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Darden (DRI) Rides on Cheddar's Acquisition Amid High Costs

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Darden Restaurants, Inc.DRI banks on major top-line building initiatives and cost-cutting measures to drive growth. Further, the acquisition of Cheddar's added an undisputed value to the company's portfolio of differentiated brands.

However, high costs of operations, intense competition and Darden's limited international exposure raise concerns.

Although shares of Darden have marginally underperformed the industry 's rally of 4.2%, we are encouraged by the company's earnings trajectory. Darden's earnings met/surpassed the Zacks Consensus Estimate for 17 straight quarters. In the second quarter of fiscal 2019 , Darden's earnings increased 26% year over year on the back of higher revenues. Results were also aided by the company's relentless efforts in improving the basic operating factors of the business - food, service and atmosphere.

Cheddar's Acquisition to Drive Long-Term Growth

Acquisition of Cheddar's helped Darden in enhancing its scale. Although the chain's total sales declined 1.4% in the second quarter of fiscal 2018, sales at new Cheddar's grew 2.6% year over year. Further, management has made significant operational readjustment to the brand, which is expected to reap long-term benefits.

Apart from making good 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 and expects to realize cost synergies of $22-$27 million by the end of fiscal 2019. Over the current fiscal year, Darden plans to make significant non-guest facing changes, which is expected to have an impact on restaurant level execution. Darden sees Cheddar bringing incredible opportunity for long-term growth.

Cost-Saving Initiatives Bode Well

Darden is focusing on a cost management plan, under which it is trying to significantly cut operating costs. For fiscal 2018, cost savings resulted in synergies of about $10 million. Moreover, the company plans to reinvest any incremental savings into pricing and long-term growth drivers for the business, particularly emphasizing on enhancing quality to drive market share gains.

Concerns

Apart from high labor costs, Darden's non-franchised model makes it susceptible to increased expenses. Since all the restaurants are owned and operated by Darden, instead of signing franchise agreements and putting the burden of costs on the franchise, the company is solely responsible for the expenses of operating the business.

Total operating costs and expenses increased 5.2% year over year in the first six months of fiscal 2019. 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 period contracted 50 basis points (bps) on a year-over-year basis.

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

We believe that this Zacks Rank #3 (Hold) company needs to expand its presence beyond the United States in order to offset the impact of cutthroat competition in the saturated domestic market. 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.


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

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