Darden Restaurants (NYSE:DRI) has been doing a great job of navigating a difficult food inflation environment. Meanwhile, the company should post strong Q3 results as restaurant industry traffic has been strong to start the year. However, I would be cautious on the stock as the year progresses given the likelihood of a recession and the impact on diners.
Company Profile
DRI is an operator of several full-service restaurant brands. The company operates in 4 segments: Olive Garden, LongHorn Steak House, Fine Dining, and Other Restaurants.
Olive Garden is DRI's largest concept, with nearly 900 owned and operated locations. The concept focuses on Italian food with dinner entrées ranging between $10-20, and lunch items between $8-10. Its average check per person was $21 in fiscal 2022, and 5.5% of its sales were alcohol.
LongHorne, meanwhile, is steakhouse restaurant operating primarily in the eastern U.S. Dinner entrées range from $12.50-$32.50, while lunch items cost between $9-13. The average check per person was $24 in fiscal 2022, and 9% of its sales were alcohol. The company owned and operated about 550 LongHorne locations.
The Fine Dining segment consists of DRI's Capital Grille and Eddie V's concepts. Both brands carry much higher checks and a lot more percentage of their sales are from alcohol - both at over 27%. The average check per person at Capitol Grill is around $47.50 and a whopping $109 at Eddie V's.
DRI's Other segment consists of a variety of full-service restaurant concepts, including Cheddar's Scratch Kitchen, Yard House, Seasons 523, Bahama Breeze, and The Capital Burger. Cheddar's is the largest concept in terms of number of locations. Most of Cheddar's locations are found in Texas and throughout the southern, mid-western, and mid-Atlantic regions. It's on the value side, with an average check per person of only $16.50.
Opportunities
DRI is one of the largest owners of full-service restaurants in the country, which gives it scale, marketing, and buying power advantages. Continuing to drive same-store sales as well as 4-wall unit economics and corporate efficiencies thus is key for company.
Over the past year, the company has done a great job of driving sales, although segment profit margins have been down given headwinds with food inflation. As food costs moderate, DRI should have the opportunity to improve margins, as it's done a nice job managing labor costs and marketing expenses.
One area the company is looking to take advantage of is off-premise sales. Towards this end, the company is investing in technology to both improve the guest experience and more efficiently take orders and payments.
On its FYQ2 call in December, CEO Riccardo Cardenas said:
"Across our brands, we continue to drive strong execution of the off-premise guest experience through ongoing investments in technology that reduce friction for our guests and our operators. For example, many of our guests still prefer to call in their To Go order.
"However, taking payment over the phone or when the guests arrived is both inefficient for our teams and inconvenient for our guests. To help address this, we rolled out online payment for call-in orders during the quarter, enhancing convenience for our guests and making our To Go specialists more efficient. To Go sales remain sticky across our core casual dining brand, accounting for 25% of total sales at Olive Garden, 14% at Longhorn and 13% at Cheddar's. Digital transactions accounted for 62% of all off-premise sales during the quarter and 10% of Darden's total sale."
Unit expansion remains another growth driver for DRI. The company plans to open between 55-60 new restaurants this fiscal year, spending between $525-575 million. While construction costs have increased, the company said that its 4-wall unit economics for new restaurants have also improved. Value-oriented Cheddar's is one concept that the company has been really high on with opening new locations.
On its earnings call, Cardenas said:
"Let me talk high level about Cheddar and talk a little bit about the opening. Cheddar's has made significant improvements in their business model versus pre-COVID, even with significant inflation, they had a lot of productivity enhancements with the simplified menu and a streamlined menu so that we felt more comfortable opening restaurants at a quicker pace. Not only that, they have really built their leadership pipeline and have been able to staff all of these restaurants with managing partners that have run Cheddar's, and we have a pipeline of more ready to go as we open restaurants. So yes, this was our highest quarter of openings for Cheddar's. …
"We had 7 restaurants versus last year at Cheddar's 4 in the quarter. And those restaurants are performing really well. So they're primarily in markets close to where Cheddar's already exists. It's not like we're -- we have a lot of restaurants opening in brand-new markets. But we are looking at newer markets to open Cheddar's in. But as we mentioned early on in the acquisition of Cheddar's, we thought we had more room to infill markets that they already have restaurants. So that helps us leverage our scale in those markets that helps us leverage our supply chain and our people."
Coming out of the pandemic, experiences, including eating out, remain high on consumers' lists of where to spend their discretionary income. That combined with price increases, should continue to drive sales. The company said on its most-recent earnings call that it is looking at price increases of about 6%.
Risks
The economy likely remains the biggest risk to DRI, as dining out at full-service restaurants tends to be one of the first places consumers cut back on during periods of economic weakness. DRI's core brands can get some trade-down action, but traffic and sales would likely take a sizable hit in a recession.
Inflation also remains a risk. On the one side, food inflation continues to outpace price increases, which hurts margins. On the other side, inflation is making it so that consumers have less discretionary spending power. This particularly can hurt families with incomes $50K or under and their willingness to eat out, which the company discussed on its FQ2 call.
Labor is another risk, as the restaurant industry has had difficulties filling open positions. However, DRI looks to be doing a good job on this front, saying each of its brands is fully staffed, and the manager staffing is at historic highs.
Valuation
DRI currently trades around 14x the FY 2024 (ending May) consensus EBITDA of $1.7 billion and 16x the FY25 consensus of $1.8 billion.
It trades at a forward PE of 17x the FY24 consensus of $8.70.
The company is projected to grow revenue 5.6% in FY24 to $11.0 billion
Its valuation is considerably higher compared to rivals like Bloomin' Brands (BLMN), which trades at an EV/EBITDA multiple of 8x 2024 EBITDA, and Dine Brands (DIN), which trades a 10.7x. Texas Roadhouse (TXRH), meanwhile, trades at around 12.5x 2024 EBITDA.
The stock historically often trades between 9-12x trailing EBITDA.
Conclusion
DRI has been doing a really nice job running its restaurants despite food inflation headwinds. Traffic and sales are both up nicely. Meanwhile, it's growing its unit count as well, focused on expanding its Cheddar's concept.
Early indications are the restaurant traffic is off to a good start for 2023. Given the mild winter weather across much of the country this isn't surprising, and is overall bullish for the restaurant industry.
That said, I'm not a fan of owning a restaurant stock that is trading at the high-end of its historical range ahead of what could become a weakening consumer environment. We haven't seen that stop patrons from dining out yet, but there are a lot of headwinds working against the consumer as the Fed pushes rates higher and inflation remains elevated.
Expect DRI to post strong Q3 results. However, I could see the stock fall to around $100 if a recession hits later this year, which would drop it to around pre-COVID levels and more in-line with its historical multiples.
Geoffrey Seiler
Former Senior Equity Analyst at $600M long-short hedge fund Raging Capital.
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