:SRG). Currently, SRG consists of the Capital Grille, Bahama Breeze, Seasons 52, Eddie V's, and Yard House brands.

According to sources, Barington Capital is insisting on splitting up Darden into two new companies: one with its high-growth chains like The Capital Grille and the other with core but sluggish brands like Red Lobster and Olive Garden.

Darden has been reeling under pressure for quite some time now. Last month, the company reported its first-quarter fiscal 2014 earnings from continuing operations of 53 cents per share, which fell shy of the Zacks Consensus Estimate by nearly 23.2% and the year-ago level by around 37.6%. Margin shortfall and soft revenues pressurized earnings during the quarter.

Sales at two of its core brands, Red Lobster and Olive Garden, remained under pressure for most of fiscal 2013. Despite noticing some improvement in both brands in the fourth quarter of fiscal 2013, Darden failed to maintain the momentum and underperformed in the first quarter of fiscal 2014. Sales at Olive Garden and Red Lobster were down a respective 0.4% and 5.5% in the first quarter.

The only bright spot amid this languishing scenario was the performance of SRG and LongHorn Steakhouse, which recorded sales growth of 72.7% and 14.2%, respectively in the recently-concluded quarter. The SRG brand basically caters to young, multicultural and high-income guests, which helps it to survive economic volatility.

As per Darden’s email-statement, the said proposal was intended to increase shareholder value. Darden has been returning shareholder value continuously over the years, through share buybacks and dividends, irrespective of economic peaks and valleys.

Over the last five years ending fiscal 2013, Darden increased its dividends at a rate of 22% on a compounded average annual basis. As of Oct 9, 2013 its dividend yield stands at 4.70% -- one of the highest in the restaurant industry.

Our Take

Given Darden’s recent lackluster performance, a conducive restructuring is strongly needed – be it in the form of a split or some other measures. Darden’s share performance has not been up to the mark of late. As of Oct 9, Darden’s share price hovered around the mid-point of its 52-week range of $44.11 to $55.90 per share that too after speculations about a split started.

Although the company is taking some cost-saving initiatives to boost its profits and gain financial flexibility, the benefit might not be sufficient enough for bottom line growth amid faltering consumer confidence.

Darden currently carries a Zacks Rank #3 (Hold). Others players in the same industry, which look attractive at current levels include AFC Enterprises Inc. (AFCE), Cracker Barrel Old Country Store, Inc. (CBRL) and Domino's Pizza, Inc. (DPZ), all carrying a Zacks Rank #2 (Buy).
 

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