Uncategorized

Darden equity off to a good start, bonds next?

admin | January 10, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Darden Restaurants Inc. (DRI) equity has had a nice start to the year, with the stock up 4.94% (as of market close on 1/9/20), outperforming the S&P 500 by 358 bp. DRI’s value proposition, menu enhancements and off-premise expansion should not only help continue to drive same restaurant sales (SRS) but fuel margin growth. The outperformance of the equity could follow-through to the bonds, re-tightening spreads to competitors. At issue DRI 2048 bonds traded 15 bp back of McDonald’s 2047. Investors searching for yield can swap out of the MCD 4.45% 3/1/47 into the DRI 4.55% 2/15/48, picking up 70 bp of yield, and for a take-out of nearly 11 points.

Consensus estimates for fiscal year 2020 are calling for EBITDA margin growth of 20 bp to 14.3%, as DRI continues to aggressively manage non-restaurant expenses to offset both food and labor inflation. The margin growth is impressive as management remains committed to keeping price increases below both inflation and that of its competitors. That said, while DRI raised prices by 2% in the most recent quarter to offset commodity increases of 1.7%, labor inflation of 4% was offset by a combination of pricing, menu mix and productivity increases. This led to a 30 bp improvement to the operating margin during the quarter.

Gaining Market Share

While casual dining witnessed some softness last year, Darden (DRI) continued to outperform the casual dining index. DRI’s two largest banners, Olive Garden and LongHorn Steakhouse – which represent over 70% of total revenues and 75% of operating profit – continue to drive growth and gain share. In the most recent quarter, Olive Garden posted SRS of 1.5%, which outperformed the industry benchmark by 120 bp. This was Olive Garden’s 21st consecutive quarter of SRS growth. LongHorn posted impressive results with SRS of 6.7%, meaningfully outperforming the industry benchmark by 640 bp. LongHorn’s sales growth streak is even longer than Olive Garden’s, with 27 consecutive quarters of SRS growth.

Balance sheet/liquidity remains strong

DRI management remains committed to keeping lease adjusted leverage in the 2.0x-2.5x range, which we estimate is currently 2.25x. Leverage, not adjusted for leases, remains under a turn at 0.8x. Liquidity is strong as DRI ended the most recent quarter with total cash on hand of $157 million and availability under its revolver of $683 million. Furthermore, the company has no debt maturing until 2027 and generated nearly $800 million of free cash flow on an LTM basis.

Last year, DRI lost out on its bid to purchase Del Frisco’s Restaurant Group (DRFG), with the assets being sold to private equity. While management consistently looks at opportunities to add to the portfolio when appropriate, management is unlikely to deviate from its historical financial policy and continue to look at acquisitions that are of the “tuck-in” size. This enables DRI to use cash on hand as well as some debt to finance the acquisition, while keeping leverage within or close to management’s target range.

Guidance reaffirmed again

Management once again reaffirmed all aspects of its fiscal 2020 guidance including SRS sales growth in the 1%-2% range, net sales growth of 5.3%-6.3% and total capital expenditures in the $450 to $500 million range. While capital spending has been increasing on an annual basis, adjusted EBITDA/capex has been declining annually. For fiscal 2019 adjusted EBITDA/capex was 2.6x, down a tick from 2.7x in the prior year. Management’s reiteration of guidance underscores their confidence in their banners as they continue to outperform peers and take market share.

Relative value

While DRI has no IG casual dining peers, the DRI credit (Baa2/BBB/BBB) can be compared relative to McDonald’s Corp. (MCD – Baa1/BBB+/BBB). MCD continues to increase leverage to return cash to shareholders, with estimated lease adjusted leverage currently at 3.8x, over a turn higher than DRI. The DRI 4.55% 2/15/48 bonds continue to look attractive relative to MCD 4.45% 3/1/47 as they are trading 70 bp wide to MCD. At issue the DRI 2048 bonds were trading about 15 bp behind MCD 4.45% 3/1/47 and have traded as close as 5 bp apart. In 5-year CDS, DRI trades roughly 4 bp behind MCD. In 30-year CDS, which is less liquid than 5-year, DRI trades 26 bp behind MCD. For investors searching for yield the 70 bp is an attractive pick up to move into a less liquid credit. Furthermore, a swap out of the MCD 4.45% 3/1/47 into the DRI 4.55% 2/15/48 provides for a take-out of nearly 11 points.

admin
jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.