Olive Garden's financial recovery within Darden Restaurants

Olive Garden's Recovery

Olive Garden has certainly gone through its issues and travails over the recent years. As part of its parent company Darden, there has been some very valid concerns about the longevity and long-term success of Olive Garden and the other brands that have or currently do fall under the Darden Restaurants banner. However, things are looking up for Olive Garden right now. Even so, it has been a struggle and there has been a lot of trial and error. Through it all, Darden seems to have Olive Garden soundly on the right track right now and it remains to be seen if that shall continue. While Olive Garden has certainly been through some rough times, they seem to have righted the ship and they are now moving on to better things.

Literature Review

Summary of Darden Inc.

As indicated in the introduction, Olive Garden is actually one of several restaurants that falls under the corporate parent known as Darden Restaurants. Based out of Orlando, Florida, Darden's current lineup of restaurants include Olive Garden, Longhorn Steakhouse, Bahama Breeze, Seasons 52, The Capital Grille, Eddie V's and Yard House (Yahoo Finance). Darden use to also have Red Lobster in its collective but they sold that company about two years ago for about $2.1 billion in a divestiture that is still criticized as being the wrong move. The Red Lobster brand was sold to private equity firm Golden Gate Capital (Jannarone). Anyhow, Darden has since soldiered on and they have absolutely kept Olive Garden within its midst. Even after the aforementioned divestiture of Red Lobster, Darden still has a rather sizeable share of the restaurant sector around the country. They have about 1,500 restaurants across all of their brand names and they employee not quite 150,000 employees. Darden as its own name has been around since 1968. Despite the sale of Red Lobster, Darden has enjoyed sales growth over the last two-year-to-year periods including 2013 to 2014 and 2014 to 2015. The 2015 to 2016-year just ended May 31st, 2016 and the data has not yet been released for that time frame (Yahoo).

Darden Financials

To drill down a little more on the financials, the author of this report would look at the financial statements and other relevant data for the company. As just noted, the overall revenue figures for the company are quite good from fiscal year 2013 to the present despite the internal leadership struggles and sale of Red Lobster, as will be mentioned in the coming paragraphs and sections. In fiscal year 2013, the company made about $5.9 billion in sales. In fiscal year 2014, this figure rose to $6.2 billion. In fiscal 2015, the figure rose even sharper to $6.7 billion. Gross profit over those same time windows generally rose but did dip in the 2014-year. The figures, respectively, were $1.3 billion for 2013, $1.295 billion for 2014 and $1.422 billion in 2015. As for net income applicable to common shares, much the same thing happened. The net income in fiscal year 2013 was $411 million. The net income figure was $286 million in fiscal 2014, a fall of more than a fourth. However, the figure strongly recovered (much like gross profit) in fiscal year 2015 to about $709 million. Operating income did much the same thing. All three fiscal years had a profit of somewhere between $300 million and $400 million but there was a dip in 2014, much like the other metrics. In short, total revenue has been good overall but there was a dip in operating income, net income and net income applicable to common shares in fiscal year 2014 as compared to what revenue was doing ... which always rose (Yahoo Finance.

The balance sheet reveals a little more cause for concern. Total assets hovered around $7 billion in fiscal years 2013 and 2014 but fell to a bit less than $6 billion in 2015. However, the good news is that overall debt has fallen over that same time frame. The total liabilities for Darden was $4.8 billion in 2013 and then rose a bit to $4.925 billion in 2014. However, there was a sharp fall in total debt to about $3.6 billion in 2015. Accounts payable fell from $531 million to $404 million over that time frame but the biggest reason debt fell was a sharp fall in long-term debt. The 2013 and 2014 figures were $164 million and $222 million, respectively. However, that figure was a scant $15 million in 2015 (Yahoo Finance).

The cash flow statement is a little dourer. Indeed, the net income (as mentioned before) took a sharp dip in between 2013 and 2015. However, it remained positive. The company shed nearly two billion in money when it came to cash flows from financing activities. Beyond that, the company only gained about $10 million a year in 2013 and 2014. However, that figure to rose the better part of half a billion in fiscal 2015. Investing activities was also a drain on cash flow. The company shed a total of nearly two billion dollars in investing activities including more than a billion in 2013 alone. That number shrunk below half a billion in 2014 and o less than a quarter billion in 2015. The current analyst opinions for Darden are mixed. There are more upgrades than downgrades, however. Raymond James, mentioned elsewhere in this report, has them at "underperform," which was a change from market perform. This followed another downgrade that they did in October 2015, which shifted them from "outperform" to "market perform." In short, they were shifted down two times in the span of less than three months. On the other hand, Piper Jaffray upgraded them to "overweight," Maxim Group upgraded them to "Buy" and Credit Suisse upgraded them to "Outperform." Other hedge funds and groups keeping an eye on them include Goldman, Deutsche Bank and Guggenheim.

Hedge Funds Make Their Play

As for the trials and tribulations of Olive Garden, there were many. 2014 was notable for Darden even beyond the sale of Red Lobster. Indeed, there roughly ten different events that Darden went through that led to some realistic questions about where Darden would be in five to ten years ... or even by 2020. It started when one of the more prominent hedge funds out there, known as Barington Capital, insisted that Darden should spin off both Red Lobster and Olive Garden. Both of those chains were struggling mightily at the time and Barington was of the mind to cut bait and get rid of them both. Not long after that, another hedge fund entered the fray but did so in a financial way. Indeed, Starboard Value entered the situation and bought a 5.6% stake in Darden. They were out there saying much the same thing as Barington as it related to Olive Garden and Red Lobster. Darden Corporate was steadfast in holding onto Olive Garden but decided to part ways with the Red Lobster brand. This was seen as a way to acknowledge that change was necessary but Darden refused to capitulate when it came to getting rid of Olive Garden (Summers).

Sale of Red Lobster

The spat between Barington, Starboard and Darden got much nastier. Many shareholders in the Darden sphere decided that they wanted a voice. Of course, Barington and Starboard were among the people that thought that way. However, Darden did not seem to listen much, let alone care, about the feedback from the stockholders and stakeholders because they executed the sale of Red Lobster with little further notice. Beyond that, there are many that say that the company could and should have gotten a lot more than the $2.1 billion that got for the sale. Many people, including the two hedge funds involved, were very critical of the deal and this led to a mutiny where people with the hedge funds went for control of the Darden Board of Directors. Making things worse, the earnings figures for the company as a whole fell by roughly a third just as all of this was going on (Summers).

Shareholders Revolt

There was at least one casualty that came as a result of the hastily done sale of Red Lobster and that was Darden Chairman and CEO Clarence Otis. He announced that he would leave at the end of the year or when his replacement was found, whichever happened first. The fallout continued when the company's annual meeting was delayed by two whole weeks. It was originally going to happen in Orlando on September 30th. However, Darden decided a delay was in order so that proxy materials could be released. The main purpose of that pivot was to state its case against the Starboard plan. Starboard, for its part, was rather vicious in that they declared that what Darden was going was "an act of prolonging shareholder suffering at the time" (Summers).

Starboard took full advantage of that delay. They penned a three-hundred-page report that absolutely lambasted and denigrated Darden for what they had done as it related to Olive Garden. The verbiage in that report ran the gamut from how the asparagus was too long and that the "cooks" in the kitchens of the Olive Gardens should learn how to cook pasta. This treatise by Starboard led to a great number of people taking Starboard's side when it came to the fight between Starboard and the existing Darden board, an effort that eventually led to the entire board being replaced with new people. Olive Garden employees glommed onto the movement by offering a petition with more than seven thousand signatures. The basic gist of the petition was to say that things at Darden needed to change and change immediately. However, there was a bit of a knife in the back for the remaining people at Darden given that the departing CEO who had quit would get a grand total of $36 million in cash payouts including $23,000 per week in severance over the two years after his departure. Much of the rest came from stock options that Otis had in his possession (Summers).

Better Times for Darden and Olive Garden

Fast forward two years later and Olive Garden and the larger Darden name seem to be doing a lot better. Indeed, Darden had growth rates of about 6.8% for the report that was issued for the third fiscal quarter of 2016. One of the identified problems that seems to have been part of the solution at Olive Garden is that many of Olive Garden's platters and other offerings are laden with carbohydrates and this runs against the grain of the evolving food palates of many Americans who are seeking meals that are healthier. It was not just the food that was changed and molded when it came to the recover. Indeed, about 430 restaurants were spun off into what is known as Four Corners Property Trust, traded as FCPT on the New York Stock Exchange. They are what is known as a real estate investment trust, or REIT for short. Further, it would seem wise that Olive Garden was not cut loose by Darden as they currently make up the lion's share of Darden's revenue. As of April 2016, that percentage was a smidge more than half of the grand total. Same store sales are fairly strong but some investors are less than enthused about the overall figures and performance. Indeed, there was an extra week in the latest fiscal calendar so the two periods being compared are obviously not apples to apples in terms of length of time. The people that know this and looked at a true side-by-side and apples-to-apples comparison happily report that the gains are still not quite five percent, so the news is still good overall. The one and major thing that Olive Garden can point to is that overall foot traffic through their restaurants is going up. Indeed, if the total number of customers is going up, the net result should be higher sales, all else equal. This runs counter to what Olive Garden was getting away with in the past whereby increase price points were cancelling out a lot of (but not all of) the foot traffic amounts falling at stores (Duprey, 2016).

There are some more nuts and bolts to the Darden recover that deserve their own mention. When the aforementioned CEO Otis was jettisoned, he was replaced with then-Chief Operating Officer Gene Lee. His results cannot be questioned all that much based on the merits. Indeed, the last twelve months before February 2016 revealed that only 37 restaurant stocks in the Russell 2000 were beating Darden. Of course, Olive Garden is not popular in all corners of the markets they inhabit. Indeed, people in cities like New York have higher tastes and tend to go other places. Even so, Olive Garden is doing quite good overall. One need only look at the percentage gains or losses that Olive Garden weathered from 2013 to 2015. In the 1st quarter of 2013, Olive Garden was in the proverbial cellar with a loss of nearly seven percent. They turned around a bit in the second quarter with a growth rate of one percent but they things went very south again and they lost four percent in the third quarter. The pattern happened again as they lost less than one percent in the fourth quarter of 2013 but then lost five percent and change in the first quarter of 2014. Changes started to take hold at that point. Their loss lessened to 3.5% in the second quarter of 2014 and then 1.2% in the third quarter. Growth periods started in the fourth quarter of 2014 with a rate of less than one percent. This rose to just over two percent in the first quarter of 2015, a little over three percent in the second quarter of 2015, a slight fall in the third quarter of 2015 and then a further fall to about one percent even for the last quarter of 2015 (LaChapelle).

A huge part of what has led to better performance from Olive Garden is focusing on the basics. Indeed, Darden has implemented a number of cost savings for its latest fiscal year ending in May. They found about $80 to $90 million to carve out from the last year and they plan about another $40 million for the coming year. The salient question asked by a lot of people is whether this is just a temporary gain or if Olive Garden and Darden can sustain this over time. Not everyone is convinced that the changes are lasting and enduring. Indeed, an analyst by the name of Brian Vaccaro, who works for Raymond James, cut the rating for Darden to "underperform." This basically means that he is suggesting that the stock be sold. He added to this, however, that he was taking this position because the stock was "priced for perfection" given its recent good performance and the unlikelihood that this would continue into the foreseeable future (LaChapelle).

Other analysts are taking similar positions, but for slightly different reasons. For example, there is the opinion of Shelly Banjo with Gadfly. She asserts that Darden operates in the "middle market" when it comes to restaurants. They are obviously between fine dining restaurants that outstrip them in terms of costs and the cheap fast food outlets like Taco Bell, McDonald's and Burger King. Beyond there are the fast casual places like Chipotle, Five Guys and Panera. All of these niches and price points in concert with increase wealth inequality around the country has led to a "squeeze" on mid-market restaurants like the ones operated by Darden, at least in the estimation of people like Banjo. Beyond that, Darden would be playing with fire if they cut costs too much. Indeed, many people that work at Olive Garden live and die based on tips and this could easily lead to them coming in to work sick because they do not have a guaranteed salary and there are not mandatory sick days in many jurisdictions. Indeed, only the coasts of the United States have sick leave laws in most situations and waitresses are often only being paid about $2-3 an hour from the restaurant, with the rest coming from tips most of the time. Beyond that, cutting costs can lead to things not happening that really need to happen. Exhibit A when it comes to this is the currently plight of Chipotle which is struggling to get their sales back up to where they were after several bouts with bacteria and viruses being present in their food and/or the restaurants themselves. The nasty bugs include E.coli and norovirus. The point is that cutting costs can only accomplish so much and cutting things too much to the bone can lead to important things being missed or bad habits becoming commonplace (LaChapelle).

One waste that could be a very valid concern and perhaps a very easy fix for Olive Garden is the common practice of the company to dole out all of the salad and bread sticks that customers want. Such a practice may dovetail neatly with the faux Italian culture that the company tries to portray. However, it surely also leads to a lot of wasted food as not all of that salad and breadsticks are being eaten. Beyond that, there is often a flat charge associated with those limitless piles of breadsticks and salad. In other words, if the charge is $7.99, that is all the company is going to get whether a customer eats one plate or salad or five plates and the salad itself (as well as the breadsticks) are doled out in batches and baskets ... not single-serve plates. One of the champions of this complaint, to no one's surprise, is Starboard Value ... the same hedge fund mentioned earlier. Starboard is actually not advocating a complete abandoning of the policy. Rather, they say it just needs to be tweaked in a certain way. However, even if the criticism from Starboard was muted, there were other facets to it. This included not using salt in the pasta water to the "non-Italian" options that appear on the menu. However, the excess breadsticks thing would seem to one of their pain points. Indeed, it would seem that policy has been (or maybe still is) that breadsticks should be one for everyone at the table plus one extra for every round that is delivered. However, it would seem that some servers were getting lazy and were just putting piles of them on the table irrespective of how many people were there and where they were in their meal, whether it be before or after the entrees were delivered. There seemed to have been great merit to what Starboard was saying as the estimated that Olive Garden was burning through 675 to 700 million breadsticks a year. Since that is an average of three per customer per meal and since the average customer does not eat that many, that points to a lot of waste either due to delivery of too much food to the table or too many going cold in the kitchen and being thrown out at night. As for salting the pots with the pasta, Olive Garden was apparently doing that to help their pots last longer. Starboard was incredulous at this idea since the focus seem to be saving a few bucks on some cheap pots that get a lot of use even with the salt rather than delivering a better food experience for the customers. The general case that Starboard was making was that good and/or service quality as a whole was suffering due to cost cutting in the wrong part of the business model and the quality of the food being a drag will hurt the business more than anything else, at least of an internal nature.

Conclusion

In the end, Darden seems to have learned its lesson. Public companies and their executives or board members cannot just act with impunity and assume that the shareholders will not make a ploy to stop them. Of course hedge funds and major shareholders can sometimes be wrong or there can sometimes be an even better plan. However, those sorts of things emerge and gain acceptance through dialog and cooperation. The tradeoff of being a public company is that one is accepting public dollars (investments) and the people who made those investments expect to have their investment rewarded rather than their wishes or desires ignored. This can go double when employees are part of the clarion call against unilateralism from the board or the CEO and yet the board or CEO still does what they want. However, the mechanisms that prevent some dictatorial behavior did what they should have done and now Darden and Olive Garden seem to be on the right path and with new management. It remains to be seen, however, whether their current best practices are the best for the long haul and whether the coming economic and social changes waiting in the wings will affect the markets and people's pocketbooks as much as is feared and loathed by some analysts.