Restaurant group Darden (click ticker for report: ), owner of chains like LongHorn Steakhouse, Red Lobster, Olive Garden, and Yard House, warned that its second quarter results will be weaker than expected. Net operating earnings are expected to total $0.25-$0.26 per share, well below the consensus estimate of $0.46 per share, with $0.05 lost due to the acquisition of Yard House and one penny lost to Hurricane Sandy.
Perhaps the most surprising portion of the announcement was the momentum we were seeing going into the quarter, particularly at Red Lobster and LongHorn. Olive Garden saw same-store sales fall 3.8% in September, 3.9% in October, and 2% in November, driven mostly by huge drops in traffic. Red Lobster, which had finally seen some more stable footing after adjusting pricing, saw same-store sales fall 7% in October and 2.8% in November after a roughly flat September. Even LongHorn, which has been the standout restaurant of the group, saw a decline during every month of the quarter, though traffic held up much better than it did at the others.
The firm also cut its guidance going forward, slashing its revenue growth outlook to 7.5%-8.5% from its previous guidance for 9%-10%; it also cuts its same-store sales growth outlook to the range of -1% to 0%. Earnings had previously been forecasted to grow 5%-9%, but now the company expects earnings of $3.29-$3.49 per share (net of Yard House costs), which implies an earnings decline.
What’s going on at Darden? Management seemed to acknowledge the severity of the situation, mentioning that promotions from previous years are not working and that it needs to shift strategies. Unfortunately for Darden, we think the company is encountering some powerful headwinds that are damaging its largest brands. With the emergence of Panera (click ticker for report: ), Chipotle (click ticker for report: ), and other “high-end” fast food options, we think the dining space is becoming increasingly competitive, especially as consumers continue to seek value. In addition to providing quality food at a cheaper price, these fast-casual concepts often exclude wait-staff, saving consumers a few extra dollars each trip.
Furthermore, the company has to deal with concerns about the healthfulness of its food, particularly the carb-heavy Olive Garden and the fat-heavy LongHorn Steakhouse. Higher-income consumers tend to prioritize healthfulness, so we think the company could be losing sales from both ends of the market—one squeezed by income, while the other is squeezed by waistlines.
We like the acquisition of the Yard House brand, which focuses on premium alcohol sales and premium bar foods. However, considering the lackluster results of BJ’s Restaurant (click ticker for report: ), which we’d consider a similar concept, we question how well the Yard House is growing sales in the current environment.
Even after a decline in the share price, we continue to believe shares are fairly valued (the share price falls within our fair value estimate range). We’ll be monitoring the company’s change in marketing and promotions, but we currently believe fiscal year 2013 will remain fairly challenging. A score of 4 on the Valuentum Buying Index (our stock-selection methodology) suggests that the near-term picture doesn’t look too great.