Please refer to pages 53 to 55 for Important Disclosures, including the Analyst's Certification. Darden Restaurants (DRI-NYSE) Stock Rating: Market Perform Industry Rating: Market Perform October 9, 2014 Andrew Strelzik 212-885-4015 BMO Capital Markets Corp. [email protected]Strategic Actions Balance Weak Olive Garden Fundamentals ; Initiating With Market Perform Investment Thesis We are initiating coverage of Darden with a Market Perform rating and $52 pric e tar get . Alth ough we rec ogn ize the poss ibil ity for stra tegi c act ions and believe they wil l cont inue to supp ort DRI’s stoc k, we expect the likely long timeline for an Olive Garden turnaround to pressure FY2015 EPS toward the low end of guidance and would not be surprised if DRI falls short o fexpectations. In addition, we believe DRI’s long-term earnings potential will be determined largely by its ability to drive a turnaround at Olive Garden. We estimate that a 100 basis point (bps) improvement in Olive Garden comps wil l contribute $0.10 to EPS. First, in the near term, Darden should benefit fro m several non-operating actions that drive 32 percentage points (pp) of our FY2015 earnings growth expectation. In addition, LongHorn and Specialty Restaurant Group are bright spots and should continue to generate solid growth, while DRI’s G&A ratio likely will fall to 9% by the end of FY2015. Second, over the long term, we expect Darden to generate 10%-plus EPS growt h reflecting solid LongHorn and Specialty fundamentals, the eventual decline in beef p ric es, a nd sha re rep urc hase s. We assume stab ili zin g Oliv e Gar den co mps rather tha n growth beca use we believe t here is a long road to ach ieving a turnaround. That said, the Olive Garden turnaround becomes increasingly important beyond FY2015 as one-time EPS benefits will not recur, margin opportunities likel y are more limi ted, and Dard en likely wil l not further deleverage. Forecasts & Valuation Our FY2015 and FY2016 EPS of $2.23 and $2.47 are $0.01-$0.02 below consensus. Our price target reflects a blend of 1) $45 target based on fundamentals as we assign a 20x P/E to our FY2015 EPS and 2) $56-$57 target based on DRI’s possible break-up value. We assign a 40% probability to DRI continuing to operate in its current structure. The 20x P/E implies a 40%-45% prem ium to DRI ’s historical multiple (1 4x). DRI currently is trading at a forward 12-month P/E of 22x. Recommendation We are initiating coverage of Darden with a Market Perform rating and $52 price target. Price (8-Oct)$49.99 52-Week High$54.89 Target Price$52.0052-Week Low$43.56 20 30 40 50 60 1.5 2.0 2.5 3.0 3.5 4.0 Darden Restaurants, Inc. (DRI) Price: High,Low,Close(US$) Earnings/Share(US$) 0 50 100 0 50 100 Volume (mln) 2010 2011 2012 2013 2014 50 100 150 50 100 150 DRI Relative to S&P 500 Last Data Point: October 8, 2014 (FY-May.) 2013A 2014A 2015E 2016E EPS$1.90 $1.56 $2.23 $2.47 P/E22.4x 20.2x CFPS- $1.32 - $1.11 - $1.35 $0.11 P/CFPSna nm Rev.($mm)$5,921 $6,286 $6,602 $6,688 EV($mm)$8,083 $8,083 $8,083 $8,083 EBITDA($mm)$695 $650 $745 $813 EV/EBITDA11.6x 12.4x 10.8x 9.9x Quarterly EPS Q1 Q2 Q3 Q4 2013A$0.49 $0.10 $0.69 $0.61 2014A$0.32 $0.07 $0.68 $0.49 2015E$0.32a $0.27 $0.81 $0.88 Dividend$2.20 Yield 4.4% Book Value$16.08 Price/Book 3.1x Shares O/S (mm) 131.9Mkt. Cap (mm) $6,594 Float O/S (mm) 103.8Float Cap (mm) $5,189 Wkly Vol (000s) 7,938Wkly $ Vol (mm) $393.3 Net Debt ($mm) na Next Rep. Date na Notes:All values in US$ First Call Mean Estimates:DARDEN RESTAURANTS INC (US$) 2015E: $2.24; 2016E: $2.48
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Dividend $2.20 Yield 4.4%Book Value $16.08 Price/Book 3.1
Shares O/S (mm) 131.9 Mkt. Cap (mm) $6,59Float O/S (mm) 103.8 Float Cap (mm) $5,18Wkly Vol (000s) 7,938 Wkly $ Vol (mm) $393.Net Debt ($mm) na Next Rep. Date n
Notes: All values in US$First Call Mean Estimates: DARDEN RESTAURANTS INC (US$2015E: $2.24; 2016E: $2.48
We are initiating coverage of Darden with a Market Perform rating and a $52 price target, whi
implies 4% upside from current levels. On a fundamental basis, we see downside to Darden’s sto
as the likely long timeline required for a turnaround in Olive Garden trends likely will pressu
earnings toward the low end of Darden’s FY2015 guidance, and we would not be surprised if Dardwere to fall short of its expectations. That said, we recognize the possibility for strategic actions bas
on pressures from activist shareholders and believe the possibility of such actions will continue
support Darden’s stock above its underlying value based on the company's earnings outlook.
We expect Darden to generate 43% earnings growth in FY2015 largely reflecting non-operati
improvements; however, Olive Garden trends likely will remain lackluster for at least the ne
several quarters, creating create downside earnings risk. First, the combination of deleveragi
(16 pp), share repurchases (6 pp), and the absence of shared support costs (10 pp) drive 32 pp of o
are bright spots within Darden’s portfolio as the steak segment is the strongest in casual dining, wh
“polished casual” and fine dining outperforms casual dining trends. We believe LongHorn wcontinue to generate solid comparable-restaurant sales growth as retail beef prices should remain
record levels for the foreseeable future and there is a strong relationship between casual dining ste
traffic and retail beef prices. In addition, the Specialty Restaurant Group should continue to bene
from its concentration in fine dining and “polished casual” owing to the more favorable price-val
perception and more “occasion-based” dining (consumers are less likely to forego eating out for
occasion relative to casual dining occasions). Third, we expect Darden’s G&A ratio to fall to 9%
the end of FY2015 as we estimate a $50 million cost savings opportunity in FY2015 ($50 million r
rate by the end of the year). The cost savings likely will create a 100 bps margin tailwind as
estimate FY2015 G&A ratio of 9.2% relative to 10.3% in FY2014. That said, we believe the potent
Olive Garden turnaround is the key to driving upside to expectations and we believe 1) the turnarou
will take several quarters, and 2) the long timeline to achieving a turnaround creates downside riskearnings estimates.
Over the long, term we expect Darden to generate double-digit earnings growth assumin
stabilizing Olive Garden trends; however, we believe Olive Garden trends becom
increasingly important beyond FY2015. First, our longer term earnings growth expectati
reflects ongoing strong LongHorn and Specialty Restaurant Group fundamentals, marg
expansion opportunities with the eventual decline in beef prices, the full benefit of FY20
balance sheet deleveraging, and ongoing share repurchases. Second, we do not assume Oli
Garden returns to comparable-restaurant sales growth in our longer term earnings outlook becau
we believe Darden has a long road ahead to achieve a turnaround. That said, a turnaround wou
significantly improve Darden’s comparable-restaurant sales growth and earnings trajectory givits size in Darden’s portfolio (nearly 60% of sales). We estimate that a 100 bps improvement
Olive Garden’s annual comparable-restaurant sales trends would contribute 60 bps to its blend
same-store sales growth and approximately $0.10 to EPS. Third, the Olive Garden turnarou
becomes increasingly important beyond FY2015 as one-time benefits from FY2015 will not rec
(e.g., shared support cost shift), margin opportunities likely are more limited outside of the be
price decline, Darden likely will not further deleverage its balance sheet, share repurchases cou
slow with greater free cash flow deterioration if Olive Garden trends do not stabilize, and t
Olive Garden: Leading casualdining Italian concept with 25%share of Italian segment. Nearlyfully penetrated in U.S.
LongHorn Steakhouse: Casualdining steak concept. Regionalfootprint with opportunity toexpand nationally.
Bahama Breeze: Casual diningconcept focused on Caribbean-inspired dishes. Opportunitiesfor unit expansion.
Seasons 52: “Polished casual”concept with seasonally-inspired menus. Specializes in
lighter options as all menu itemsare 475 calories or lower.Opportunities for unitexpansion.
The Capital Grille: Fine-diningsteakhouse with select unitexpansion opportunities.
Eddie V’s: High-end seafoodconcept with unit expansion
potential.
YardHouse: Casual dining
concept with a focus onAmerican dishes and craft beers.Opportunities for unitexpansion.
Exhibit 4. Darden Concept’s Comparable-Restaurant Traffic ChangRelative to Industry
‐8.0%
‐4.0%
0.0%
4.0%
8.0%
C o m p a r a b l e R e s t a u r a n t T r a f f i c
‐
Y ‐ o
‐ Y
C h a n g e
Industry Olive Garden LongHorn
Source: Knapp Track, Company Reports and BMO Capital Markets
LongHorn Steakhouse (22% of Darden’s sales) generated average comparable-sales grow
of 3.0% over the last three years as the concept posted positive comparable-restaurant sal
growth in all but two quarters over that period. LongHorn’s same-store sales growth h
outpaced casual dining industry comps by 320 bps over the last three years driven by 400 b
of traffic outperformance, according to Knapp Track data. In fact, LongHorn’s comps are
line with Outback Steakhouse’s domestic comps over that period and trailed Tex
Roadhouse’s steak category-leading comps by only 100 bps.
Specialty Restaurant Group’s (20% of Darden’s sales) comparable-restaurant sales improv
an average of 2.6% over the last three years and outpaced casual dining industry same-stosales by 280 bps, according to Knapp Track data. The segments’ same-store sales increas
in all but one quarter over the last three years and the only decline occurred in the weath
impacted FY3Q14 (severe weather and a Thanksgiving timing shift created a 160 bps a
Group shows broad-based strength across its concepts over time owing to the following:
o Capital Grille (6% of sales) posted average same-store sales growth of 4.1% over the l
three years, and outperformed industry comps by 430 bps, while comps declined on
once over that period.
o Bahama Breeze (3% of Darden’s sales) generated 2.3% average same-store sales grow
over the last three years, and outpaced industry comparable-restaurant sales by 250 bpBahama Breeze’s comparable-restaurant sales declined in only two quarters during th
period.
o Eddie V’s (1% of sales) generated 2.0% average same-store sales growth a
outperformed industry comps by 340 bps over the last six quarters (acquired
November 2011). Comps declined only once over that period.
and should contribute to ongoing momentum. The steak category remains one of the mo
resilient in casual dining. Casual steak category traffic outperformed casual dining industry traf
in all but 6 of the last 28 months, according to NPD Group data, as traffic increased an average
40 bps over that period relative to a 170 bps decline in casual dining segment traffic. In additio
casual steak category traffic growth outpaced the year-over-year change in bar/grill, Mexica
Italian, and seafood segment traffic by 130, 250, 380, and 430 bps, respectively, over the sam
period. Notably, LongHorn should continue to benefit from strong steak segment trends givnational advertising to maintain top-of-mind brand awareness within the segment (FY2014 w
the first year in which LongHorn had sufficient scale for national advertising over an entire ye
and an average check that is largely in line with the segment and Outback Steakhouse (i.e., $
Casual steak segment traffic likely will remain supported over the next several years
increasing wholesale and retail beef prices. First, beef prices likely will remain elevated un
2016 as the 2012 and 2013 U.S. calf crops (two-year leading indicator of slaughter-rea
cattle supply) imply a 1%-3% decline in cattle supplies in 2014 and 2015. Second, althou
we expect wholesale beef prices to begin sliding in 2016, retail beef prices may not decli
with the initial fall in wholesale prices as 1) retail beef gross margins contracted over the lfour to five years as the increase in wholesale beef prices outpaced the increase in retail be
prices by 2,100 bps; 2) retailers may maintain high beef prices amid sliding wholesale pric
to recapture the lost margin, particularly in light of ongoing overall grocery margin pressur
and 3) the 3%-4% increase in retail beef sales from year-ago levels over the last 12 mont
(despite significant inflation) likely will not incentivize lower beef prices when wholesa
prices begin to slide.
Exposure to the “polished casual” and fine-dining segments coupled with Baham
Breeze’s superior concept differentiation should continue to support Specialty Restaura
Group’s comparable-restaurant sales growth momentum. We expect Darden’s Specia
Restaurant Group to maintain its comparable-restaurant sales growth momentum as 1) 50%-55
of its sales are from higher-end (e.g., fine dining, polished casual) chains – a segment of t
industry that shows greater resilience than the casual dining industry; and 2) Bahama Bree
(15%-20% of Specialty Group sales, true casual dining) benefits from material bra
differentiation. First, Capital Grille, Eddie V’s, and Seasons 52 compete in the fi
dining/polished casual segments of the restaurant industry ($40-$90 average check) th
outperformed the traditional casual dining segment over the last several years, in part as
customer base is more affluent and better positioned in terms of disposable income in the curre
tepid economic/consumer environment. Specifically, average fine dining sales and traffic grow
(three-month rolling average) over the last two or more years of 5%-6% and 2%-3%, respective
outpaced casual dining sales and traffic growth by 400-500 bps and did not underperform casu
dining in any month over that period. Second, although Bahama Breeze competes in t
traditional casual dining segment, we believe its superior brand differentiation as a Caribbea
themed concept should continue to support its growth trajectory owing to a more limit
Exhibit 10. Casual and Fine Dining Sales – Year-Over-Year Change
‐2%
0%
2%
4%
6%
8%
10%
Y ‐ o
‐ Y C h a n g e i n D o l l a r s
‐ 3
M o n t h R o l l i n g
A v e r a g e
Fine Dining Casual Dining
Source: NPD Group and BMO Capital Markets.
Exhibit 11. Casual and Fine Dining Traffic – Year-Over-Year Change
‐6%
‐4%
‐2%
0%
2%
4%
6%
8%
Y ‐ o
‐ Y C h a n g e i n T r a f f i c
‐
3 M o n t h R o l l i n g
A v e r a g e
Fine Dining Casual Dining
Source: NPD Group and BMO Capital Markets.
An inflection in Olive Garden's comparable-restaurant sales trends would meaningfuchange Darden’s comp and earnings growth trajectory. We believe Darden has a long ro
ahead of it to achieve a turnaround at Olive Garden reflecting material brand degradation in t
eyes of consumers, in our view, and the time required for consumers to both recognize changes
the concept and change their visit frequency behavior. That said, Darden is in the process
implementing strategic initiatives to improve the concept's long-term positioning. The potent
for a turnaround in Olive Garden trends would significantly improve Darden’s comparab
restaurant sales growth and earnings trajectory given its size in Darden’s portfolio (nearly 60%
sales). For instance, we estimate that a 100 bps improvement in Olive Garden’s annu
comparable sales trends contributes 60 bps to its blended same-store sales growth and $0.10
EPS. Darden’s initiatives to improve Olive Garden’s trends include 1) a new logo (introduced
FY2014) and restaurant design (75 units to be remodeled in FY2015, three years to remodel t
350 units identified for remodels, remodel candidates have comps 200 bps below other units a
generate mid-single-digit comp improvement with remodel); 2) an updated menu that launched
late February with lighter and lower priced options (Cucina Mia selection with $9.99 price poin3) reinvesting cost savings in higher quality ingredients (e.g., higher quality proteins); 4) Pron
lunch menu that facilitates faster lunch visits (less than 45 minutes); 5) greater leadership focus
underperforming restaurants; 6) tablet introduction in FY2015 to improve guest experience; a
7) a shift in its advertising strategy toward a balance between a brand building and pri
promotion message from a heavily price related message.
Unit Expansion Opportunities at Select Concepts Support Long-TermGrowth Outlook
LongHorn’s transition to a national chain from its current regional footprint coupled wi
greater penetration of Specialty Restaurant concepts across the U.S. should create lon
term growth opportunities. We believe Darden’s mid- to high-single-digit long-term reven
growth expectation (implies low- to mid-single-digit annual unit growth as Darden assum
1%-2% same-store sales growth) is achievable assuming an eventual turnaround in Olive Gard
reflecting unit expansion opportunities across select concepts. New store openings not on
provide a consistent base for Darden’s sales growth algorithm, but also create a highly visib
sales growth profile that is within the company’s control. For instance, Darden had generated 8
average sales growth over the last four years that exceeds mature casual dining peers (3% f
Bloomin’ Brands and less than 1% growth for Brinker), but trails less mature peers, such
Chuy’s (+31%), Buffalo Wild Wings (+24%), and Texas Roadhouse (+11%).
International expansion represents an opportunity, but the preference for franchise/licen
agreements limits the impact for shareholders and likely is not a material focus given k
issues in the U.S. In line with other casual dining concepts, Darden has long-term internation
unit expansion opportunities. In fact, Darden has 55 international units currently a
commitments for 250 international units over the next three to four years. Darden’s internation
expansion currently focuses on the Middle East, Brazil, other South and Central Americ
countries, and Malaysia. That said, the impact of Darden’s international expansion appea
limited as Darden prefers franchise/license agreements for international expansion rather th
joint ventures or company-owned units to limit risk. In addition, we do not expect a shift
Darden’s international strategy to capture greater international returns in light of the significa
management focus on operations in the U.S., particularly Olive Garden.
Cost Savings, Lower Investments, Cost Shift to Red Lobster, and LoweBeef Prices Should Create Margin Expansion Opportunities
Darden’s margin structure fell over the last several years and trails that of its casual dinin
peers despite recent cost saving efforts. Darden’s operating and EBITDA margins (excluding R
Lobster) of 5%-6% and 10%-11% in FY2014 both fell 140-155 bps and 280-320 bps over the last o
and two years, respectively, reflecting food cost inflation, rising other restaurant operating cos
comparable-restaurant sales declines, and an estimated $25 million (40 bps margin headwind)
shared support costs that move to Red Lobster in FY1Q15 (Darden disclosed only that the c
headwind was $0.15 to EPS in FY2014, following the sale of Red Lobster to Golden Gate Capital
July 2014). Darden’s margin structure fell below its casual dining peer group’s operating aEBITDA margins that are in the 7%-8% and 12%-13% range, respectively, and are the lowest in o
casual dining coverage. Darden realized margin degradation despite a renewed focus on cost savin
in FY2014 as Darden began implementing initiatives to generate cost savings at both the company a
restaurant level. First, Darden identified $60 million of SG&A savings and realized $25 million of t
savings in FY2014 owing to three rounds of headcount reduction, lower/more efficient marketi
spending, and lower other corporate fees. Second, Darden realized $30 million of restaurant-level c
Darden’s operating margins should improve in 2015, albeit followed by slower marg
expansion in 2016 as several items are only incremental to FY2015. We expect Darden
operating margins to improve by more than 100 bps in FY2015 and almost fully recapture t
margin degradation realized in FY2014. The ability to achieve our FY2015 margin expansi
expectations is highly visible, in our view, as cost savings are already achieved/identified, t
transition of shared services costs to Red Lobster is not in question, and the marketi
investments for LongHorn and the Specialty Restaurant Group are complete (although it arguably the most important for DRI’s stock, we believe only the comparable-restaurant sal
trend is in question; we estimate a 100 bps improvement in comparable-restaurant sales trends h
a 30 bps impact on margins). That said, Darden’s margin improvement likely will become mo
modest in FY2016, with the decline in beef prices likely the largest contributor.
Our expectation for more than 100 bps operating margin expansion in FY2015 reflects 1) 5
bps contribution to margins from the incremental $50 million of company-level cost savin
from its $60 million in identified savings (assumes $10 million of costs to achieve saving
2) 15-30 bps as the shared services costs were allocated to Red Lobster when the sale clos
(end of July), 3) 15-20 bps contribution from the absence of marketing investment costs
LongHorn and Specialty Restaurant Group in FY2014, and 4) approximately 20 bps
margin expansion from a modest comparable-restaurant sales growth improvement (w
estimate a 100 bps improvement in comparable-restaurant sales trends creates 30 bps
margin expansion). The most significant margin expansion likely will be realized in G&A
That said, we expect a more modest 50+ bps operating margin improvement in FY2016 a
further margin expansion likely must be driven by accelerated same-store sales growth
1) opportunities for company-level cost savings likely are more muted; 2) addition
restaurant-level savings across concepts likely can be achieved, we expect a majority of t
savings to be reinvested, similar to the initial Olive Garden savings; and 3) Darden will l
the shift in shared services costs and absence of marketing investments.
Darden’s food cost inflation should remain somewhat manageable over the next 18 months
1) Darden is more than 50% covered for its food costs in FY1H15 at a low- to mid-sing
digit inflation level; and 2) the potential for 10%-plus lower dairy/oil (12% of input baske
chicken (8% of inputs), and seafood (12% of inputs) prices in FY2H15 and FY2016 shoumitigate the impact of likely higher beef costs (20% of input basket).
o Beef prices (20% of commodity basket) likely will continue to exceed year-ago leve
over the next 18 months as cattle supplies tighten further from the lowest levels since t
1950s. Specifically, 1) the CY12 and CY13 U.S. calf crops (a two-year leading indica
of slaughter-ready cattle supplies) fell 1%-3% below year-ago levels to the lowest lev
in 60 years, and 2) heifer retention to rebuild cattle supplies further removes cattle fro
the slaughter supply.
o Dairy prices (12% of commodity basket) likely will decline low- to mid-teens in 20
reflecting 1) pressure on U.S. prices from the 40% decline in global dairy prices (U.
prices have yet to fall due to high butter prices), 2) more normal China demand, 3) a 2% plus increase in U.S. production, and 4) the absence of EU production limits for the fi
o Chicken prices (8% of commodity basket) likely will fall 10% in 2015 as chick
producers accelerate supply expansion to 3%. Record chicken margins supported
multi-year-low corn prices (low-$3 level relative to the $5-$7-plus range from 2011
2013) provide confidence that chicken producers will accelerate production growth wh
pullet supplies become available. Chicken producers’ eagerness to increase producti
already is evident in recent egg set growth (8-10 week leading indicator of producti
growth). Chicken industry sources indicate production growth should begin to accelera by July reflecting greater pullet availability in late fall/early winter (nine-month leadi
Exhibit 23. Relationship Between Chicken Margins and Production
‐8%
‐6%
‐4%
‐2%
0%
2%
4%
6%
8%
10%
12%
55
65
75
85
95
105
115 C h i c k e n P r o d u c t i o n‐
T h r e e M o n t h R o l l i n g A v e r a g e
Y ‐ o‐ Y C h a n g e
C h i c k e n C u t o u t M a r g i n ( c e n t s / l b )
‐ ‐
T h r e e M o n t h
R o l l i n g A v e r a g e ( L a g g e d
S e v e n M o n t h s )
Chicken Margin Chicken Production
Disconnect due to
supply limitations
Source: Bloomberg and BMO Capital Markets.
Exhibit 24. Egg Sets and Chicks Placed
-9.0%
-7.5%
-6.0%
-4.5%
-3.0%
-1.5%
0.0%
1.5%
3.0%
4.5%
6.0%
7.5%
Y e
a r - O v e r - Y e a r
% C h a n g e
( R
o l l i n g
6 W e e
k A v e r a g e
)
Egg Sets Chicks Placed
Source: USDA and BMO Capital Markets.
Although lower price point menu items likely create a modest headwind to comparabl
restaurant sales growth, the menu items likely are margin-enhancing. For instance, westimate the food cost ratio on Olive Garden’s Cucina Mia menu items to be 28% relative
Darden’s 30%-plus consolidated food cost ratio.
Although margin opportunities likely are more modest beyond FY2015, the eventu
contribute $40 million of profits, 60 bps to margins, and $0.20-$0.25 to EPS assuming the savin
are not reinvested. First, beef prices likely will increase in 2015 as 1) 2014 cattle supplies like
will decline 1.5%-2.0% to the smallest supply since the early 1950s; 2) 2015 cattle supplies like
will tighten further as the 2013 U.S. calf crop, which is a 14-month leading indicator of slaugh
ready cattle supplies, declined 1% to the lowest level since the early 1950s; and 3) beef pric
likely must increase before falling as heifer retention to rebuild cattle supplies removes cat
from the slaughter supply. Heifer retention began to gain momentum in 2014 as the percentageheifers in the weekly cattle slaughter mix fell an average of 1%-2% below year-ago levels to d
in 2014 relative to flat with year-ago levels in 2013 (fewer heifers in the slaughter mix impl
heifers are retained for breeding). Second, the onset of heifer retention implies initial cattle/b
supply growth in 2016 owing to the timing of the lifecycle (two years), which should begin
pressure beef prices. Moreover, the likely competing protein supply growth (i.e., chicken a
pork) should contribute to lower beef prices.
Exhibit 25. Beef Prices
140
150
160
170
180
190
200
210 220
230
240
C h o i c e B e e f C u t o u t V a l u e ( c e n
t s / l b )
Source: Bloomberg and BMO Capital Markets.
Exhibit 26. 2014 Beef Inflation
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
B e e f I n f l a t i o n
Source: Company Reports, Bloomberg, and BMO Capital Markets
The Red Lobster sale, a pullback in capex, and a potential cash flow inflection could crea
opportunities to support EPS growth and shareholder returns. We estimate that t
allocation of Red Lobster sale proceeds should contribute 1) $0.25 and $0.07 to EPS in FY20
and FY2016, respectively, from balance sheet deleveraging; and 2) $0.10-$0.15 and $0.03-plus
FY2015 and FY2016 EPS from the accelerated share repurchase program (timing of debt p
down and share repurchases imply incremental benefit to FY2016). In addition, the ability
repurchase shares on an ongoing basis could contribute an additional $0.03-$0.05 annually EPS.
Darden announced its intention to allocate the proceeds ($1.6 billion) from the Red Lobst
sale and the cash savings from a nearly $100 million reduction in capex spending (related
slower unit growth) toward 1) a $500-$600 million accelerated share repurchase progra
(completed by October) that is incremental to the company's original intention to repurcha
up to $200 million of stock in FY2015, and 2) paying down $1 billion of debt (completed
August). The debt pay-down should reduce Darden’s leverage ratio (excluding Red Lobste
to 2.2x from 4.2x (the highest in our coverage).
An inflection in cash flow generation (assuming Olive Garden fundamentals do not deteriora
further) likely would create greater capital allocation focus on share repurchases over the neseveral years as 1) Darden plans to maintain its current dividend until earnings growth aligns
payout ratio with its 50%-60% target range, 2) Darden’s earnings may not grow into its payo
ratio for three to five years, and 3) Darden likely will not further deleverage its balance sheet. W
estimate Darden could begin repurchasing 1.5-2.0 million shares of stock on an ongoing annu
basis beginning in FY2016 assuming stabilizing Olive Garden trends reflecting 1) an accelerati
of Darden’s cash flow from operations from the recent $500-$600 million range to nearly $7
million in FY2016 as earnings improve, 2) a reduction of capex spending to $335 million fro
$415 million last year, and 3) stable dividend. That said, there is a risk that share repurchas
could slow if Olive Garden trends deteriorate further.
Opportunities to “Release” Value With Strategy Shift or PortfolioOptimization if Olive Garden Turnaround Fails
Darden may begin to “release” value through a shift in its strategy or portfolio optimizatio
if the Olive Garden revitalization fails to take hold. In light of the CEO and potential boa
member changes coupled with the likely long timeline for a turnaround at Olive Garden, w
believe the opportunity exists for Darden to embark on a new strategic direction.
We would not be surprised if Darden begins to augment its strategy over the next 6-
months as 1) its new CEO, once appointed, may seek to establish a new path; and 2) Dard
shareholders may elect activist investor Starboard’s nominees to Darden’s board of directo
in the October 10th vote, similar to recent actions at Bob Evans. Components of Darden
strategy that could be augmented include, but are not limited to, 1) initiatives to impro
Olive Garden trends; 2) marketing spending across its portfolio; 3) unit growth trajecto
particularly for LongHorn and Specialty Restaurant Group; and 4) capital allocation. F
instance, Bob Evans' shareholders elected four of the eight nominees proposed by Sand
Asset Management to Bob Evans’ board in late August in an effort to bring about a change
strategy.
We assign a 60% probability to Darden embarking on portfolio optimization strategies ov
the next 12 months as the company implements initiatives to improve Olive Garden trend
That said, enduring poor Olive Garden trends could eventually lead to portfolio optimizati
strategies. We believe a break-up is the most likely method of portfolio optimization a
derive a break-up value of $56-$57/share based on our FY2015 estimates (15%-20% upsi
from current levels). Our break-up value assumes the following:
o $705 million of EBITDA, reflecting our continuing operations estimate of $745 milli
and $40 million of dis-synergies. Our dis-synergy assumption reflects $20 million ea
for LongHorn and Specialty Restaurant Group based on the $15 million of stranded co
with the Red Lobster sale and the likely need for additional support infrastructur
management investment, while we assume no dis-synergies for Olive Garden (curresupport infrastructure stays with Olive Garden). Note that every $10 million of d
synergies reduces our break-up value by nearly 2%.
o $8.2-$8.3 billion enterprise value, which implies an 11.5x-12.0x EV/EBITDA multip
based on comparable trading multiples and a 25% acquisition premium. We assign
elevated 25% acquisition premium owing to the company's ability to reaccelerate grow
at LongHorn and Specialty Restaurant Group coupled with depressed earnings from hi
beef costs.
o Full benefit of $1 billion debt pay-down and accelerated share repurchase from the R
Olive Garden performance and risk to turnaround at the concept could continue to weight
earnings and stock.
Headwinds to growth from weak casual dining and macro trends, segment dynamics, and casu
dining unit oversupply.
Potential for above-average volatility owing to diverse portfolio, operational changes, a
Specialty unit growth.
Greater commodity risk given high beef exposure and flexible purchasing strategy.
Structural increases in labor costs could create margin headwinds.
Olive Garden Performance and Risk to Turnaround at the ConceptCould Continue to Weigh on Earnings and the Stock
Deteriorating Olive Garden trends have weighed on Darden’s overall performance over t
last several years. After a post-recession recovery in FY2011 (+1.2%), Olive Gardencomparable-restaurant sales trends deteriorated and have declined over the last three years, a
the decline in same-store sales has accelerated over that period. The poor Olive Garden tren
pressured Darden’s blended comparable-restaurant sales to modest growth in FY2012 a
declines in both FY2013 and FY2014 as both LongHorn and Specialty Restaurant Gro
comparable-restaurant sales increased on an annual basis in each of the last three years. Fir
Olive Garden’s same-store sales declined an average of 2.1% over the last 12 quarters a
underperformed casual dining industry comps by 190 bps over that period, according to Kna
track data. Weak Olive Garden trends largely reflect declining traffic as Olive Garden has realiz
lower traffic in 10 of the last 12 quarters, including a 270 bps average traffic decline over th
period. Second, Olive Garden’s comparable-restaurant sales declines accelerated from a 1.2
decline in FY2012 to 1.5% in FY2013 and 3.4% in FY2014, while Olive Garden comparabrestaurant sales declined 3.5%-5.5% in each of the last two quarters. Accelerating traffic declin
drove the increasingly poor comparable-restaurant sales as Olive Garden traffic declined 1.4%
2.7%, and 4.0% in FY2012, FY2013, and FY2014, respectively (5.6% average decline over t
last two quarters). Third, Olive Garden’s poor same-store sales were somewhat isolated within t
casual dining Italian segment as its comps trailed casual Italian segment peer Carrabba’s by 3
bps over the last 12 quarters and Carrabba’s outperformed casual dining industry same-store sa
The ability to sustainably reverse Olive Garden trends is uncertain and the turnarou
likely would take an extended period. Darden’s management implemented initiatives
improve trends at Olive Garden, including a new logo (introduced in FY2014) and restaura
design (75 units to be remodeled in FY2015), an updated menu that launched in late Februa
with lighter and lower priced options, reinvesting cost savings in higher quality ingredients (e.
higher quality proteins), Pronto lunch menu that facilitates faster lunch visits (less than
minutes), greater leadership focus in underperforming restaurants, tablet introduction in FY20to improve guest experience, and a shift in its advertising strategy toward a balance between
brand building and price promotion message from a heavily price-related message. That said, t
ability to sustainably reverse deteriorating Olive Garden trends 1) is uncertain given the inabili
to stem the prolonged weakness in Red Lobster trends (average monthly traffic decline of 3.4
over the last five years accelerating to 9.4% decline over the last 12 months); and 2) likely wou
take an extended period, reflecting material brand degradation in the eyes of consumers, the tim
required for consumers to both recognize changes at the concept and change their visit frequen
behavior, and near-term pressures from the change in promotional strategy.
Exhibit 36. Initiatives Did Not Stem the Tide of Weak Red Lobster Trend
‐15%
‐10%
‐5%
0%
5%
10%
R e d
L o b s t e r M o n t h l y S a m e S t o r e S a l e s
‐
Y ‐ o
‐ Y C h a n g e
Source: Company Reports and BMO Capital Markets
Although Darden’s shift in marketing strategy toward brand building from price po
promotions could have long-term benefits, we believe the shift likely will pressure comparab
restaurant sales in the short term. First, Olive Garden’s monthly comparable-restaurant sales a
the year-over-year change in the frequency of casual Italian segment “combined item specials” (i
special designed to combine items at a lower price point) show a strong relationship, as shown
Exhibit 37, according to NPD Group data. Second, given the relationship, Olive Garden like benefited incrementally from the increased use of “combined item specials” in the segment over t
last two years (given Olive Garden’s 25% share of the segment, a large portion of the promotions a
attributable to the concept) as the promotions accounted for more than half of total casual Itali
segment promotions over the last one to two years and have increased in frequency from 21%
segment promotions in CY2011 to 40% in CY2012 and 50%-plus in CY2013/CY2014. However,
slowest growth since at least the recession and approximately half its average pace of unit growth ov
the last five years (4.9% growth excluding Red Lobster and acquisitions).
Headwinds to Growth From Weak Casual Dining and Macro Trends,Segment Dynamics, and Casual Dining Unit Oversupply
Poor casual dining trends create headwinds to growth across the casual dining segmen
Casual dining segment trends remain exceedingly lackluster. Average casual dining sales growof only 0.4% over the last three years trailed industry growth by an average of 250 bps reflecti
lackluster comparable-restaurant sales – led by weak traffic. Casual dining is the only su
segment across the restaurant industry to realize lower overall traffic in any of the last three yea
as traffic has declined 1%-3% in each of the last three years. Casual dining comparable-restaura
sales increased an average of only 20 bps over the last three years as traffic declined an average
160 bps (offset by 180 bps of check growth). Comparable-restaurant sales trends weakened ea
year as traffic declines accelerated. Specifically, comparable-restaurant sales growth decelerat
from 150 bps in 2011 to 50 bps in 2012, followed by a 140 bps decline in 2013 as traffic declin
accelerated from 40 bps in 2011 to 170 bps in 2012 and 270 bps in 2013 (accelerating declin
have persisted to date in 2014 as traffic fell more than 300 bps through August).
Exhibit 39. Casual Dining and Industry Sales Growth
Exhibit 50. Disposable Income Remains a Challenge Relative to Inflatio
‐6%
‐4%
‐2%
0%
2%
4%
6%
8%
Y e a r ‐ o v e r ‐ Y e a r C h a n g e i n R e a l
D i s p o s a b l e I n c o m
e
Largely rangebound
Source: Bureau of Labor Statistics and BMO Capital Markets.
Steak/Italian shares of total casual dining orders that are in line with other major food item
coupled with less fragmentation in those segments create headwinds to growth. First, the
is a case to be made that underlying growth in segments that represent nearly 80% of Darden
sales may not outpace full-service industry growth given that the steak and Italian share of to
full-service dining entrees is in line with other major food items. For instance, 7% and 9% fu
service dining orders include steak and pasta, respectively, which is in line with sala
Asian/Indian, burger, fish, and Mexican food order shares in the 7%-10% range, according
NPD Group data. Second, the less fragmented steak and Italian segments underscore the need
Darden to continue taking share from other large chains. We estimate that the top 500 full servi
dining chains in the steak and Italian categories account for only 40%-60% market share in tcategories, which is among the highest across full-service dining segments and exceeds t
consolidated share of the 500 largest chains across full service dining of 30%-35%.
Exhibit 51. Food Share of Full Service Dining Entrées
2%
4%
6%
8%
10%
12%
14%
16%
S h a r e o
f F u
l l S e r v
i c e
D i n i n g
E n
t r e e
O r d e r s
Source: NPD Group and BMO Capital Markets.
Although the casual dining segment reduced units every year from 2009 to 2013, w
believe additional unit rationalization may occur as we estimate the segment may be near
10% oversupplied. Importantly, we believe independent restaurants and underperforming fo
segments within casual dining could lead the unit rationalization. First, the casual dining segme
appropriately began reducing units in 2009 as traffic slowed; however, unit declines slowed
each of the last three years (only 10 bps decline in 2013) despite accelerating comparab
restaurant traffic declines. Second, although traffic did not begin to decline until 2009, unit tren began outpacing traffic in 2006 driving a decline in transactions per unit after average annu
growth of nearly 100 bps in the six years prior. Third, we estimate the casual dining segment h
9%-10% unit oversupply as 8,500 fewer units would be required to re-establish the transactio
Exhibit 52. Casual Dining Industry May Be 10% Oversupplied in Termsof Units
41
42
43
44
45
46
47
48
T r a n s a c t i o n s P e r U n i t ( 0 0 0 )
Transactions/Unit
9%‐10% fewer
units required
to achieve
historical
growth rate
Source: Euromonitor and BMO Capital Markets.
Potential for Above-Average Volatility Owing to Diverse Portfolio,Operational Changes, and Specialty Unit Growth
Darden’s business model is inherently more volatile than many of its casual dining pee
Darden’s diverse portfolio of brands across categories (e.g., casual dining, polished casual, fine dinin
and segments (e.g., Italian, steak, ethnic, bar and grill) creates a more volatile business model than t
more concentrated portfolios of its restaurant peers because it is more difficult to manage a portfo
with such diversity of brands and consumers, while spreading thin management’s focus across
brands. We would not be surprised if the volatility of Darden’s performance remains above average
the next several years as it focuses on the Olive Garden turnaround and the level of focus on Oli
Garden creates pockets of weakness in its other brands (particularly Specialty Restaurant Grou
similar to Bloomin’ Brands recently weaker trends at Carrabba’s and Bonefish as the compafocused on its Outback Steakhouse refresh. For instance, the volatility of Darden’s same-store sal
and operating margins around its average is the greatest among the casual dining companies in o
coverage as the standard deviation of its same-store sales and operating margins over the last three ye
of 1,180% and 22%, respectively, compares with the 55% and 8% averages across our covera
(excluding Darden). Similarly, Bloomin’ Brands, which operates the second-most diverse portfo
among casual dining companies in our coverage with five brands, has the second-highest deviation fro
its average same-store sales (64%) and operating margin (11%) – albeit well below the volatility
Darden’s portfolio.
Operational changes at Olive Garden and still-strong Specialty Restaurant Group u
growth could lead to temporarily higher costs, particularly labor and marketing. Operationchanges and unit expansion into new markets tend to create inefficiencies, particularly in labo
that could pressure margins in the near term. For instance, Bloomin’ Brands, Buffalo Wild Win
Chuy’s, and Texas Roadhouse all experienced labor inefficiencies over the last 12 months or so
it implemented operational changes (e.g., lunch, enhanced service models) and expanded into ne
markets. Moreover, the expansion of Specialty Restaurant Group brands into new geographi
likely will require greater brand building investments to generate brand awareness and attra
consumers in the tepid casual dining industry environment, particularly given broad-based u
expansion into new geographies by other casual dining concepts.
Greater Commodity Risk Given High Beef Exposure and FlexibPurchasing Strategy
Darden’s elevated beef exposure creates greater commodity price risk as be
fundamentals remain challenging. To be clear, there are indications that beef prices could pe
in CY2015 and become a tailwind for Darden in CY2016 as the onset of heifer retention impli
cattle supply expansion. That said, the near-term outlook for beef prices (20% of Darden
commodity basket) remains onerous, beef prices likely will become a greater headwind befo
improving, and the timing of cattle herd expansion remains somewhat uncertain. In additio
despite locking in prices, Darden employs a flexible purchasing strategy as Darden attempts
time its beef purchases based on its view of the market. Market price speculation creates grea
exposure to misjudging the price outlook that is limited by more deliberate purchasing strategi
(but also could be an advantage in a declining beef price environment).
The near-term outlook continues to imply higher beef prices as cattle supplies remain multi-decade lows and the calf crop provides visibility into tighter 2015 supplies. First, be
prices recently reached record highs as 2014 cattle supplies 1) fell to the lowest level sin
the early 1950s, 2) declined in each of the last seven years (0.5%-2.1% declines), a
3) declined more than 15% in the last 20 years. The structural decline in cattle suppl
largely reflects a shift in diets away from beef toward chicken (per capita U.S. be
consumption declined 19% over the last 20 years, while chicken consumption increas
20%), feed cost spikes in 2007/08 and 2011/12, and drought in the Southwest and Plains th
limited the ability to rebuild cattle supplies. Second, slaughter-ready cattle supplies likely w
decline again in 2015 as the 2013 calf crop (a two-year leading supply indicator) fell 1% fro
Beef prices likely will increase further before an eventual decline as heifer retention rebuild supplies inherently removes heifers from the slaughter-ready supply. For perspectiv
2.5% heifer retention implies a 75 bps reduction in cattle available for slaughter as heife
have accounted for 30% of total slaughter over the last 10 years.
We continue to believe the onset of heifer retention over the last several months coupled w
slowly improving pasture conditions in key cattle producing regions indicates that be
supplies will begin to expand in CY2016. That said, the timing of cattle herd expansio
remains somewhat uncertain as grazing conditions could reverse with poor weathe
Specifically, while large areas of west Texas, Kansas, and Nebraska have improved 1
drought categories since the spring, the states remain at varying levels of drought (i.
“exceptional”, “extreme”, “severe”, or “moderate” per the U.S. Drought Monitor categori
and worsening drought conditions likely would slow or end near-term heifer retention.
Structural Increases in Labor Costs Could Create Margin HeadwindsThe combination of potential changes to tipped wages and healthcare legislation crea
structural headwinds to restaurant margins. The restaurant industry faces headwinds fro
potential changes in tipped wage and the implementation of the Affordable Care Act. We estim
that the casual dining segment requires 300 bps of pricing to offset a 10% change in the tip cre
and 400 bps of pricing to offset the impact of the Affordable Care Act.
There is a risk that minimum tip-credit levels could increase within the broader increase
minimum wage, although the probability, timing, and magnitude of a potential change
somewhat uncertain. A change to the tip-credit would create a meaningful headwind f
Darden and the full-service restaurant segment broadly. In a worst-case scenario, t
elimination of the tip-credit could increase casual dining labor costs by 75% in states threcognize the minimum tip credit and federal minimum wage levels as we estimate restaura
costs for tipped employees account for one-third of total labor costs and the wage for tho
workers would increase from $2.17 to $7.25. To be fair, the probability of such a seve
change appears somewhat limited. The tip credit allows full-service dining companies to p
minimum wage levels. Currently 19 states (35%-40%) employ the federal minimum tippe
wage level of $2.13, 25 states have minimum tipped-wages above the federal minimum, a
7 states do not recognize tip credits (i.e., companies must pay full state minimum wage befo
tips).
Restaurant companies appear to believe the Affordable Care Act could create a 30-100 b
margin headwind across the industry beginning in 2015 before taking action to mitigate t
impact. To be fair, there are significant unknowns regarding the number of employees th
will opt-in to the healthcare plans provided, the level of coverage selected, and the ability
shift labor schedules to mitigate the impact (fewer hours per week in an effort to reduce
employees’ hours below the threshold). That said, the specific commentary related to t
impact of healthcare beginning in 2015 includes 1) 100 bps impact for Chipotle; 2) 30-50 b
headwind for Noodles, which likely includes some offsets; 3) minor increase in healthca
costs for Brinker (although the impact is somewhat limited as Brinker’s previous health pla
largely were compliant with ACA); and 4) a several million dollar increase for Tex
Roadhouse, which we estimate implies a 30 bps margin headwind.
Darden appears somewhat well positioned to offset potential labor cost headwinds. FirDarden likely could offset headwinds from the Affordable Care Act over a two-year peri
with pricing at the high end of its normal range as Darden tends to increase prices 1%-2%
Second, Darden’s likely FY2015 rollout of tablet technology creates opportunities to mitig
labor inflation through greater labor efficiencies.
Long Timeline for Olive Garden Turnaround Limits EarningsUpside
Darden likely will achieve FY2015 earnings at the low-end of its guidance range and the
may be downside risk as Olive Garden performance likely will continue to weight o
earnings over the next several quarters. We estimate Darden will achieve FY2015 EPS $2.23, which is at the low end of its $2.22-$2.30 guidance range and $0.01 below consens
expectations. Our estimate implies 43% earnings growth reflecting the combination
deleveraging, accelerated share repurchases, cost savings, the absence of $0.15 of shared suppo
costs that shifted to Red Lobster after the sale was completed, and solid LongHorn and Special
Restaurant Group fundamentals. That said, we believe the potential Olive Garden turnaround
the key to driving upside to expectations and 1) we believe the turnaround likely will take seve
quarters, and 2) the long timeline to achieving a turnaround creates downside risk to earnin
estimates.
We estimate deleveraging (16 pp), share repurchases (6 pp), and the absence of shar
support costs (10 pp) drive 32 pp of Darden’s expected FY2015 earnings growth. FirDarden allocated $1 billion of the proceeds from the Red Lobster sale toward balance she
deleveraging, which should contribute $0.25 to FY2015 earnings. Second, Darden allocat
the remaining $500-$600 million of Red Lobster proceeds coupled with an additional $10
$200 million of cash toward share repurchases. The $700 million buyback should contribu
$0.10 to FY2015 earnings growth. Third, $0.15 of shared support costs shifted to the divest
Red Lobster business following the completion of the deal.
LongHorn Steakhouse and Specialty Restaurant Group fundamentals are bright spots with
Darden’s portfolio. First, Darden should benefit from solid underlying steak segment tren
as the steak segment is the strong food segment within casual dining. High retail beef pric
are likely contributing to the steak segment outperformance, and LongHorn should contin
to benefit in FY2015 as retail beef prices should remain at record levels over the next
months or so. Second, the Specialty Restaurant Group should continue to benefit from fi
dining sub-category outperformance and more resilient “polished casual” trends relative
the casual dining sub-segment.
Cost savings should create G&A leverage. Specifically, we expect Darden’s G&A ratio to f
to 9% by the end of FY2015 as we estimate a likely $50 million cost savings opportunity
FY2015 ($50 million run rate by the end of the year). The cost savings likely will create
100 bps margin tailwind as we estimate FY2015 G&A ratio of 9.2% relative to 10.3%
FY2014.
Olive Garden investments and the likely slow pace of the concept’s turnaround likely w
limit additional earnings growth in FY2015. The ability to sustainably reverse deterioratiOlive Garden trends 1) is uncertain given the inability to stem the prolonged weakness in R
Lobster trends (average monthly traffic decline of 3.4% over the last five years accelerati
to a 9.4% decline over the last 12 months); and 2) likely would take an extended period
time reflecting material brand degradation in the eyes of consumers, the time required
consumers to both recognize changes at the concept and change visit frequency behavior, a
near-term pressures from the change in promotional strategy.
Over the long, term we expect Darden to generate double-digit earnings growth assumin
stabilizing Olive Garden trends; however, we believe Olive Garden trends becom
increasingly important beyond FY2015. First, our longer term earnings growth expectati
reflects ongoing strong LongHorn and Specialty Restaurant Group fundamentals, marg
expansion opportunities with the eventual decline in beef prices, the full benefit of FY20
balance sheet deleveraging, and ongoing share repurchases. Second, we do not assume Oli
Garden returns to comparable-restaurant sales growth in our longer-term earnings outlo because we believe Darden has a long road ahead to achieve a turnaround. That said, a turnarou
would significantly improve Darden’s comparable sales growth and earnings trajectory giv
Olive Garden's size in Darden’s portfolio (nearly 60% of sales). We estimate a 100 b
Overvalued on Fundamentals, but Cannot Rule Out StrategicActions
A little perspective on Darden’s stock performance. Darden’s stock has underperformed t
S&P 500 over the last one-, three-, and five-year periods, as well as over the last six and nin
months. Specifically, Darden’s stock increased 9%, 13%, and 52% over the last one, three a
five years, relative to a 17%, 70%, and 86% increase in the S&P 500 over the same periods. addition, Darden’s stock fell 1% and 5% over the last six and nine months, respectively, relati
to a 7% increase in the S&P 500 over both periods. However, Darden’s stock outperformed ov
the last three month (8% increase for Darden relative to flat S&P 500) as pressure from activ
investors intensified.
Our target price of $52, which implies 4% upside from current levels, reflects a combinati
of our fundamental valuation and our break-up value estimates to account for the potent
for strategic actions. We assign a 40/60 probability to 1) Darden continuing to operate in
current structure, and 2) strategic action to release value from Darden’s underlying assets. Fir
we derive a $45 price target on a fundamentals basis as we assign a lofty 20x P/E to our $2.
earnings estimate for FY2015. The 20x P/E implies a 40%-45% premium to DRI’s historicmultiple reflecting the likelihood that FY2015 earnings are depressed by recent Olive Gard
performance and the potential for materially stronger earnings if management’s turnarou
initiatives take hold. Second, we derive a $56-$57 price target based on our analysis of Darden
potential break-up value based on our FY2015 expectations.
DRI, which is trading at a forward 12-month P/E and EV/EBITDA of 22x and 10-11x,
trading well above its historical average valuation, as shown in Exhibits 55 and 56. Darden
premium multiple relative to historical levels likely reflects the growing pressures for chan
among activist investors. While we cannot justify the current multiple on a fundamental bas
DRI likely will continue to trade well above its historical multiple unless it becomes clear th
activist pressure will not result in a material changes.
Based on fundamentals, DRI likely should trade at a discount to its casual dining peers an
the stock historically trades at a 20% discount to its peer group. That said, Darden’s curre
multiple is a 15% premium to its peers. First, Darden is among the most mature casual dini
companies in our coverage, and we believe its potential for unit growth is somewhat limite
Second, the likelihood of an Olive Garden turnaround appears uncertain and likely will ta
several quarters. Given the size in DRI’s portfolio, Olive Garden's poor fundamentals like
would continue to limit comparable-restaurant sales growth and margin expansion. Thir
DRI’s dividend likely would be at risk absent an Olive Garden turnaround, and potent
share repurchases could slow as free cash flow generation deteriorates.
* Current EPS is the 4 Quarter Trailing to Q2/2014.* Valuation metrics are based on high and low for the fiscal year.* Range indicates the valuation range for the period presented above.
I, Andrew Strelzik, hereby certify that the views expressed in this report accurately reflect my personal views about the subject securities or issuers. Ialso certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in thisreport.
Analysts who prepared this report are compensated based upon (among other factors) the overall profitability of BMO Capital Markets and their
affiliates, which includes the overall profitability of investment banking services. Compensation for research is based on effectiveness in generatingnew ideas and in communication of ideas to clients, performance of recommendations, accuracy of earnings estimates, and service to clients.
Analysts employed by BMO Nesbitt Burns Inc. and/or BMO Capital Markets Limited are not registered as research analysts with FINRA (exception:Alex Arfaei). These analysts may not be associated persons of BMO Capital Markets Corp. and therefore may not be subject to the NASD Rule 2711and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analysaccount.
Methodology and Risks to Price Target/Valuation
Methodology: Our $52 price target implies a blend of our fundamental valuation and our break-up value estimates.Risks: Aggressive strategic actions to release value, a stronger/earlier turnaround in Olive Garden trends, more aggressive share repurchases, improvingmacroeconomic conditions, and multiple expansion if results exceed expectations.
Hold Market Perform 50.9% 8.4% 31.3% 51.2% 39.9% 39.5%
Sell Underperform 5.0% 3.4% 1.3% 5.5% 1.5% 5.1%
* Reflects rating distribution of all companies covered by BMO Capital Markets Corp. equity research analysts.** Reflects rating distribution of all companies from which BMO Capital Markets Corp. has received compensation for Investment Banking services a
percentage within ratings category.*** Reflects rating distribution of all companies from which BMO Capital Markets Corp. has received compensation for Investment Banking
services as percentage of Investment Banking clients.**** Reflects rating distribution of all companies covered by BMO Capital Markets equity research analysts.***** Reflects rating distribution of all companies from which BMO Capital Markets has received compensation for Investment Banking services a
percentage of Investment Banking clients.
Rating and Sector Key (as of April 5, 2013):
We use the following ratings system definitions:OP = Outperform - Forecast to outperform the analyst’s coverage universe on a total return basisMkt = Market Perform - Forecast to perform roughly in line with the analyst’s coverage universe on a total return basisUnd = Underperform - Forecast to underperform the analyst’s coverage universe on a total return basis(S) = speculative investment;
NR = No rating at this time;R = Restricted – Dissemination of research is currently restricted.
BMO Capital Markets' seven Top 15 lists guide investors to our best ideas according to different objectives (CDN Large Cap, CDN Small Cap, USLarge Cap, US Small cap, Income, CDN Quant, and US Quant have replaced the Top Pick rating).
Prior BMO Capital Markets Ratings System (January 4, 2010–April 4, 2013):
For Other Important Disclosures on the stocks discussed in this report, please go tohttp://researchglobal.bmocapitalmarkets.com/Public/Company_Disclosure_Public.aspx or write to Editorial Department, BMO Capital Markets, 3Times Square, New York, NY 10036 or Editorial Department, BMO Capital Markets, 1 First Canadian Place, Toronto, Ontario, M5X 1H3.
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be construed as advice designed to meet the particular investment needs of any investor. This material is for information purposes only and is not anoffer to sell or the solicitation of an offer to buy any security. BMO Capital Markets or its affiliates will buy from or sell to customers the securities ofissuers mentioned in this report on a principal basis. BMO Capital Markets or its affiliates, officers, directors or employees have a long or short positionin many of the securities discussed herein, related securities or in options, futures or other derivative instruments based thereon. The reader shouldassume that BMO Capital Markets or its affiliates may have a conflict of interest and should not rely solely on this report in evaluating whether or notto buy or sell securities of issuers discussed herein.
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Nesbitt Burns Inc.The following applies if this research was prepared in whole or in part by Andrew Breichmanas, Iain Reid, Tony Robson, David Round, Edward Sterckor Brendan Warn: This research is not prepared subject to Canadian disclosure requirements. This research is prepared by BMO Capital MarketsLimited and subject to the regulations of the Financial Conduct Authority (FCA) in the United Kingdom. FCA regulations require that a firm providingresearch disclose its ownership interest in the issuer that is the subject of the research if it and its affiliates own 5% or more of the equity of the issuer.Canadian regulations require that a firm providing research disclose its ownership interest in the issuer that is the subject of the research if it and itsaffiliates own 1% or more of the equity of the issuer that is the subject of the research. Therefore BMO Capital Markets Limited will only disclose itsand its affiliates ownership interest in the subject issuer if such ownership exceeds 5% of the equity of the issuer.To U.S. Residents: BMO Capital Markets Corp. furnishes this report to U.S. residents and accepts responsibility for the contents herein, except to theextent that it refers to securities of Bank of Montreal. Any U.S. person wishing to effect transactions in any security discussed herein should do sothrough BMO Capital Markets Corp.To U.K. Residents: In the UK this document is published by BMO Capital Markets Limited which is authorised and regulated by the FinanciaConduct Authority. The contents hereof are intended solely for the use of, and may only be issued or passed on to, (I) persons who have professionalexperience in matters relating to investments falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order2005 (the “Order”) or (II) high net worth entities falling within Article 49(2)(a) to (d) of the Order (all such persons together referred to as “relevant
persons”). The contents hereof are not intended for the use of and may not be issued or passed on to, retail clients.
Unauthorized reproduction, distribution, transmission or publication without the prior written consent of BMO Capital Markets is strictly prohibited.
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ADDITIONAL INFORMATION IS AVAILABLE UPON REQUEST BMO Financial Group (NYSE, TSX: BMO) is an integrated financial services provider offering a range of retail banking, wealth management, and investment acorporate banking products. BMO serves Canadian retail clients through BMO Bank of Montreal and BMO Nesbitt Burns. In the United States, personal acommercial banking clients are served by BMO Harris Bank N.A. (Member FDIC). Investment and corporate banking services are provided in Canada and the through BMO Capital Markets.
BMO Capital Markets is a trade name used by BMO Financial Group for the wholesale banking businesses of Bank of Montreal, BMO Harris Bank N.A. (Memb
FDIC), BMO Ireland Plc, and Bank of Montreal (China) Co. Ltd. and the institutional broker dealer businesses of BMO Capital Markets Corp. (Member SIPC) aBMO Capital Markets GKST Inc. (Member SIPC) in the U.S., BMO Nesbitt Burns Inc. (Member Canadian Investor Protection Fund) in Canada, Europe and AsBMO Capital Markets Limited in Europe and Australia, and BMO Advisors Private Limited in India.
Nesbitt Burns” is a registered trademark of BMO Nesbitt Burns Corporation Limited, used under license. “BMO Capital Markets” is a trademark of Bank of Montreused under license. "BMO (M-Bar roundel symbol)" is a registered trademark of Bank of Montreal, used under license.
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