Darden's Olive Garden Needs Some Spicing Up

Full-service restaurant operator Darden Restaurants (NYS: DRI) came out with second-quarter results that were below analyst expectations. The company has been struggling over the past year with its largest restaurant chain, Olive Garden. Let's take a closer, Foolish look at what's cooking with Darden.

On the menu
The company dished out a 6.1% increase in second-quarter sales, to $1.83 billion. This included comparable sales growth of 1.8% companywide. Darden served up an unpalatable 28% decline in earnings, mainly due to flagging performance at Olive Garden.

Olive Garden delivered the weakest sales growth, up 0.9% to $836 million, mainly due to lower comparable sales. Red Lobster, on the other hand, saw sales up by 8.3%, to $602 million, driven by higher comparable sales. The company's Longhorn Steakhouse chain saw 13.7% higher sales at $255 million, also driven by new restaurant openings and higher comparable sales. Specialty group sales were 19.1% higher, due to better comparable sales. On the margins front, Darden's gross margins went down 200 basis points to 20.3%.

Sour olive
For the past year, Darden Restaurants has gone through tumultuous times with Olive Garden. The chain has been witness to falling sales and traffic coupled with promotional failures and heightened competition. The chain's problems include being part of an already overcrowded casual-dining market, coupled with pricing pressures at a time when food prices are going sky high.

The casual-dining sector has been through a rough year in general. This is mainly because of a shift in consumers' preference in favor of cheaper fast-casual chains such as ChipotleMexican Grill (NYS: CMG) and Panera Bread (NAS: PNRA) . Growth in these fast-casual chains has outpaced traditional restaurant growth recently, and is expected to do so going forward. These restaurants cater to price-conscious consumers while realizing attractive unit economics. Expect competition from this space to remain a major obstacle for Darden going forward.

The chief executive was candid enough to remark that the company was not taking bold enough steps to enhance Olive Garden's popularity. However, he claimed that January would see a change in its promotional approach along with a new menu.

During the financial crisis, the Olive Garden realized better retention of households with incomes below $50,000 than the larger industry. However, the chain has lately lost many of these clients to competitors with more attractive pricing.

A silver lining
Darden does expect inflation to cool off for the second half of the fiscal year. In the meantime, the company is working on initiatives to save around $65 million to $75 million for fiscal 2012. These savings will be in the form of optimizing its labor force, automation of its supply chain, and centralizing its maintenance facilities.

The Foolish bottom line
With high food prices and increased competition, Darden will likely continue to face margin pressures in the months to come. Moreover, given that the flagging Olive Garden chain forms a major portion of Darden's business, the company's performance will likely be weighed down in spite of the good performance of its other chains. Don't forget to stay up to speed with the latest on Darden's performance by adding it to your very own stock watchlist.

Keki Fatakia does not hold shares in any of the companies mentioned in this article. The Motley Fool owns shares of Chipotle Mexican Grill, Panera Bread, and Darden Restaurants. Motley Fool newsletter services have recommended buying shares of Panera Bread and Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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