Why Darden Restaurants Needs to Sell Olive Garden Now

Darden Restaurants revealed its fourth-quarter and full-year fiscal 2014 earnings last Friday. The results mirrored the past several quarters as both Olive Garden's and Red Lobster's poor performance dragged down the company overall.

Despite the casual dining industry growing more competitive each quarter as a whole, several other restaurant companies like Bloomin' Brands and The Cheesecake Factory have been able to maintain or improve on their sales numbers.

Even though Darden Restaurants sold Red Lobster last month, Olive Garden still presents a big problem for the company. In fact, there are many reasons Olive Garden needs to be sold sooner rather than later.

Source: Olive Garden.

Earnings show Olive Garden is still hurting Darden Restaurants
During the fourth quarter, Darden Restaurants saw revenues of $2.32 billion, which were short of expectations of $2.33 billion, but above the $2.30 billion in the fourth quarter of fiscal 2013. However, $666.2 million of fourth-quarter revenues was drive by discontinued operations, mostly in Red Lobster. Overall, net income plunged 35% to $86.5 million.

For the year, net income fell 30.5% to $286.2 million, even though revenues rose 2.4% to $8.76 billion.

The story recently, however, has been same-store sales for Darden Restaurants. Looking at 2014 overall, same-store sales grew 2.7% and 1.6% for LongHorn Steakhouse and the Specialty Restaurant Group, respectively. In contrast, same-store sales for Olive Garden and Red Lobster fell 3.4% and 6%, respectively.

By comparison, same-store sales for Bloomin' Brands were flat despite a 1.6% drop in traffic. In its most recent quarter, The Cheesecake Factory saw same-store sales increase 0.9% despite bad winter weather. Both companies saw their net incomes fall moderately last quarter while revenues rose 6% and 4%, respectively.

Bloomin' Brands and The Cheesecake Factory dealt with the same obstacles Darden Restaurants faced last quarter, including bad weather, increases in commodity prices like beef, and an increasingly competitive environment. Yet, Darden Restaurants performed a lot worse. This is because Olive Garden is still a big cloud over Darden Restaurants.

Why Darden Restaurants needs to sell Olive Garden now
With now 837 locations, if Olive Garden wasn't too big of the Darden Restaurants pie before the Red Lobster sale, it certainly is now.

In fact, if we look at Darden Restaurants' portfolio purely in terms of total revenues, Olive Garden may soon account for just under 60% in total revenues. Even if we factor in recent trends regarding same-store sales, Olive Garden will still account for over half of Darden Restaurants' revenues for the next several years.

Credit: Darden Restaurants' annual financial data.

This introduces another problem -- same-store sales. Olive Garden has not shown any clear signs of a turnaround. Same-store sales for March, April, and May were -4.4%, -2.6%, and -3.3%, respectively.

Yet, Darden Restaurants again reiterated during its conference call last Friday its plans to invest in Olive Garden.

In what management calls a "brand renaissance," near-term plans for Olive Garden include an expanded menu with customization options, despite the desire to simplify operations and recipes. New PIastra grills are supposed to improve the quality and consistency of grilled items. Money is also set aside for new service training for the staff.

Additionally, a partnership with Ziosk will introduce tabletop tablets to begin testing in August. This is at the same time that Olive Garden's new online ordering system is to be completed.

Finally, new plate ware and ongoing remodeling goals are in process. This alone counters not only the recent investments in the new online ordering system, but the fact that management stated that the take-out business is now 8% of total sales for Olive Garden, and growing 10% annually.

Just some of the investments going into Olive Garden's "brand renaissance."  Source: Darden Restaurants.

Lastly, Italian restaurant industry trends show that the segment is currently in the mature phase of its life cycle. Through 2018, it is expected that the segment will increase at an annualized rate of just 1.1%. Carrabba's Italian Grill has been the worst performer of Bloomin' Brands. Despite contributing 17% of last fiscal year's sales, the Italian concept recently saw same-store sales fall 1.8%.

Even The Cheesecake Factory has hedged against Italian entrees for its restaurant concepts by offering a diversified menu. The Grand Lux Café was originally conceived to be mainly Italian, French, and Austrian. However, its menu has become more eclectic and offers a little of everything today.

The biggest reason to sell Olive Garden
Consistency is the biggest problem when it comes to Olive Garden and the other six existing brands within Darden Restaurants. Five of the six brands were created in 1990 or after. LongHorn Steakhouse was actually formed in 1981, a year before Olive Garden. However, the brand has consistently outperformed its segment.

Even Darden Restaurants admitted in a presentation earlier this year that four of the five brands within the Specialty Restaurant Group were aimed at Generation X customers. The Capital Grille instead targets higher-income customers.

Nevertheless, there is a good chance that inconsistency between Olive Garden and the other brands has led to some cannibalization of customers choosing one of the other six restaurants over Olive Garden, differentiation and customer targeting issues, and massive marketing investments annually.

While synergies may be a possibility within the other six restaurants, at this point, Olive Garden just seems too different to make sense for Darden Restaurants going forward.

What Darden Restaurants should look like to maximize profits and growth. Source: Darden Restaurants.

Bottom line
One could say that Olive Garden is the Achilles Heel of Darden Restaurants. However, its size makes it more of the heart of the overall company.

Instead, LongHorn Steakhouse should be the heart of the company going forward in order to take more market share away from companies like Bloomin' Brands.

The Specialty Restaurant Group needs to be the future. This is because based on recent earnings, these are the types of restaurants customers are willing to spend money in. This is especially highlighted when we consider the fact that visits to midscale and casual dining restaurants dropped last quarter on a year-over-year basis by 4% and 2%, respectively.