Darden's California Fight A Huge Mistake

By Will Ashworth | June 24, 2013 AAA

Darden (NYSE:DRI) CEO Clarence Otis is fighting California's passage of Assembly Bill 880, which prevents large companies from cutting workers' hours to avoid paying for insurance under the Affordable Care Act.

While Darden's made some good moves in the last year including acquiring Yard House, its upscale-casual brewpub restaurant, its latest protest is blatantly stupid and an affront to both its employees and shareholders. As long as Darden maintains this position, investing in its shares makes absolutely no sense whatsoever. Here's why.

A Difficult Year
Those are the CEO's words…not mine. Darden announced Q4 earnings June 21 that were good on the sales end of things and not-so-good when it comes to earnings. The multi-brand restaurant chain missed earnings per share estimates by two cents coming in at $1.02, 11% lower than a year ago, thanks to higher operating and acquisition costs. It did, however, manage to deliver positive comparable restaurant sales growth of 2.2% in the quarter and they should continue to grow in subsequent periods. As I mentioned above, it has done some good things in the past year. Besides buying Yard House, its decision to seriously reduce the number of new Olive Garden locations couldn't have come soon enough. Its specialty restaurant group and LongHorn steakhouse is where its future lies.

Puzzling Decision
One of the best reasons for U.S. companies to do business in Canada is universal healthcare. Despite operating costs that are generally higher north of the border and employment laws much stricter than in the U.S., the simple fact that businesses have cost certainty when it comes to health care (excluding cost of drug plans, etc.) allows them to focus on doing business rather than fighting with government bureaucrats and insurance companies. While the Canadian medical system has definite flaws of its own, I've recently had the opportunity to see both systems under a microscope.

My parents spend three months every winter down in Florida to escape our harsh winter. In January both my parents got sick and required medical attention. To help cover some of the potential cost they take out insurance, which is expensive and doesn't cover a whole lot when push comes to shove, putting them out of pocket for a significant portion of the hefty bill. Upon returning to Canada my mom has been in hospital for almost a month with little cost to her personally. Sure, she's had to pay higher taxes over the years to finance this so-called extravagance, but I can tell you my entire family is grateful she isn't on the hook for her extended stay.

SEE: Fighting The High Costs Of Healthcare

And this is what is so puzzling about Darden's fight. California's proposed bill is simply trying to protect those working full-time (more than 30 hours) but paid hourly from having their hours cut. The company would rather see employees who already make minimum wage earn less so it can avoid a penalty of up to $5,500 per employee per year than to do the right thing and provide health insurance to its front-line employees who interact with customers every day. It's shameful morally and extremely short sighted from a business perspective.

Cost To Restaurants Overstated
According to the Kaiser Family Foundation, Massachusetts has the highest average per person monthly premium in the individual market at $437 or $5,244 per year. The national average is $215 per month or $2,580 per year and California's yearly cost is $1,884. The average of the three is $3,236 per year. Let's assume that Darden agreed to pay 50% of the cost with the employee paying the rest; it would cost Darden $6.5 million annually in California, its third largest state in terms of locations behind Florida and Georgia. Its approximate revenue in fiscal 2013 from California is $466 million with a store contribution margin of 22% (after food and beverage, labor and other restaurant-related expenses) or $103 million. It's making a big stink over something that might cut their profit in the state by 6%. Yet, its top five executives were paid $20.6 million in 2012 or more than three times the potential cost in California.

Starbucks (Nasdaq:SBUX) is considered by Fast Company to be the most innovative company in the food business. One of the reasons is that it provides health care benefits to all employees working more than 20 hours. A benefit that costs the company more than $300 million annually. Yet, the issue might be a hullabaloo about nothing. Many employees will be able to get insurance through a family member. AFC Enterprises (Nasdaq:AFCE), which operates Popeye's, feels many others will simply opt out choosing to pay the $95 fine instead of getting company-offered insurance. Still others, like employees at Whole Foods (Nasdaq:WFM) are already offered good health care benefits and won't be affected in the slightest by the Affordable Care Act.

Bottom Line
Darden's got some serious problems in its legacy restaurants with Olive Garden being its biggest. The Yard House acquisition is a sign management knows its two original brands' best days are behind it. Therefore, it amazes me that CEO Clarence Otis would do anything to upset employees (whether warranted or not) in one of its biggest states. This issue is a red herring; his fight in California tells me he's not paying attention to what really matters at Darden.

Starbuck's health care costs amount to 3% of its overall revenue…a pittance. He should stop bellyaching and do what he's paid to do and that's operate successful restaurants--something you can't do if you're running down your employees.

Until Darden puts the focus back on its employees and not saving money, I'd absolutely avoid owning its stock. In this situation, cheap never translates into better.

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