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Steven Cohen and the Food Industry

September 20, 2013 | About:
The recent economic recession has forced many restaurants to adjust offers as a response to diminished disposable incomes. Let us take a look at future prospects for full-service restaurant Darden (DRI), and fast-food giant McDonald's (MCD) to discern what their strategy is, and what the future holds for them according to the gurus.

Known Tastes for Profits, with Poor Satisfaction

Headquartered in Oak Brook, Ill., McDonald's is the world's largest chain of fast food restaurants. The business is based on a franchise business model, and has spanned over 119 countries. The brand has been so successful that the price for a Big Mac is a standard for measuring purchasing power parity. Most importantly, the gurus holding the largest positions have increased their positions throughout 2013.

Today, McDonald's is facing some economic headwinds that have reflected in its second quarter report. A slow economic recovery in the Eurozone has had a direct impact on sales volume, especially in the German and French markets. Additionally, operations in China, Japan and Australia have been negatively affected by recent price hikes. Moreover, margins related to U.S. operations have seen reductions due to a greater focus on the dollar menu. At last, short-term policies during 2013 in the U.S. will keep the competition away, while at the same time affecting operating margins.

Ahead, McDonald's Plan to Win is expected to continue driving growth because the firm only holds 10% of the informal eating out market. However, the scheme may be compromised if short-term policies are not modified. On another note, store openings in the Asia-Pacific area and modernization for U.S. locations have not stopped amid an adverse economic environment. Moreover, the firm has set forth a plan to reduce owned stores in order to improve ROE and EPS.

Financially, McDonald's is strong. Most importantly, it holds an operating margin of 31%, but an eye should be kept on rising debt levels. Currently trading at 18.1 times its earnings, carrying a 24% discount to the industry average, the stock is undervalued. Hence, it should come as no surprise that the gurus holding the largest positions have incrementally increased their holding. Among them there are Jeremy Grantham, Jim Simons, Ken Fisher and Bill Nygren.

In the end, McDonald’s is a great company, but I remain bearish about it because it is extremely vulnerable to macroeconomic headwinds like debt concerns in Europe, decelerating growth in Asia and intense competition in the U.S. The company expects performance in the second half of 2013 to be under pressure due to a sluggish business environment.

Remodeling Expansion Model

Headquartered in Orange County, Fla., Darden International is the world’s largest full-service restaurant operator. Its restaurants are spread throughout the U.S. and Canada. Among the brands in its portfolio, the most renowned ones are Red Lobster, Olive Garden and LongHorn Steakhouse.

The latest news indicates that sales continue to suffer from tailwinds related to the 2008 recession and low consumer confidence. Here I again take the side of Steven Cohen, who sold his stock in McDonald’s and increased his position within Darden International.

At this time, Darden international is developing new additional strategies to combat slower sales, mainly because previous initiatives proved to fall short of expectations, negatively impacting operating margins, while growth remains elusive. Additionally, government regulation concerning health care is expected to pressure performance and reduce earnings by $0.06 per share. On the up side, Red Lobster and Olive Garden experienced a pickup in sales volume related to short-term promotional policies.

Future plans for Darden International includes, first, remodeling of Olive Garden and Red Lobster locations, and second, drive growth in the Specialty Restaurant Group through the full integration of recent Yard House. Moreover, expected domestic and international expansion will fuel growth in the long term, strengthening the wide economic moat created.

The balance sheet for Darden International is moderate because debt level has doubled last year. And, net income and cash flow continue to feel the pressure from adverse economic conditions. Trading at 15.9 times its earnings, packing a 33% discount to the industry average, the stock is attractive. I share Steven Cohen’s optimism over the stock because the company has been reaping benefits from two of its high-potential acquisitions, and revenues were in line and grew year over year.

Dessert

I prefer Darden International over McDonald’s because of the company’s business strategy driven by a strong value proposition and decent unit-level execution. McDonald’s, instead, continues with its decade-old Plan to Win and franchise strategy that does not deliver real growth.

Disclosure: Vanina Egea holds no position in any stocks mentioned.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


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