As the economy continues to wobble along in the U.S., economically sensitive businesses like restaurants continue to face some significant challenges. Newer concepts like BJ's Restaurants (Nasdaq:BJRI) and Buffalo Wild Wings (Nasdaq:BWLD) continue to bring in the patrons, but many established chains are having to work harder and harder for even minor improvements in comp-store growth.
That puts Darden Restaurants (NYSE:DRI) in a tough spot. Darden is definitely a well-run veteran restaurant operator, but the company's core restaurants like Olive Garden and Red Lobster are hardly novel to the restaurant going public. With same-store sales coming in a little weak for the fiscal fourth quarter and the stock sporting a fairly robust multiple, it seems like this is a stock that is going to be stuck for at least a little while longer.
Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers
Tough Conditions in Q4
Darden reported that revenue rose nearly 4% in the fourth quarter, but this number missed the average sell-side guess due to weaker comps. Although the company's "specialty" group saw 2.7% comp-store growth, the core restaurant group saw a combined same-store sales decline of 1.9% (against a 2.2% improvement last year). Declines were led by Red Lobster (down 3.9%), while Longhorn saw a 3% increase and Olive Garden saw a 1.8% comp decline.
Profits and margins were incrementally better, but not strong enough to fully compensate for the weaker sales. Restaurant-level profits rose a little more than 4% and restaurant margins improved by 20 basis points. Operating income rose 10% overall.
SEE: How To Analyze Restaurant Stocks
Back to the Drawing Board (Again)
Darden did underperform the casual dining industry (at least as measured by Knapp Track). On a more anecdotal basis, it seems like performance across the sector wobbles from quarter to quarter. Brinker (NYSE:EAT) and Cheesecake Factory (Nasdaq:CAKE) are stronger now, but Darden has done better in past quarters.
At least some of the weaker comps seemed to come from less-effective promotions, and the company has been talking about overhauling the menu and promotional focus at Olive Garden. For better or worse, that's how the casual dining industry operates today - it's a "dueling banjos" competition between companies like Darden, Brinker, DineEquity (NYSE:DIN) and other casual chains such as Buffalo Wild Wings and Red Robin (Nasdaq:RRGB) where menu promotions, value pricing and new products shift traffic on a month-to-month basis, but with nobody grabbing a sustained lead.
Will Traffic Swing Back from the Counters?
It is clear that over past few years, diners have shifted from sit-down restaurants to counter-based QSRs like McDonald's (NYSE:MCD), Subway, Panera (Nasdaq:PNRA) and so forth. At least some of this has to be due to the power of the low-priced value menus, but some may also be due to the efforts of companies to upgrade their menu offerings.
The scale and limited menu offerings of the QSRs give them a hard-to-beat cost advantage, but it doesn't seem unreasonable to think that this advantage is not unbeatable. As mentioned, companies like Buffalo Wild Wings are bringing in customers, so diners will drive by the drive-thrus if they see a compelling reason to do so. For Darden, then, that means that restoring traffic could be as much about restoring the idea of a "special" dining experience as competing solely on price.
SEE: 6 Easy Ways To Save At Restaurants
The Bottom Line
I think Darden is a well-run restaurant operation, but I'm not so excited by the stock. Even with healthy forward cash flow growth assumptions, it's difficult to see these shares as significantly undervalued. What's more, the sluggish growth performance in Q4 and conservative management guidance won't do any favors for analyst numbers. For these reasons, I'd pass on this stock for the time being.
At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.