Why Olive Garden and Red Lobster Will Never Be Great Again

Red Lobster
Red Lobster

Things appear to be looking up for restaurant operator Darden (DRI).

The company behind Red Lobster and Olive Garden -- as well as the smaller LongHorn Steakhouse, Capital Grille, and Bahama Breeze concepts -- saw its stock hit a new all-time high on Friday after it posted better-than-expected quarterly results.

You won't be terribly impressed.

Sales for the fiscal quarter ending in late August climbed 5%, but that was the result of expansion and the acquisition of 11 Eddie V's restaurants. Combined same-unit sales at Olive Garden, Red Lobster, and LongHorn Steakhouse fell 0.3%. Comps were positive at Olive Garden for the first time in six quarters, but weakness at Red Lobster kept the combined store-level performance negative.

Earnings from continuing operations rose less than 4%, though aggressive buybacks lowered the shares outstanding to the point where diluted earnings per share rose 9% to $0.85 a share.
The market cheered that Darden narrowly beat Wall Street's profit target of $0.84 a share, but it probably wouldn't have been a beat without the stock repurchases.

Unlimited Breadsticks -- and Heartache

JP Morgan (JPM) didn't buy into last week's new all-time high, downgrading the shares on Monday. The stock's valuation was the reason for the new "neutral" rating, as Darden was nearing the analyst's $63 price target.

Bulls will argue that Darden is cheap, fetching just 14 times this fiscal year's projected profitability. The restaurant operator trades at only 13 times estimated earnings for the new fiscal year, which starts next June. We also can't dismiss the deliciously tempting 3.6% yield.

However, what if things don't get better?

There are 705 Red Lobster restaurants and 797 Olive Garden locations. This makes up 75% of Darden's 2,006 eateries, so it's safe to say that the stock's future direction rests on the success of these two chains.

It isn't pretty right now. Traffic at the two chains fell sharply in two of the past three months. Darden has tried to push through higher prices -- things like boosting the price of its "never-ending pasta bowl" promotion 10% to $9.95 this year -- but patrons are holding back.

Darden is responding to the slower traffic at stores by turning to broadening the non-seafood options at Red Lobster and adding small plates and light dishes at Olive Garden. It probably won't be enough.

Fast Casual Is the New Casual

In its recent Restaurant DemandTracker survey, consulting firm Consumer Edge Insight reveals that customers are trading down to fast casual -- the quick-service restaurant niche that includes Chipotle Mexican Grill (CMG) and Panera Bread (PNRA) -- in surprising fashion.

Cash-strapped foodies trading down from fine dining are jumping over Darden's casual dining stronghold to go right to the cheaper eateries.

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There's certainly nothing wrong with the quality of a Chipotle burrito or a Panera sandwich. The inconvenience of having to order at a counter is more than offset by the quicker service and the lack of tipping.

Red Lobster and Olive Garden have often been casual dining punch lines. Olive Garden's old "when you're here, you're family" tagline only attracted more derision.

Darden's other chains have held up better. Capital Grille is an elite chophouse. Its recently acquired Yard House is a foodie-friendly pub. Seasons 52 draws in fashionable calorie counters. However, these promising concepts are just too small to move the needle at Darden.

Larger trends are working against Red Lobster and Olive Garden, and the stock barreling toward a new high late last week is at odds with the challenges of winning back patrons.

Check, please.

Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article. The Motley Fool owns shares of Darden Restaurants, Panera Bread, and Chipotle Mexican Grill. Motley Fool newsletter services have recommended buying shares of Chipotle Mexican Grill and Panera Bread.

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