Darden (DRI) Rides On Cheddar's Acquisition, High Costs Hurt

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Darden Restaurants, Inc. DRI continues to ride on various sales-boosting initiatives along with cost-saving efforts. Acquisition of Cheddar's has also been adding value to the company's portfolio of differentiated brands. However, high costs, associated with restaurant operations and limited international presence, are concerns.

Recently, Darden posted better-than-expected first-quarter fiscal 2019 results . Earnings not only surpassed the Zacks Consensus Estimate but also grew 35.4% from the year-ago quarter. In fact, Darden's earnings surpassed the consensus mark for 15 straight quarters. Backed by such impressive earnings trend, shares of the company have rallied 35.8% in the past year, outpacing the industry 's collective growth of 9.2%.

Cheddar's Acquisition to Provide Long-Term Benefit

Darden's acquisition of the small restaurant chain, Cheddar's Scratch Kitchen (Cheddar's), in April 2017 added an undisputed casual dining value to its portfolio of differentiated brands. It also helped Darden to enhance its scale. In first-quarter fiscal 2019, Cheddar's witnessed total sales growth of 6.5%, driven by organic new restaurant growth and franchise restaurant acquisition growth of 10.5%.

Further, sales at the other business segment grew 7.1% in the reported quarter, driven by new net restaurants and purchase of 11 Cheddar's franchise restaurants in the second quarter of fiscal 2018.

Apart from making progress with the integration of Cheddar's, the company seems to gain more confidence in its outcome. In fiscal 2018, management realized roughly $10 million of cost synergies. It expects to realize $22-$27 million by the end of fiscal 2019. Over the current fiscal, Darden plans to make significant non-guest facing changes, which is expected to have an impact on restaurant level execution. Darden expects Cheddar to bring incredible opportunity for long-term growth.

Sales-Building Initiatives - Major Growth Driver

Darden relies on extensive sales-building strategies to drive incremental traffic and revenues. In order to boost performance of the Olive Garden brand, the company implemented a set of initiatives under its Brand Renaissance Plan. These included simplifying kitchen systems, improving sales planning and scheduling, operational excellence to improve guest experience, developing core menu items, allowing customization, and making smarter promotional investments.

At LongHorn, the company strives to attract guests by focusing on core menu, culinary innovation and providing regional flavors. It is also working on its marketing strategy to improve execution - customer relationship management and digital advertising, as well as a strong promotional pipeline, which leverage the segment's expertise.

Further, the company continues to focus on strengthening in-restaurant execution through investments in quality and simplification of operations in order to augment guest experience.

These initiatives have helped the company to witness sales growth across each of the brands in first-quarter fiscal 2019. Subsequently, overall top line grew 6.5% from the prior-year quarter.


High labor costs, associated with restaurant operations, are expected to keep Darden's near-term profits under pressure. Further, the non-franchised model makes the company susceptible to increased expenses. Since all the restaurants are owned and operated by Darden, it is solely responsible for expenses of operating the business.

Total operating costs and expenses increased 6.3% year over year to $1.9 billion in the fiscal first quarter. This was led by an overall increase in food and beverage costs, restaurant labor and expenses, and marketing costs. As a result, operating margin in the reported quarter contracted 20 basis points (bps) on a year-over-year basis.

Meanwhile, Darden's restaurants are located in the United States and Canada, and it has no exposure in international markets. While several fast-casual restaurateurs like Mc Donald's MCD , Domino's DPZ and YUM! Brands YUM are capitalizing on the emerging market potential, Darden seems to be slow on this front.

We believe that the company needs to expand its presence beyond the United States in order to offset the impact of cutthroat competition in the saturated domestic market.

Darden currently carries a Zacks Rank #3 (Hold). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Business , Stocks
Referenced Symbols: DRI , YUM , DPZ , MCD

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