Darden’s Release of Red Lobster Catches Investors by Surprise

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Darden Restaurants (NYSE:DRI) just made a huge announcement that is sure to catch investors by surprise. The Orlando-based company is the struggling owner and operator of many full-service restaurants in the United States and Canada. It operates restaurants under the Red Lobster, Olive Garden, LongHorn Steakhouse, Capital Grille, Bahama Breeze, Seasons 52, Eddie V’s Prime Seafood, and Wildfish Seafood Grille brand names. On January 1, it owned and operated approximately 2,100 restaurants. But that is all about to change, as the company has decided to release its Red Lobster holdings.

Darden is selling Red Lobster, perhaps the most popular of its holdings behind Olive Garden. This is somewhat of a surprise, although the Street was expecting some sort of change. This is because the company announced late last year that it planned to either spin off or sell Red Lobster to improve its financial performance. Both Olive Garden and Red Lobster have been losing customers in recent years, and the company has tried various menu changes and marketing campaigns in hopes of winning back business.

How bad are the financials? Darden suffered a 19.6 percent plunge in profit year over year as its two largest brands continued to struggle with depressed sales and foot traffic. Revenue dipped 1 percent to $2.2 billion, missing Wall Street’s expectations. During the most recent quarterly earnings, the stock dropped to 82 cents per share, or $109.7 million, from $1.02 a share, or $134.4 million a year earlier. There are about 700 Red Lobster locations and 830 Olive Gardens in North America. Same-store sales at Olive Garden slid 5.4 percent during the quarter.

Foot traffic into Olive Garden restaurants open at least a year dove 4.9 percent in February. Red Lobster, however, was the most significant laggard. Darden said late last year that it plans to split 705 Red Lobster units from its system, whether by selling it or spinning it off to shareholders. That decision has now been made. Red Lobster is no small enterprise. It brought in $611 million in revenue in the third quarter but saw same-store sales dive 8.8 percent and visits decline 11.9 percent. In fact, only Darden’s Longhorn saw an increase in same store sales, rising 0.3 percent on $363 million in revenue.

One of the reasons the Darden’s restaurants are underperforming is that they are facing severe competition from local businesses, Ruby Tuesdays, Chipotle, Joe’s Crab Shack, and others.

Darden CEO Clarence Otis has noted that Red Lobster has been unable to capture higher-income customers. Thus, the company is selling Red Lobster. Darden believes it can turn things around by focusing on the Olive Garden brand. Darden recently modified the logo for Olive Garden and has been adding lighter menu items, as well as smaller dishes that it says better fit with eating trends in order to capture more diners.

Investors are balking at Darden’s plans to sell only Red Lobster, saying that the company should separate Olive Garden and Red Lobster as a pair from its other, more successful chains, which include Longhorn Steakhouse and Capital Grille. But the deal will provide Darden with a significant amount of cash with which to work. Darden will see proceeds of about $1.6 billion, of which $1 billion will be used to retire outstanding debt, leaving $600 million to rebrand and expand the Olive Garden. The company said it expects the deal to close in its first fiscal quarter.

The news isn’t being digested well on the Street, as shares are currently down 4 percent, to $48.70. The company is in need of cash and will need to focus on rebranding their menu at Olive Garden in order to attract business. As the economy improves, same-store sales cannot keep sliding. In turn, share prices continue to suffer. The company is in transition, and as such, expect Darden shares to trade with extreme volatility in the next few months.

Disclosure: Christopher F. Davis holds no position in any stocks mentioned and has no plans to initiate a position. He has a sell rating on Darden stock.

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