Here’s Why Investors Are Fed Up With Olive Garden
Estimize | Sep 11, 2014 12:59AM ET
Casual dining restaurant chains have been struggling lately, and a few of them are resorting to bizarre marketing tactics to get attention. TGI Friday’s offered its diners all-you-can-eat appetizers for 10 bucks. Gawker’s Caity Weaver decided to put Friday’s up to the test by going on a 14 hour mozzarella stick binge. According to her account she didn’t enjoy her 7 plates of mozzarella sticks, but she also failed to find the restaurant guilty of false advertising.
The latest ridiculous casual dining sale comes from Olive Garden, a brand of Darden Restaurants Inc (NYSE:DRI). Instead of offering unlimited appetizers for a single seating, Olive Garden is thinking bigger. Olive Garden is promoting a 7 week pass for all the carbs you can jam into your stomach. For just $100, 1,000 lucky diners had the privilege of purchasing the “Never Ending Pasta Pass” which also includes bread sticks and Coca-Cola (KO) brand soft drinks. The passes sold out in 45 minutes flat on Monday. Over 50 of the passes appeared on eBay by Wednesday, fetching as much as $399 a piece.
“What we’re trying to do is get some attention,” Jay Spenchian, executive vice president of marketing admitted to USA Today. “It’s sure to provoke a reaction…”
If Olive Garden’s goal was to muster attention, mission accomplished. But the self deprecating promotion underscores one major problem universal to all of Darden’s restaurants, and they seem to be missing the point.
Giving away unlimited pasta to 1000 people might get Darden some PR, and it may be true that there is no such thing as bad PR. But Darden Restaurants is facing stiff competition from the meteoric rise of fast casual eateries. The explosive rise of chains like Chipotle Mexican Grill Inc (NYSE:CMG) (CMG) and Panera Bread Company (NASDAQ:PNRA) have cut into Darden’s business and threaten the company’s future. As a result Darden Restaurants has been going through a rough patch financially, and turmoil between management and two activist investor shareholders has grabbed headlines.
Earnings per share at Darden Restaurants have now dropped 7 quarters in a row on a year over basis (yoy). Over the past 3 quarters profits have fallen by a minimum of 17%. In a perhaps near-sighted attempt to cut costs, CEO Clarence Otis Jr. went ahead with a $2.1 billion deal to sell the Red Lobster chain, infuriating Darden’s hedge fund investors.
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The larger of the two funds, Starboard Value, has accused management of taking the easy way out rather than focusing on shareholder value. Starboard Value is leading a proxy war against Darden’s board of directors and senior management. After the sale of Red Lobster was completed on July 28, Clarence Otis Jr. announced that he would be stepping down from the helm by the end of the year. Starboard acknowledged Mr. Otis’s decision as a step in the right direction, but commented that their fund will not be satisfied until there is a majority change to the board.
Last week Darden Restaurants preannounced that earnings would fall between 31 and 33 cents per share for the quarter ending August 28. If Darden reported at the top of that range (33c EPS) that would still represent a 38% drop in year over year earnings on an adjusted basis. The official earnings report is set for release on Friday, before the market opens.
Earnings are slated to drop 38%, and the Estimize community expects sales to plummet too. Contributing analysts on Estimize are forecasting quarterly sales of just $1.611 billion, only $11 million ahead of the Wall Street consensus. If analysts on Estimize are correct, sales will drop 25% yoy.
Now that Darden has dropped Red Lobster, it’s going to rely on Olive Garden and its other smaller properties for growth. In its earnings pre-release Darden noted that Olive Garden locations which had been remodeled saw a 10% increase in store traffic. However, the 300 locations still needing a remodeling saw an average same-restaurant sales drop of 2.1% compared to FQ1 of last year.
Casual dining chains are in a tailspin while healthier more convenient alternatives are eating their lunch. Health is a major secular trend which is transcending the food business right now, even Apple Inc (NASDAQ:AAPL) is getting into health monitoring with its new Apple Watch. Depending on selling cheap breadsticks and pasta in 2014 is an uphill battle and Olive Garden is in need of some serious thought. With its new promotion Olive Garden is doing nothing other than saying “Hey, look at us, we sell really, really cheap carbs.”
Whether it be by taking a quick look at McDonald's (NYSE:MCD) recent sales figures or a glance in the other direction at the expansion of Whole Foods Market Inc (NASDAQ:WFM) and The Hain Celestial Group Inc (NASDAQ:HAIN), all indicators suggest that Darden Restaurants is trying to fly its kite into a major headwind. It’s time for Olive Garden to focus on cooking with olives and ingredients from gardens, not passes to pig out on pasta.
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