Darden Restaurants: There Is Just No Bottom in Sight

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Darden Restaurants Inc. (NYSE:DRI) is really a company that needs no introduction. It owns and operates some of the best-known 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.

The stock has been under some serious pressure of late, as its last few quarters have been really weak. We recently learned the company would be selling Red Lobster, which further has pressured shares. In this article, I will highlight the company’s most recent earnings miss and elaborate on why shares are a sell in my opinion.

The company continues to lose steam. Why? Pitiful performance. Fourth-quarter diluted net earnings per share were 65 cents, which compares to $1.01 in last year’s fourth quarter. That is a decline of 36 percent. Of course, the company had its excuses, claiming net earnings per share for the fourth quarter of this year were adversely affected by approximately 19 cents due to legal, financial, advisory, and other costs related to implementation of the strategic action plan Darden announced in December 2013, as well as charges related to various asset impairments.

Shockingly, sales were up slightly year over year. Fourth-quarter total sales from continuing and discontinued operations were $2.32 billion, which compares to $2.3 billion in the fourth quarter last year. As a result of the pending sale of Red Lobster, operating results for Red Lobster are included in discontinued operations for all periods presented. However, the company did not allocate any general and administrative operating support expenses to net earnings from discontinued operations.

It should also be pointed out that diluted net earnings per share in the fourth quarter of this year include 36 cents from continuing operations and 29 cents from discontinued operations. Of the approximately 19 cents that adversely affected diluted net earnings for this year’s fourth quarter, approximately 13 cents affected continuing operations, and approximately 6 cents affected discontinued operations.

Diluted net earnings per share for the fourth quarter of last year include 59 cents from continuing operations and 42 cents from discontinued operations. Net earnings in the fourth quarter of this year were $86.5 million, which includes $48.4 million from continuing operations and $38.1 million from discontinued operations. Net earnings in the fourth quarter of last year were $133.2 million, and included $78.5 million from continuing operations and $54.7 million from discontinued operations.

I mentioned sales were up, but the loss of Red Lobster, while freeing up cash to invest in existing operations, is going to pressure revenues and income going forward. Fourth-quarter total sales from continuing and discontinued operations were $2.32 billion, which compares to $2.3 billion in the fourth quarter last year. Total sales for the fourth quarter of this year include sales of $1.65 billion from continuing operations and sales of $666.2 million from discontinued operations.

Total sales in the fourth quarter of last year include sales of $1.59 billion from continuing operations and sales of $706.5 million from discontinued operations. The increase in total sales for the fourth quarter of this year reflects the operation of 69 net new restaurants compared to the fourth quarter last year, as well as same restaurant sales increases for LongHorn Steakhouse and the company’s Specialty Restaurants, offset by same-restaurant sales declines for Olive Garden and Red Lobster.

One good piece of news is that in the fourth quarter, U.S. same-restaurant sales increased 2.4 percent at LongHorn Steakhouse and 2 percent at the Specialty Restaurant Group. However, this was immediately offset by a same-store sales decline of 3.5 percent at Olive Garden and 5.6 percent at Red Lobster.

Looking ahead, the company missed earnings by 10 cents per share and revenues by $10 million. The stock is to be avoided right now, with all of its transitional issues. Competition is growing, and the company’s same-store sales just aren’t improving. Margins are being pressured, and the company seems to be scrambling to get back on track. The one thing that can keep share prices from plummeting too far is its dividend, and it yields 4.5 percent now.

Thus, the downside is limited if the dividend is maintained. If it gets cut, it is hard to tell where the bottom is. At this juncture, I rate shares a sell and assign a $40 price target. I recommend getting out while you can and reallocating to a superior company.

Disclosure: Christopher F. Davis holds no position in Darden Restaurants and has no plans to initiate a position in the next 72 hours. He has a sell rating on the partnership and a $40 price target.

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