Darden Earnings: Traffic Gains and Margin Improvement Validate Management Strategy

After narrow-moat Darden DRI outperformed industrywide traffic by 700 basis points during fiscal third-quarter 2023 (Black Box Intelligence), we’re finally giving the firm credit where it’s due. The company appears to have learned its lesson after raising prices too aggressively amid the global financial crisis, and its commitment to structurally lower marketing expenses in lieu of using discounting to buy traffic is a meaningful step forward. After digesting wide industry outperformance, and management commentary suggesting long-term margin expansion, and a massive (340-basis-point) sequential improvement in its restaurant EBITDA margin, to 20%, we expect to raise our $123 fair value estimate by more than 15%, leaving shares trading in a range we’d consider fairly valued.

Darden’s restaurants continue to exceed full-service industry benchmarks due to strong customer satisfaction and value perception, with consumers flocking to the firm’s brands after years of underpricing inflation strengthened its value proposition. While we’d previously struggled to rationalize how the full-service stalwart could emerge from coronavirus structurally more profitable, the combination of labor efficiencies (120-basis-point improvement relative to pre-COVID-19), more disciplined marketing (200 basis points), and leverage over other restaurant expenses (40 basis points) have underpinned slightly higher unit-level margins than pre-COVID-19 (higher food costs largely offset). That sharply contrasts profit pressure across the rest of our restaurant coverage—which remains nearly 400 basis points below its long-term restaurant margin benchmarks. Management suggests those gains will likely be retained, and better restaurant economics validate their 2.5%-3.0% near-term unit growth targets.

We expect to raise our long-term operating margin forecast to 12.2% from 10.9% previously, driving 10-year annual operating profit growth of 5.2%, up from 4.1%. Our 5% annual growth forecast is unchanged.