Darden Restaurants, Inc. (DRI, Financial) owns and operates full-service dining restaurants in the United States and Canada under the trade names Olive Garden®, LongHorn Steakhouse®, The Capital Grille®, Yard House®, Bahama Breeze®, Seasons 52®, Eddie V's Prime Seafood® and Wildfish Seafood Grille®. The company also used to own the Red Lobster chain of restaurants, which it sold in 2014. As of February 2015, the company operated 1,528 restaurants out of which 845 belonged to the Olive Garden brand, 478 belonged to the LongHorn Steakhouse brand and remaining belonged to other smaller brands.
After years of mismanagement, the company's business was struggling in 2014 when an activist hedge fund Starboard Value LP initiated a position in the company. The fund gave its detailed plan on how to turnaround Darden's ailing business in September 2014 and was able to completely oust Darden's (now ex- ) board in October 2014.
The company's turnaround plan is working, and its stock has gained over 30% in the last year. Comparable Store Sales have turned positive for each brand, and the company intends to open 34 net-new restaurants in 2015. Sell side analysts are expecting the company's EPS to grow 6.84% in the current year and 14.80% next year.
Deutsche Bank analyst Brett Levy recently initiated coverage on the company with a Buy rating. In his research report, he wrote,
"Darden Restaurants is in the process of re-establishing its casual dining leadership position by leveraging its scale, improving its food (taste, quality, etc.) and operations, after a number of years of underperformance. We believe the company's willingness to evaluate all aspects of its business model, along with a fresh perspective from the top, can help return this storied restaurant company to its prominent position across the industry."
In addition to improving operation, Darden also has an opportunity to create value by divesting its real estate portfolio. KeyBank analyst Christopher O'Cull believes that there is a good probability of a spinoff of Darden's real estate assets. He worked with Key Bank's REIT research team to quantify the upside opportunity and sees an additional $5-$7 per share upside. According to him,
"Working with the KBCM REIT research team, we evaluated the potential benefits for shareholders of a tax-free spinoff of Darden’s real estate to a REIT entity (PropCo). Following a spinoff, shareholder value is expected to be created by PropCo distributing at least 90% of its annual taxable income as dividends, pursuing additional real estate transactions to diversify its income base, and reducing its cost of capital from the business model and growth prospects associated with REIT status. These attributes, along with the fact that REITs do not pay corporate taxes, have historically resulted in premium valuations for REITs (Triple Net currently 16x EV/ EBITDA) relative to restaurant stocks (CDR segment currently 10x). Assigning a higher valuation multiple to the rental income under a REIT structure than the “lost” operating income of the restaurant company could create an additional $5-$7 per Darden share of value; additionally, PropCo could be spun off with plenty of debt capacity providing fuel for further growth/tenant diversity.”
Darden is trading at a PE of 22.83 and has a dividend yield of 3.40%. I believe the company is an interesting turnaround story to bet on giving its improving operations and potential to create additional value by divesting real estate portfolio.
