Darden (DRI) Strategic Efforts Bode Well: Should You Hold?

Shares of Darden Restaurants, Inc. (NYSE:DRI) are riding high on sales building initiatives, improved core operating fundamental, Cheddar's acquisition and impressive earnings trend. As a result, shares of the company have rallied 28% in a year’s time, outperforming the industry’s 10.8% growth. However, higher operating expenses remain a concern. Let’s delve deeper.

Hidden Catalysts

Darden’s acquisition of the small restaurant chain, Cheddar's Scratch Kitchen (Cheddar's), in April 2017 has added an undisputed casual dining value to the company’s portfolio of differentiated brands. It also helped Darden to expand its scale further. In the first quarter of fiscal 2019, Cheddar’s total sales grew 6.5% driven by organic new restaurant growth and franchise restaurant acquisition growth of 10.5%.

In order to boost the performance of the Olive Garden brand, the company implemented a set of initiatives under its Brand Renaissance Plan. These initiatives included simplifying kitchen systems, improving sales planning and scheduling as well as operational excellence to enhance guest experience, developing new core menu items, allowing customization, and making smarter promotional investments.

Supported by these initiatives, Olive Garden posted the 16th consecutive quarter of positive comps in first-quarter fiscal 2019. Meanwhile, Darden is focusing on technology-driven initiatives like the system wide rollout of tablets in order to capitalize on the digital wave that has hit the U.S. fast casual restaurant sector. This initiative has already boosted sales over the past few quarters.

At LongHorn, this Zacks Rank #3 (Hold) company strives to attract its guests by focusing on core menu, culinary innovation and providing regional flavors. Darden is also working on its marketing strategy to improve execution, customer relationship management and digital advertising as well as build a strong promotional pipeline that leverage the segment’s expertise.

Meanwhile, the company continues to focus on strengthening its in-restaurant execution through strategic investments in quality and simplification of operations in order to augment the guest experience. Backed by these strategic efforts, segmental comps have registered growth for 22 consecutive quarters.

Concerns

Increased wages and costs incurred due to the implementation of the Affordable Care Act resulted in higher labor costs. This, in turn, is expected to persistently keep profits under pressure. The company’s non-franchised model also makes it susceptible to increased expenses.

Since all the restaurants are owned and operated by Darden, instead of signing franchise agreements and putting the burden of costs into the franchisee, the company is solely responsible for the expenses of operating the business.

Total operating costs and expenses increased 6.3% year over year to $1.9 billion. This uptick can be attributed to an overall increase in food and beverage costs, restaurant labor and expenses, and marketing costs. Consequently, operating margin in the reported quarter contracted 20 basis points (bps) on a year-over-year basis.

Key Picks

Some better-ranked stocks in the same space are Dunkin' Brands Group, Inc. (NASDAQ:DNKN) , Dave & Buster's Entertainment, Inc. (NASDAQ:PLAY) and BJ's Restaurants, Inc. (NASDAQ:BJRI) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Dunkin' Brands Group has an impressive long-term earnings growth rate of 12.4%.

Dave & Buster's Entertainment delivered positive earnings surprise in each of the trailing four quarters, the average beat being 13.7%.

BJ's Restaurants reported better-than-expected earnings over the preceding four quarters, the average beat being 33.2%.

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