Back to Main

Darden Restaurants: Time to Get the Check

By: Martin Tillier
Posted: 12/19/2013 3:33:00 PM
Referenced Stocks: DRI;EAT

It always worries me when a management team starts to talk about "enhancing shareholder value," as Darden Restaurants (DRI) did this morning. Some see share buybacks, spinning off or selling parts of a business and increasing dividends as a good thing. After all, isn't sharing in the profits of a business the whole point of owning shares? Well, yes and no.

Ownership is also about participating in the growth of a company, and a focus on returning money to shareholders would suggest that management cannot find a better, growth related use for that money. This is particularly worrying in the casual dining industry, where popularity comes and goes, and innovation is essential, not just for growth but often for survival. If you doubt that, just ask Friendly's.

If you haven't heard, Darden Restaurants announced this morning that they would be separating their "Red Lobster" brand, either by sale or spinoff, reducing unit growth (i.e. not opening as many new restaurants) and forgoing acquisitions, among other things. Oh, and they missed earnings expectations for the third consecutive quarter. The last two earnings release dates are obvious in DRI's chart; they are the big red lines.

DRI chart

DRI will look remarkably similar this time around, as the stock has lost around 5% in early trading. Usually, when there is a big reaction to an earnings release like that, I look for the contrarian trade on the basis that traders overreact to almost everything. In this case, however, I will make an exception.

DRI will maintain their $0.55 dividend and expects to continue to do so when any dividend from a spun off Red Lobster is included, but after five years of increasing payments, maintenance may not be enough to keep shareholders happy, even with a buyback program. This 4% yield and DRI’s consequent role as a dividend stock has undoubtedly resulted in some support (the stock is up around 17% this year), but at around 18 times projected earnings, it looks overvalued even after this morning’s move.

Last month, in writing about fast food stocks, I suggested that Americans were increasingly showing a taste for spicier foods and that phenomenon is also likely to influence the mid-tier casual dining sector. For that reason, if nothing else, I would prefer the owners of Chili's, Brinker International (EAT) to Darden for those seeking exposure to the industry and a dividend return, even though EAT offers only around a 2% yield.

EAT chart

EAT is also trading lower today in reaction to the disappointing results and outlook from DRI, but is approaching a likely support level around $45 and, despite being up 46% this year, may still have some room to the upside. Even in this case, though, I would keep a close eye on earnings scheduled for January 22nd.

In most areas, brand recognition is a huge positive for a company, but once you get above the fast food level it can be a double edged sword at best for restaurants. Some people remain loyal to a brand, but for many the temptation to try something new is strong. When that desire takes hold, menu changes can only take you so far and DRIs decision to shrink rather than grow may well indicate that that particular wall has been hit. It's probably time for investors to get the check and head home.