Sit-down restaurants have come back into favor over the past year or so, and Darden (NYSE:DRI) has gone along for the ride ... even though company growth really hasn't improved all that much. Darden remains a strong player in the industry, with two of the largest concepts (Olive Garden and Red Lobster) and sustained double-digit returns on capital. Although Darden shares don't look like much of a bargain today, the market may not be through with it yet, as menu revamps could spur better traffic and earnings.

Credit Card Comparison: Find the credit card that is right for you.

First Quarter Results Meet Expectations
Although there was some deviation from expectations on particular line items, Darden basically delivered the sort of quarter that the Street expected.

Revenue rose about 5%, with company growth in the "big three" (Olive Garden, Red Lobster and Longhorn) actually shrinking 0.3%, while the specialty restaurant group saw 2.2% growth. Restaurant traffic generally increased through the quarter for Darden, though Red Lobster's poor performance (down 2.6%) sapped some of the momentum from Longhorn (up 3.6%). Olive Garden looks like it's still in a rut, with comps up just barely (0.3%).

Margins were solid. Restaurant-level margins improved almost a point and a half, helped by lower labor costs and lower food costs. Operating income rose more than 5%, leading to a slight improvement in operating margin.

SEE: The Top 5 Ways Restaurants Make You Spend More

Revamping Menus to Drive Traffic
The good news and bad news for Darden is that the company's two largest concepts are so well-known to diners. To a certain extent, you either like Olive Garden and/or Red Lobster or you don't; pricing can make a difference on the margin (increasing or decreasing the frequency of visits), but it's really the core menu that makes the brand.

To that end, it sounds like management is looking for a serious revamp at Red Lobster and ongoing refinements at Olive Garden. At Red Lobster, management is apparently looking to increase the non-seafood menu content to 25% (from about 8% currently). That's a big swing, and arguably a risky move, but it could help freshen and remake the brand.

For Olive Garden, it sounds like the plans are less ambitious. There's going to be some more fine-tuning on portion size, nutrition and price, but it doesn't sound like management is looking to make big changes.

Is Yard House a New Beginning?
Darden paid $585 million in cash for the 39-store Yard House chain, a somewhat more upscale concept than its largest chains. Management has said that it believes the market can support 150-200 stores, and if it can maintain Yard House's very strong unit volume (an average of over $8 million, second only to Cheesecake Factory (Nasdaq:CAKE), I believe this could be a significant future driver.

Are Diners Tired of Burgers?
Judging by the performance of the stocks in this sector, as well as the recent interest in the IPO of Outback Steakhouse operator Bloomin' Brands (Nasdaq:BLMN), investors are banking on a recovery in company growth at sit-down chains. Such a recovery isn't exactly obvious in the results at Cheesecake Factory, Brinker's (NYSE:EAT), Chili's, Maggiano's or DineEquity (NYSE:DIN), but at least the companies are positive again.

Less pressure from food and labor costs should continue to help the sector, but a wholesale improvement in traffic probably needs better job and wage numbers first. Then again, maybe diners are tired of the McDonald's (NYSE:MCD) value menu and want to go back to sit-down restaurants.

SEE: McDonalds: A History of Innovation

The Bottom Line
Perhaps Darden's menu plans will help stimulate better growth, but it already looks like the Street expects a lot of improvement. Even high single-digit adjusted free cash flow growth over the next decade doesn't lead to an appealing fair value once the company's debt is factored in. Cash flow doesn't necessarily move stocks in the short-term, however, so investors may look at Darden's single-digit EV/EBTIDA ratio and the prospects for double-digit operating income/EBTIDA growth and still think they're getting a bargain.

At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  3. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  6. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  7. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  8. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
  9. Mutual Funds & ETFs

    ETF Analysis: Schwab US Broad Market

    Take an in-depth look at the Schwab U.S. Broad Market ETF, an incredibly low-cost fund based on a wide selection of the U.S. equity market.
  10. Professionals

    Tips for Helping Clients Though Market Corrections

    When the stock market sees a steep drop, clients are bound to get anxious. Here are some tips for talking them off the ledge.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  5. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  6. BHD (Berhad)

    The suffix Bhd. is an abbreviation of a Malay word "berhad," ...
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  4. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  5. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
  6. What happens to the shares of stock purchased in a tender offer?

    The shares of stock purchased in a tender offer become the property of the purchaser. From that point forward, the purchaser, ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!