Why Darden Restaurants Is a Sell in the Near-Term

Darden Restaurants Inc. (DRI) is the world's largest publicly held casual dining restaurant company. It owns and operates the Olive Garden®, Red Lobster®, LongHorn Steakhouse®, The Capital Grille®, Yard House®, Bahama Breeze®, Seasons 52®, Eddie V's Prime Seafood® and Wildfish Seafood Grille® restaurant brands.

Below Analysts' Expectations

Darden Restaurants is the largest full-service restaurant company in the world. As of May 26 2013, the company operated 2,138 restaurants in the U.S. and Canada, all of which are owned by the company, except three restaurants located in Florida and three restaurants located in California that are owned by joint ventures managed by the company. As of the same date, the company had 37 franchised restaurants in Japan, the Middle East, Puerto Rico and Mexico pursuant to area development and franchise agreements. But unfortunately, sales declined at its best known brands. Darden´s performance was hurt by a sales drop at its Red Lobster chain, which it plans to separate the segment either through a spin-off or sale. This transaction could take place in 2015. Olive Garden also underperformed analysts' expectations for the major part of fiscal 2013.

Inflation Risk

Outlook for food inflation at Darden is higher than in the past, so food and beverage expenses ratio will be higher year over year. Commodity inflation will be between 2.5% to 3.0% in fiscal 2014 and most of the food inflation will come from proteins, particularly beef and seafood. Furthermore, energy costs are also likely to be up year over year. As a matter of fact, earnings for fiscal 2014 are probably declining in the range of 15% to 20%.

Long-Term Drivers

The Specialty Restaurant Group (SRG), which includes Bahama Breeze and The Capital Grille, has grown over the last couple of quarters. Eddie V's Restaurants and Yard House might be meaningful long-term drivers, as we think most of the growth in the next years will come from the acquisition of those restaur! ants.

Analyst Recommendation

The firm is currently Zacks Rank # 3 - Hold, and it also has a longer-term recommendation of "Underperfom." For investors looking for a Zacks Rank # 1 – Strong Buy, Ignite Restaurant Group Inc. (IRG) and The Wendy's Company (WEN) could be the options.

P/E, Earnings and ROE

In terms of valuation, the stock sells at a trailing P/E of 18.5x, trading at a premium compared to the industry. Earnings per share (EPS) decreased by 42.3% in the most recent quarter compared to the same quarter a year ago. The company missed the Zacks Consensus Estimate for both earnings and revenues in fiscal second quarter 2014.

Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The ratio has decreased when compared to the same quarter one year prior. Let´s compare the current ratio with the peer group in the next table:

Ticker	Company Name	ROE (%)
DRI	Darden Restaurants	20
WEN	Wendy´s	2.36
EAT	Brinker International, Inc.	109.37
BWLD	Buffalo Wild Wings, Inc.	15.36
DNKN	Dunkin Brands Group Inc	36.06

As we can see, the firm has a higher ROE than Wendy´s and Buffalo Wild Wings, Inc. (BWLD), but far less than the ones from Dunkin Brands Group Inc (DNKN) and Brinker International, Inc. (EAT).

Final Comment

As outlined in this article, the company underperformance in its core brands, Red Lobster and Olive Garden resulted in lower sales in the last quarter. Darden was not the only one facing trou! ble, othe! r restaurants such as Dine Equity (DIN) and Yum! Brands (YUM) have also fallen short. On the other hand, we see we think Darden can continue to get benefitted from the acquisitions.

With a closed price level that was not very different from its closing price of one year earlier, in this opportunity I would recommend investors to stay away from this stock. Hedge fund gurus have also been active in the company in fourth quarter 2013. Gurus like Jim Simons (Trades, Portfolio), David Dreman (Trades, Portfolio) and Westport Asset Management (Trades, Portfolio) have sold or reduced positions in it.

Disclosure: Victor Selva holds no position in any stocks mentioned.

Also check out: David Dreman Undervalued Stocks David Dreman Top Growth Companies David Dreman High Yield stocks, and Stocks that David Dreman keeps buying Jim Simons Undervalued Stocks Jim Simons Top Growth Companies Jim Simons High Yield stocks, and Stocks that Jim Simons keeps buying

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