A Deeper Dive Into the Murky Future of Red Lobster and Darden

Darden's (DRI) bout with financial indigestion continues.

The casual dining operator behind the Red Lobster and Olive Garden chains disappointed the market again with a lackluster earnings report on Thursday morning. Its gloomy outlook also finds it willing to spin off or unload the struggling Red Lobster concept. Olive Garden better not get too comfortable, either.

The Black Sheep at the Table

Darden runs several successful eateries outside of Red Lobster and Olive Garden. LongHorn Steakhouse, Bahama Breeze, The Capital Grille, Seasons 52, Eddie V.'s, and Yard House all posted positive same-restaurant sales growth in the fiscal second quarter that ended in late November. The problem is that they all add up to just 30 percent of Darden's sales. Red Lobster and Olive Garden continue to serve up more than two thirds of the company's business, and both chains are struggling.

For the second quarter in a row this fiscal year we find Olive Garden and Red Lobster falling short in attracting hungry patrons. Same-restaurant sales slipped 0.6 percent at Olive Garden and 4.5 percent at Red Lobster.

Things were actually even worse than those numbers suggest because of the timing of the Thanksgiving holiday this year. This is typically a slow time of year for the casual dining industry as families carve up Thanksgiving feasts that wind up lasting for days. But since Thanksgiving took place after the Nov. 24 close of Darden's fiscal second quarter, the softness from last year's period didn't carry over this time around.

Spoiler alert: Darden's fiscal third quarter is going to be even uglier because it'll include that soft Thanksgiving period.

Better Load Up on Bread Sticks While You Can

Red Lobster has been the biggest laggard for Darden, and the company has just about had enough of the 705-unit seafood chain. Darden plans to spin off Red Lobster as a standalone public company. It may also consider a sale of the chain, but there isn't likely to be a lot of excitement for the worst performer of the company's eight concepts.

The transaction won't happen right away. Darden is pointing to next summer as its target for the separation at the earliest.

%VIRTUAL-article-sponsoredlinks%However, it won't just be Red Lobster feeling the pinch. Darden also announced on Thursday that it will not open any more Olive Garden restaurants in the near term, also scaling back the expansion of its smaller more successful chains.

Slowing its build-out will naturally help preserve its money. Darden expects to reduce annual capital expenditures by $100 million, and the $50 million in annual cost savings that it announced earlier this year will now be closer to $60 million as it redirects its marketing efforts.

'Told You So'

Red Lobster and Olive Garden have seen better days, but at least one big investor thinks that Darden could be doing a better job for its shareholders. Armed with a better than 2 percent stake, Barington Capital has rolled out a plan that it believes could propel the stock as high as $80.

Spinning off Red Lobster is something that it was arguing for before Thursday's announcement, though Barington also wanted Olive Garden to be included in the move. It feels that investors would be willing to pay higher market multiples for a holding company with the six smaller eateries.

Barington also thinks that Darden could shave more in costs beyond the $50 million to $60 million that it's been targeting, and Darden's plan to scale back on new openings should help appease the investment firm.

However, Barington is also asking for Darden to discount less and spend less on marketing. That could be losing gamble. Red Lobster sales are already in a funk. How would advertising less and charging more help?

In fact, the folks dining at Red Lobster are already spending more than they did a year ago, and that could be part of the problem. Actual traffic at Red Lobster fell by 7.3 percent last month and a brutal 9.9 percent in October.

You can't succeed in the current climate as a casual dining operator if you're not discounting aggressively and effectively getting the word out.

Darden knows that the future will be a challenge. A few months ago, it predicted that it could crank out positive comps in fiscal 2014. Now it foresees negative same-restaurant sales for the combination of Olive Garden, Red Lobster, and LongHorn. With Darden in preservation mode, it doesn't seem likely that Red Lobster of Olive Garden will be mounting a turnaround anytime soon.

Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool owns shares of Darden Restaurants. Try any of our newsletter services free for 30 days.