How Will Darden Restaurants' (DRI) Margins Shape Up In Q2?

Darden Restaurants, Inc. (NYSE:DRI) is set to report second-quarter fiscal 2018 results on Dec 19, before market opens.

Notably, the company has surpassed estimates in each of the trailing four quarters, with an average beat of 2.29%. Shares of Darden have rallied 20.5% so far this year, outperforming the industry’s growth of 13.5%.

Cost Details

Darden undertakes various initiatives to drive sales which in turn are likely to boost profit margins. In addition, the company has an aggressive cost management plan, under which it has significantly cut operating costs. However, in the first quarter, total operating cost and expenses increased 13.4% primarily due to costs associated with adverse effects from Hurricane Harvey.

Food and beverage costs in the first quarter increased 12.6% from the year-ago level but was somewhat favored by 10 basis points (bps) as cost savings and pricing of approximately 1.5% more than offset commodity cost inflation. In the to-be-reported quarter, these costs are expected to increase year over year mainly owing to effects of cost inflation. The Zacks Consensus Estimate for second-quarter food and beverage expenses is pegged at $535 million, reflecting an increase of 11.9%.

Coming to restaurant labor expenses, the first quarter saw a 14.4% increase from the prior-year quarter. The trend is expected to persist owing to brand mix and wage inflation. The consensus estimate of $612 million for labor expenses calls for a 13.8% increase in the to-be-reported quarter

Restaurant expenses increased 12.9% year over year in the last reported quarter. It is further expected to rise in the upcoming quarter mainly due to higher pre-opening expenses. The consensus estimate for restaurant expenses calls for a 12.1% rise in the to-be-reported quarter.

Marketing expenses are expected to contract on better brand mix and a promotional shift at Olive Garden.

Margin Scenario

Despite the company’s overall increase in costs in the first quarter, sales increased at every segment which drove margins by 20 bps at Olive Garden. However, profit margin at the other business segment was 200 bps lower than the prior year. This is because the addition of Cheddar’s altered the segment’s profit margin mix and the exclusion of consumer-packaged goods from the segment.

In the first quarter, adjusted EBIT was down 10 bps owing to last year’s asset sale gains of $8 million. Moreover, Cheddar’s integration had a 40-bps unfavorable impact on EBIT margin on a year-over-year basis. The company expects this impact to be lower in the upcoming quarter with the completion of this integration. Excluding these factors, the first quarter saw EBIT margin expansion of 70 bps and is expected to see a rise in margins in the upcoming quarter.

Adjusted earnings per share in the second quarter are expected to grow on increased revenues across all brands. The consensus estimates for earnings in the to-be-reported quarter is pegged at 69 cents, reflecting year-over-year growth of 8.5%.

In the first quarter, earnings came in at 99 cents per share, reflecting growth of 12.5% year over year. Management noted that hurricane-related headwinds affected first-quarter earnings by approximately 1.5 cents. The company also anticipates the effects of Hurricane Irma to dent margins more in the second quarter as compared to first quarter.

Darden carries a Zacks Rank #2 (Buy).

A few other top-ranked stocks in the same space are Famous Dave's of America, Inc. (NASDAQ:DAVE) , Arcos Dorados Holdings Inc. (NYSE:ARCO) and Good Times Restaurants, Inc. (NASDAQ:GTIM) .

Dave's of America sports a Zacks Rank #1 (Strong Buy). The company’s long-term earnings growth rate is projected at 20%. You can see the complete list of today’s Zacks #1 Rank stocks here.

Arcos Dorados and Good Times carry the same Zacks Rank as Darden. Long-term earnings growth rate for Arcos Dorados and Good Times are projected at a respective 11.9% and 25%.

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