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Darden Restaurants, Inc. (DRI), Brinker International, Inc. (EAT): This Company’s Scale Ensures the Freshness of Its Products

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Darden Restaurants, Inc. (NYSE:DRI)If you ever had a meal at a restaurant that did not meet your expectations, don’t be quick to blame the chef. The lack of scale in delivery could have contributed to slower delivery of food supplies and a lower quality of the final product. But the restaurant about which I’m going to speak is different.

Darden Restaurants, Inc. (NYSE:DRI) is one of the largest full-service restaurant companies in the world. It runs more than 2,000 restaurants globally, including more than 350 Red Lobster seafood restaurants throughout the U.S. and Canada. Darden Restaurants, Inc. (NYSE:DRI)’s customers are assured of the freshness of its food offerings, by virtue of its extensive distribution network and the timeliness of food supplies delivery. Other restaurant brands under Darden Restaurants, Inc. (NYSE:DRI) include Olive Garden, LongHorn Steakhouse, Bahama Breeze, Seasons 52, The Capital Grille, Eddie V’s, and Yard House.

Economies of scale in sourcing and distribution

Darden Restaurants, Inc. (NYSE:DRI) has delivered consistent operating margins within a narrow range of 8%-10% in every single year for the past decade. This is the result of significant economies of scale.

In terms of sourcing, Darden Restaurants, Inc. (NYSE:DRI) makes more than $2 billion in purchases annually from approximately 1,500 suppliers based in 20 countries. Its diversity in sourcing helps to ensure that the prices of food supplies remain competitive and reduce over-dependence on any particular supply source.

With respect to distribution, the timeliness of delivery is a function of a restaurant’s scale. Many chefs will admit that the freshness of seafood plays a bigger part in the superior taste of their masterpieces, than their culinary skills. With its extensive network comprising 11 distribution centers operated by three distribution partners in the U.S. and Canada, Darden Restaurants, Inc. (NYSE:DRI) is able to deliver food supplies to its restaurants in an effective and efficient manner.

Brand improvement initiatives to address decline in restaurant industry traffic

Weak consumer sentiment and high unemployment rates have contributed to reduced affordability and consequently, lower restaurant traffic in the past few years. Darden has experienced declining same-restaurant traffic of about 7% from fiscal 2008 to fiscal 2012.

Darden has implemented new initiatives over the past year, with the aim of revitalizing its brands and improving consumer affordability. For its Olive Garden Italian restaurant chain, it increased its food variety to appeal to a wider range of guests, particularly focusing on healthier food choices, such as new dishes Lasagna Primavera with Grilled Chicken and Seafood Brodetto, which are below 500 calories.

Also, new core menu additions and value combos such as the $12.95 Chicken Toscano and the 2 for $25 Italian Dinner will help attract more price sensitive customers. With respect to its LongHorn Steakhouse business, Darden launched advertising campaigns emphasizing on the quality and freshness of its beef.

Outlook

While Darden registered a 12% year-on-year decline in quarterly diluted net earnings per share from continuing operations of $1.01 for the fourth quarter of fiscal 2013, there were positive operating trends observed. U.S. same-restaurant sales at LongHorn Steakhouse, Red Lobster, and Olive Garden increased 3.5%, 3.2%, and 1.1%, respectively, in the quarter. In addition, Darden increased its quarterly dividend per share by 10% to $0.55, and currently sports a 4.50% forward dividend yield.

I expect Darden to fully realize the benefits from its brand improvement initiatives in fiscal 2014, with a positive impact on public perception, restaurant traffic, and sales. Management guided for fiscal 2014 sales growth to be between 6% and 8%.

Peer comparison

Darden’s peers in the casual dining space include Brinker International, Inc. (NYSE:EAT) and Buffalo Wild Wings (NASDAQ:BWLD).

Brinker International, Inc. (NYSE:EAT) either operates or franchises close to 1,600 restaurants under the names Chili’s Grill & Bar (representing the bulk of restaurants) and Maggiano’s Little Italy. Brinker International, Inc. (NYSE:EAT) delivered a good set of results in the third quarter of fiscal 2013, increasing operating margin by approximately 70 basis points to 17.9% and earnings per diluted share, excluding special items, by 20% to $0.72 per share. Despite this, Brinker International, Inc. (NYSE:EAT) saw quarterly traffic at its restaurants Chili’s and Maggiano’s fall 3.2% and 1%, respectively.

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