Why Darden’s 2Q14 earnings fell below management’s expectations

Market Realist

Despite displeased investors, Darden may have made the best decision (Part 2 of 10)

(Continued from Part 1)

A changing industry

“Industry conditions this quarter are an affirmation that our industry is in a period of significant change.” That’s one of the first things CEO Clarence Otis of Darden Restaurant Inc. (DRI) said in the company’s second quarter fiscal year 2014 call. The restaurant must adapt, and several strategic action plans were announced that morning, on the same day. These include spinning off Red Lobster, reducing a new unit expansion, focusing more intensively on operating cost efficiency, and refining the incentive compensation plan.

Sales growth is poor 

Darden’s second quarter results were poor, missing the company’s own estimates discussed in September this year. Total sales rose 4.6%, to $2.05 billion. But much of this has been driven by new store openings. On a blended same-restaurant sales basis, results for Red Lobster, Olive Garden, and LongHorn Steakhouse as a whole fell 1.0% compared to the same period last year. While LongHorn Steakhouse showed strength, Olive Garden “made good progress” (although not as much as management anticipated according to C. Bradford Richmond), and Red Lobster performed poorly.

Rippling down

In terms of costs, food and beverage expenses were 0.35% higher than last year based on percent of sales, driven by higher shrimp and land-based protein costs. Restaurant labor expenses were 0.65% above last year as a percent of sales due to wage inflation, reduced productivity, and sales deleveraging at Red Lobster. Sales deleverage occurs when costs that have “fixed” qualities are spread across lower guest counts or checks per guest. Lower sales also negatively impacted restaurant expenses—which were already above last year due to higher repair and maintenance costs and workers’ compensation expenses.

On a slightly positive side, note that selling, general, and administrative expenses (which have historically been a significant part of the company’s overall strategy) fell 25 basis points (0.25%) due to decreased media expense at Red Lobster and Olive Garden.

Continue to Part 3

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