Don’t Doubt Darden’s South American Swing

by Will Ashworth | March 5, 2013 2:18 pm

The time has come for Latin America. The world’s richest man, Carlos Slim, lives in the region, as do 128 other billionaires. Latin America is hot, so if the stocks you own have global aspirations, they must be there.

Darden Restaurants (NYSE:DRI[1]) announced last month that it had signed a deal with Brazilian-based International Meal Company to open 60 Red Lobster, Olive Garden and LongHorn Steakhouse locations in Brazil, Colombia, Panama and the Dominican Republic over the next five years.

Darden’s established brands are having a tough go of it, but this deal could be a game-changer.

Trouble on the Home Front

Everything is relative. When Darden warned investors Feb. 22 about its third-quarter and fiscal 2013 earnings, it’s important to remember that it still expects to make at least $3.06 in diluted earnings per share. The world isn’t coming to an end, but it certainly looks a bit bumpy for its three largest brands: Red Lobster, Olive Garden and Longhorn Steakhouse. In the third quarter ending Feb. 24, Red Lobster’s same-restaurant sales will decline 7% year-over-year, Olive Garden’s by 4% and LongHorn Steakhouse by 1.5%.

Of the three, Red Lobster appears to be having the most trouble. Assuming the fourth quarter also delivers negative same-restaurant sales, it will be the fifth consecutive quarter with declining revenue. The restaurant is in the final stages of a remodeling program that will see all of its locations getting a facelift, and it introduced a new core menu in October with at least seven additional items under $15. While management sees these two changes helping to right the ship, performance has been anything but consistent.

Going forward, any real growth in its three largest brands will come from LongHorn, which currently has 416 locations and the potential for as many as 800 in the United States alone. Red Lobster and Oliver Garden will see much less unit growth as both brands try to strengthen their businesses.

Long-term, I think Darden is a stronger company by focusing on improvement rather growth for growth’s sake. Until then, it can use international franchising as its growth vehicle for established brands.

Going Abroad

The deal with the International Meal Company isn’t Darden’s first in Latin America and probably won’t be its last.

Restaurant Operators currently operates five LongHorn Steakhouses in Puerto Rico with an agreement in place for three more, along with eight Olive Gardens and three Red Lobsters by 2017.

In Mexico, Darden signed a deal with CMR (which operates 116 restaurants in Mexico) to open 37 restaurants in Mexico under the Red Lobster, Olive Garden and The Capital Grille brands. By the end of May, CMR will have opened three locations since announcing the deal in August 2011. (Look for CMR, a seasoned restaurant operator, to pick up the pace.)

Lastly, we have the latest franchise agreement with IMC to develop 60 restaurants in Brazil and three other countries.

IMC got its start in 2006 with funds from Advent International, the same private equity firm behind Lululemon (NASDAQ:LULU[2]). They’ll do justice to the brands.

While Red Lobster and Olive Garden are struggling in North America, both of their brands are widely recognized in other parts of the world. Latin America seems especially ripe for the introduction of additional American casual dining brands. According to Darden, its international franchising along with its push into consumer packaged goods (salad dressing, etc.) should generate an additional $5 million to $10 million in operating cash flow annually in 2013 and beyond. That might not seem like much, but it’ll be doing so without significant capital expenditures.

The big money is being shoveled into Darden’s specialty restaurant group, which got a huge boost in 2012 thanks to the acquisition of Yard House for $585 million. Yard House is one of America’s most exciting restaurant brands, delivering great food and beer to customers at 40 locations with seven to 10 new units opening annually.

Although the specialty restaurant group accounts for just 12% of Darden’s $8.5 billion in expected revenue in 2013, Yard House, Seasons 52 and its other three specialty brands will deliver 40% of Darden’s growth in the next few years.

That’s special indeed.

Bottom Line

Darden’s international expansion allows it to keep its established brands out there and growing internationally while it fixes them back home. Any more weakness in its stock provides investors with an exceptionally good opportunity to buy one of the biggest and best restaurant operators in the country at a definite discount.

If you invest three to five years out, it’s a buy for certain.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

  1. DRI:
  2. LULU:

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