Investment Conclusion
Darden Restaurants (NYSE:DRI) is scheduled to report F2Q2023 Earnings on December 16, 2022, before market open. The average consensus revenue and earnings per share estimates for the quarter are ~$2.42 billion and $1.42. We expect the company to beat analyst top-line and bottom-line projections for the period.
Specifically, we anticipate that the sales momentum associated with all segments of the business evidenced over recent quarters will persist, driven by potential solid demand for catering and private dining, as folks celebrate the holidays. Accordingly, based on leverage from higher sales, lighter commodity cost inflation, increased labor efficiency (as newer employees turn more productive), we expect EBIT and EBITDA margins to improve sequentially and over pre-pandemic levels but come in softer on a year-over-year basis. Therefore, for the period, earnings per share is likely to be below F2Q2022 levels, in our opinion.
For the last two quarters of FY2023, which are seasonally DRI’s strongest periods in regards to customer demand, we anticipate revenue growth to moderate somewhat due to macroeconomic challenges, but remain solid as decrease in customer demand related to the $30K to $50K group will likely be offset by sustained uptake associated with guests that earn over $100K, particularly those that partake of Olive Garden and DRI’s fine dining establishments. In addition, we expect margin expansion due to easing commodity costs that reduce the gap between the firm’s below inflation pricing and inflationary trends, lower spending related to repair and maintenance, and some shift in sales mix towards the restaurant group’s premium concepts. Therefore, for FY2023, based on potential advance in sales and margins, earnings per share and free cash flows are likely to advance over FY2022 levels.
Considering that F1Q2023 results have improved our confidence that DRI is likely to meet and exceed our conservative 10-year normalized revenue growth rate of 8%, and 10-year straight-lined operating cash flows margin of ~14%, we remain constructive on the stock. However, given that shares have appreciated beyond our 1-year Price Target of $137/share, we are downgrading DRI to a Hold. Still a great company but over valued at current levels.
(Please go through our initiation report “Darden Restaurants: Established Multi-Brand Restaurant Group Poised For Additional Growth” for our long-term opinion on the stock).
Key Takeaways From The First Quarter
F1Q2023 Results Summary. For the quarter, revenues came in at ~$2.45 billion (+6.1% compared with F1Q2022), below consensus estimates of $2.47 billion, and earnings per share were $1.56 (vs. $1.76 during the prior year’s same quarter), consistent with analyst projections. In addition, comparable sales at Olive Garden, LongHorn Steakhouse, Fine Dining, and Other Business increased by 2.3%, 4.2%, 7.6%, and 7.6%, on a year-over-year basis. On a consolidated basis, DRI’s comparable sales advanced by 4.2%, over the same time frame. Net income for the period was ~$193 million, reflecting a decline of 16.4%, relative to F1Q2022. DRI generated ~$428 million in operating cash flows over the period.
Olive Garden Sales Appeared Resilient. Although, some fraction of the casual dining restaurant chain’s clientele is derived from lower-income customers, the concept generated solid sales growth, as its target group skews towards those earning >$100K. Nevertheless, as gas prices continue to decrease, sales derived from Olive Garden’s guests that earn between $30K to $50K are appearing to stabilize, with limited instances of check management being observed.
That during the first quarter, the brand’s year-over-year sales expanded by 3.7%, off-premise sales accounted for 24% of total sales, average weekly sales represented 101% of pre-COVID levels, and customer traffic came in at ~90% compared to three years ago (despite heavy promotional activity during the period), indicate that customer demand for Olive Garden remains resilient.
Plans To Reintroduce Promotional Activity. Although a time-line was not shared, at the F1Q2023 Earnings Call, management indicated that they were reviewing strategies to likely reintroduce promotions. In that regard, we believe, and top leadership appeared to suggest that future promotions would focus on increasing brand equity, have to be operationally simple (to be consistent with DRI’s current efforts to reduce complexity in its kitchens and general operations), and not include deep discounting.
With regard to marketing any such promotions, the objective appears to be towards, digital and national level advertising that relies on bringing forth salient nuances of DRI’s restaurant concepts, such as Olive Garden’s made-from-scratch sauces, rather than concentrating on its bottom-less first course.
Considering that the restaurant conglomerate’s promotional activities have been highly successful historically, we are encouraged that management is contemplating reintroducing promotions across its brands.
Well Positioned To Outperform During An Economic Downturn. Considering that DRI’s customers represent the entire continuum of income groups from Cheddar Scratch Kitchen that caters to the lower end, to Olive Garden with its mix of lower, middle, and higher end, and its fine dining establishments, including Seasons 52, Yard House, and Capital Grille that entertain the upper class, the restaurant conglomerate reflects an ability to continue to be popular among customers, if a recession were to unfold.
In that regard, it is noteworthy that there has been a recent acceleration in demand for the firm’s fine dining, private dining, and catering segments, as urban regions have opened up, and working from the office is on an upswing. Given that a significant fraction of DRI’s restaurant concepts are higher-end, positions the company to outperform (compared to alternate restaurant groups) during a cyclical downturn, not only with respect to revenue growth, but also in regard to margin sustenance, as upscale ventures typically generate higher margins.
Guest Satisfaction Scores At Record Highs. Over recent quarters, DRI’s Olive Garden and LongHorn Steak House customers appear to rate their experiences at the establishments rather highly. LongHorn guests appear particularly happy with “how correctly the steaks are grilled”. In addition, guest satisfaction at Cheddar’s Scratch Kitchen are the best they have been, since DRI acquired the restaurant chain. Seasons 52 customers appear equally thrilled with their experience at the concept. These results are particularly encouraging, as customer satisfaction scores for the restaurant industry have declined substantially over recent years due to labor shortages associated with the viral outbreak, and then later because of the multiple government stimulus packages.
We believe, that rave customer reviews associated with DRI’s restaurants are a function of their ability to attract and retain the best talent which reflects in fully staffed restaurants. Given that customer’s typically cite quality of service as key to their ratings of restaurants, and that labor availability is vital to excellent service, DRI’s talent in keeping their establishments fully staffed is laudable.
In addition, that the service at the restaurant group’s outlets is consistent, and that the concept’s constantly attempts to add value to the plate, are alternate factors, DRI’s management cited as drivers of the excellent guest satisfaction scores.
FY2023 Guidance Reaffirmed. DRI reiterated financial estimates announced over the F4Q2022 Earnings Call. Management expects total sales of between ~$10.2 billion and ~$10.4 billion, representing a growth of 6.96% from the midpoint of the projection. Comparable restaurant sales are estimated to expand by 4% to 6% relative to 30.9% generated over FY2022. Earnings per share are anticipated to come in a range of $7.40 to $8, versus $7.40 realized over the prior year. The firm expects to open 50 to 60 new restaurants over FY2023, compared to 37 new restaurants launched over FY2022.
We are highly encouraged that DRI’s leadership remains committed to the announced guidance, despite the acceleration in economic headwinds unfolding in the country. Moreover, we believe the projections are reasonable, and considering DRI’s history of meeting and exceeding guidance, will likely be achieved.
Balance Sheet Remains Strong. At the end of F1Q2023, the company had a cash and cash equivalents balance of ~$378 million and long term debt of ~$895 million on its balance sheet. DRI can borrow an additional ~$1 billion under a revolving credit facility. Given its funding position, we believe that the firm is well equipped to operate efficiently and execute on its new unit development targets. During the first quarter, DRI repurchased $199 million worth of its common stock. In addition the company declared a dividend of $1.21/share for the period.
Bottom Line
DRI performed well during the Great Recession, based predominantly on excellent customer service. That ability is well and alive at the restaurant group’s concepts today, and is serving them well through the current unfavorable macroeconomic environment. When folks are dining out twice a month rather than five, they have a low tolerance for service shortfalls.
Therefore, we believe that if a recession were to unfold over the near-term, DRI would continue to deliver growth in revenues and earnings, making its shares an excellent investment to hide-out over the next couple of years.
M. Suhail
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