EUR 850.00 For Business Accounts Only

Morningstar | Operational Excellence Driving Market Share Gains at Olive Garden and LongHorn; Other Brands Next?

Operational excellence continued to be the key story from Darden's third-quarter update, with Olive Garden and LongHorn outperforming (comps of 4.3% and 3.5%, versus industry growth excluding Darden of 0.8% using Knapp-Track data) and operating margins increasing 50 basis points to 11.8% on impressive labor and G&A leverage. Like past quarters, the outperformance can't be traced to any individual factor. Instead, we attribute it to everyday value pricing, menu mix benefits (reduced promotions, catering, $5 beverage platform), off-premise gains (up 13% and now 15.9% of Olive Garden sales), and menu simplification/labor productivity efforts. While Olive Garden/LongHorn will face more difficult comparisons in fiscal 2020, we believe these initiatives will keep comps for both brands in the 2%-3% range next year.

If there is an area of concern, it's Darden's non-fine dining brands, where comps fell 2.7%, 2.1%, 1.3%, and 3.7% for Cheddar's, Yard House, Seasons 52, and Bahama Breeze, respectively. We share management's assessment that promotional activity from other large chains and unfavorable weather weighed on results. However, we also expect comp improvement over the next six to 18 months as Darden further implements many of the same strategies that have worked at Olive Garden, with Cheddar's potentially the largest beneficiary via employee training and online ordering.

We view the modest increase in full-year 2019 guidance as achievable, including revenue growth of 5.5% (up from 5.0%-5.5%), blended comps of 2.5%-2.7% (up from 2.5%), and diluted EPS of $5.76-$5.80 (previously $5.60-$5.70). Over the next five years, we remain comfortable calling for 6% top-line growth (2%-3% comps, 3%-4% unit) and EBIT margins growing to the low 11s (versus our forecast of 10.2% for fiscal 2019). While we expect rivals to replicate certain strategies--the basis of our no moat rating--we'll increase our $108 fair value estimate by a few dollars but see shares as fairly valued.