U.S. Markets closed

Why Darden’s operating margins are pressured by sales and costs

Xun Yao Chen

Despite displeased investors, Darden may have made the best decision (Part 5 of 10)

(Continued from Part 4)

Operating margins fell

Darden’s second quarter fiscal year 2014 operating margins fell by roughly 140 basis points compared to last year due to both lower sales at comparable restaurants and cost pressures. Cash from operating activities rose $35 during the second quarter as part of its ongoing supply chain optimization cost savings initiative.

Food supply contracted

Roughly 53% of the total food expenditure is contracted until the end of the year, which is in line with the company’s 60% it had last year. The company noted that it didn’t fully cover its use because the price for future contracts was too high compared to what it expects food prices to be in the cash market ahead.

Food inflation

Food inflation in the second quarter came in at 2.4%. However, inflation for shrimp price was in the high teens, and land-based protein inflation was in the mid single digits. The company expects to see continued upward pricing pressure on shrimp price until fiscal 2015, which spans across the second half of the 2014 calendar year and the first half of 2015, due to production issues in Asia. As a result, commodity prices are expected to increase between 2.5% and 3.0%.

Energy bill expected to be up

Management also noted that energy costs would be slightly unfavorable on a year-over-year basis, so it had contracted the majority of natural gas and electricity use already. This may tell agriculture investors that nitrogenous fertilizer producers like Terra Nitrogen Company LP (TNH), CF Industries Holdings Inc. (CF), and Agrium Inc. (AGU) could see short-term negative headwinds.

Putting it all together, Darden’s second quarter earnings came in at $0.15 per share. Same-store sales (a measure of a company’s brand attractiveness) and guest counts were down more than expected, while earnings were also negatively affected by two unusual items—first by $0.02 per share, as costs were incurred to support the expense reduction program announced in September. A further $0.03 a share was incurred for advisory and consulting services to come up with its recent “new” strategic initiatives.

Continue to Part 6

Browse this series on Market Realist: