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Morningstar | Darden’s Tepid 2020 Outlook Raises Questions, but Still Leaves Room for Upside; Shares Fairly Valued

With Olive Garden comps decelerating (2.4% versus an average of 4.4% the past three quarters) and a tepid outlook for fiscal 2020 (comps of 1%-2%, total sales growth of 5.3%-6.3%, and diluted EPS of $6.30-$6.45, versus consensus of $6.46), it’s reasonable for investors to ask whether Darden’s fourth-quarter update is indicative of structural industry headwinds, increased competition, or resetting expectations against more difficult comparisons. We believe the answer lies somewhere in between, as both Olive Garden and LongHorn (up 2.4% and 3.3%) comps continue to outperform its peer group (ex-Darden industry comps declined 0.8% using Knapp-Track data) through operational excellence and not heavy discounting; but Darden’s noncore, non-fine-dining brands (comps fell 3.2%, 1.4%, 2.1%, and 1.9% for Cheddar's, Yard House, Seasons 52, and Bahama Breeze, respectively) are seeing pressure form smaller 10-plus unit regional concepts. Management cited strong economic conditions but also acknowledged “a bit of a slowdown in discretionary spending” year over year.

Taken together, we think that Darden investors can expect slower top-line trends versus a year ago, but with enough catalysts (greater consumer awareness for everyday value pricing, menu mix benefits from catering/beverages, increased off-premise capabilities--now 15% of Olive Garden sales--and operational improvement at Cheddar’s) to reach the high-end of the 1%-2% comp outlook for fiscal 2020. While we don’t expect Darden to repeat 2019’s 30 basis points of operating margin expansion (reaching 10%), 10-20 basis points seems realistic and should be sufficient to drive EPS toward the high-end of guidance.

Over the next five years, we’re comfortable calling for 6% top-line growth (2%-3% comps, 3%-4% unit) and EBIT margins in the low 11s. While we expect rivals to replicate certain strategies--the basis of our no-moat rating--we're maintaining our $114 fair value estimate and see shares as fairly valued.