Darden Restaurants (DRI): Sell On The Relief Rally

This morning Darden Restaurants, Inc. (DRI) posted results that, on an adjusted basis, narrowly beat market expectations. They showed EPS of $0.32 compared to consensus estimates of $0.31 and revenues broadly in line. In effect then, there were no big surprises other than maybe that things weren’t worse. The stock, in what looks like a classic relief rally is trading around 3 percent higher in the pre-market as I write. Regular readers will be aware of my views on relief rallies; they are a great chance to short a stock or cut a long position.

The thing with Darden is that they just seem to be on the wrong side of history right now. Back in December, I suggested that those long of DRI may want to take a profit at over $50. That advice has worked out pretty well, especially in light of the recommendation to buy Brinker International (EAT: + 13.11% since) if you felt you must be in the sector with a traditional name.

The reason for my then pessimism toward that sector in general, however, still exists now. There is an identifiable move in taste towards somewhat more adventurous, and certainly spicier, food in the U.S.; witness the success of Chipotle Mexican Grill (CMG) and others. Now though, there is another, probably shorter-lived, trend that is hurting DRI and their flagship Olive Garden brand in particular: low carb diets.

Followers of eating trends will be aware that this is nothing new; think South Beach and, even further back, Atkins. The history of food fads tells us that this particular one, like most that have gone before it, will be short-lived, but it may still be around long enough to do damage to a pasta based restaurant that is already struggling.

In this earnings result, management were extremely upbeat about the turnaround in that moribund brand, but the growing low carb trend will make growth in the short to medium term extremely difficult. That would be fine if the stock were priced at a huge discount, but at over 20 times forward earnings, decent growth looks to be priced into the stock at these levels.

Darden also took the opportunity to point out that many of the proposals in the “turnaround strategy” that was proposed for Olive Garden by major shareholder Starboard Value were already being implemented. I guess that is a good thing, but I cannot escape that fact that much of that proposal... too many breadsticks on the table, too much dressing on the salads, etc... sounded more like a bad review on Yelp than a plan to turn around a restaurant business.

Cutting to grow is a well-known and well-worn strategy for a business, but tweaking serving practices, while a reasonable cost cutting exercise, doesn’t strike me as the answer when comps have been falling. Olive Garden will probably survive, but the chain’s best days are behind it.

Given that lack of growth in the core brand of the company then, shorting the stock could well be a savvy move.

Darden (DRI)

Darden (DRI)

The above chart runs only to Thursday’s close, so does not include the pop this morning which takes DRI up to around the $50 mark. I would be happy to sell there, with place a stop loss order set just over the 52 week high ($54.89) at, say, $55.30 that would limit potential losses to around 10 percent. If long term dynamics do catch up with Olive Garden before the “breadstick and salad dressing effect” takes place, the downward trend that has been evident since December can be resumed, giving a decent potential for profit on the trade.

Even allowing for a slight upward revision of guidance, a big jump in a stock that beats consensus earnings by a penny on flat revenue, and in doing so actually posts a huge loss when one-time items are included, can be nothing but a relief rally. As usual, that is a signal for those with a view that extends past the next couple of trading days to sell and position themselves for the drop that will come as focus shifts back to long term trends and the lack of growth prospects that they entail.

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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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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