Darden Restaurants, Inc. has been a public company since 1995. A company born of the chain Red Lobster, Darden is a recent spin-off as a result of mergers and acquisitions of various types. Publicly traded on the New York Stock Exchange, Darden (DRI) is the parent company of Red Lobster, The Olive Garden, the now-defunct China Coast concept, and a new “Floribbean” concept: Bahama Breezes. Throughout its existence, as a part of General Mills, Pillsbury, or on its own as DRI, Darden has made waves throughout the restaurant industry.
The thought processes behind the introduction of a concept are considered revolutionary, as exemplified by the strategy behind The Olive Garden and Bahama Breezes. While Darden has not had the most stellar of income statements of late, this is a result of write-offs and write-downs of assets as a result of the failure of the chain, The China Coast. Recent years have shown consistent revenues, yet inconsistent net income, as it has been cut in half, and then redoubled it in recent years (before asset write-downs, a discrepancy that will be discussed in the introduction).
In a like manner, most components of the return on equity equation have drastically swung in recent years as a result of inconsistent leadership, and shifting management goals. However, as Darden’s management begins stabilizing the company, cutting sub-quality stores, and gearing up for the nationwide expansion of Bahama Breezes, the company appears to be heading in the positive direction. However, the entire annual report is not rosy. Upon examining Darden’s use of leverage, it would appear that the company is being careless in their management of debt.
Darden did not use a great deal of debt initially, however, they are quickly adding a great deal of short-term liabilities to their reasonable level of long-term debt. This tactic was decided to be alarming to our group. The future does indeed look bright for Darden. The company is strengthening their existing divisions, so as to increase income and support the start-up costs of Bahama Breezes on the large scale. This strategy of returning to the basics is so simple, it is Darden’s goal to revolutionize the restaurant industry with their inordinate amount of detail to simplest of tasks.
Introduction While Darden Restaurants, Inc. was only incorporated in 1995, the history of the company dates back to 1968. That year was when Bill Darden, a restaurant operator whose previous endeavor was a coffee shop in Macon, Georgia, opened the first Red Lobster. Opened in Lakeland, Florida, the chain opened five units by 1970 as it gained a reputation for fine seafood at a bargain price. General Mills purchased the five Red Lobster units in 1970, offering Darden the necessary resources to begin nationwide expansion.
The restaurant quickly grew and evolved into the largest full-service restaurant chain in the United States. Throughout the 1970’s, General Mills expanded the Red Lobster concept throughout the United States and Canada. However, General Mills desired more, and began consumer-driven research developing an Italian restaurant concept that would set the restaurant industry on its ear. By delivering a concept that met the consumers needs, rather than operational needs, The Olive Garden was a “different” kind of restaurant.
For example, based on consumer requests, larger tables were chosen, along with more comfortable chairs that had rollers on them. Though simple changes, the impact was huge, as the trend has evolved in the restaurant industry to meet the consumer’s demands. Building off the growth of Red Lobster and the success of The Olive Garden, General Mills quickly developed its entry into the restaurant industry. Under the leadership of Ron Magruder, General Mills used it expansive resources to grow into one of the largest restaurant entities in the world!
A third creation, The China Coast was founded in the early 1990’s, however, this concept failed, costing the company $44 million in losses. Through a merger in 1995, General Mills spun off its restaurant division, creating the current parent company of The Olive Garden and Red Lobster – Darden Restaurants, Inc. (DRI). With Bill Darden serving as CEO, DRI operates three divisions – The Olive Garden, Red Lobster, and Bahama Breezes, a recent creation, a calypso-themed restaurant. Currently, Red Lobster is the largest full-service restaurant chain and the largest seafood company in North America.
The company’s 680 units are company owned and operated. Of those 680 units, 646 are spread throughout every state (including the District of Columbia) but Alaska, and 34 are operated in Canada. Sales for fiscal year 1998 totaled nearly $2 billion. The Olive Garden currently operates 459 units in the United States, and 5 units in Canada. Gross sales for The Olive Garden totaled over $1 billion. Gross sales for all divisions of Darden Restaurants exceeded 3. 2 billion dollars! Darden’s net earnings in fiscal year 1998 were just over 101 million dollars, with shareholders receiving an eight-cent dividend.
There are two possible sources of discrepancies we would like to disclose in this introduction: financial histories and restructuring charges. The first source of some discrepancies throughout the paper is a lack of some financial history. In the 1998 Darden Restaurants Annual Report, there was some inconsistency in whether history from FY 1996 was used or not. For this reason, we have been forced to omit FY 1996 in some places. In all tables, the most extensive data available was used.
As a result of the closing of the China Coast concept, Darden Restaurants claimed approximately $146 million in restructuring and asset impairment charges during FY 1996 and FY 1997. Darden’s 1998 Annual Report listed earnings both before and after these charges. Likewise, in Appendix A, we have included a copy of the Financial Highlights from the 1998 Annual Report, which lists earnings both before and after the charges. In our opinion, a vital part of this analysis is to determine the direction the company is going based on comparisons to past years.
Therefore, we have chosen to neglect these charges to more accurately gauge the effectiveness of management of Darden. Return on Equity (ROE) Return on equity (ROE) is one of the most basic measures of how a company is doing. In a publicly traded company, ROE is often a measure of whether a CEO will hold his job or not. Return on equity is a ratio comprised of three elements (see Fig. 1): Figure 1: Return on equity equation Before we analyze the return on equity of Darden Restaurants, we will look at the efficiency, turnover, and leverage equations that comprise the return on equity equation.
Then, we will analyze the return on equity, and how it affects the stockholders of Darden. We will also compare Fiscal Year 1998’s return on equity to Fiscal Years 1996 ; 1997. For the sake of simplicity, all dollar figures will be in millions (unless noted), and all ratios will be as a percentage (unless noted). The ability to maximize income as a portion of your sales is a key to success in the industry. This is referred to as the efficiency ratio. As stated earlier in the report, Darden Restaurants had a net income of $101. 7 million on gross revenues (sales) of $3. 287 billion, resulting in an efficiency ratio of 3. 9% (see Fig. 2). Figure 2: Efficiency Percentage Equation Table 1 shows the efficiency ratios for Darden Restaurants, and the sales and net income figures used to determine them. Darden’s efficiency ratio is a drastic improvement over FY 1997. In FY 1997, Darden had after-tax earnings of $54. 3 million earned on $3. 2 billion in sales. During the three-year span compared, FY 1996 yielded the highest efficiency ratio with a net income of 3. 73% of $3. 191 billion in sales: $119. 2 million. | |FY 1998 |FY 1997 |FY 1996 | |Sales | $3,287. 0 | $3,171. | $3,191. 8 | |Net Income | $ 101. 7 | $ 54. 3 | $ 119. 2 | |Efficiency |3. 09% |1. 71% |3. 73% | Table 1: Darden’s Efficiency Ratios, FY 1996-1998 The increased efficiency rating in FY 1998 is commented on in the annual report. As seen in Table 1, income nearly doubled on just over $100 million increase in sales (approximately 1. 5% of FY 1997 sales). Both Red Lobster and The Olive Garden divisions noticed increased margins. In fact, The Olive Garden has nearly tripled its operating profit from three years ago!
However, the annual report cites that the main source of the increase in FY 1998 was Red Lobster. In second quarter FY 1997, many actions were taken to enhance performance in the long term. These actions included improvements in service, new recipes and new menu items. Increased earnings in FY 1998 were direct results of these actions. The second element of the return on equity equation is the turnover ratio. Again, the turnover ratio consists of the total amount of sales divided by the total amount of assets. Turnover represents how many times the assets “turned-over” generating their value in income.
In FY 1998, Darden turned over their assets 1. 65 times (see Figure 3). Following the equation, this is found by dividing total sales of $3. 287 billion divided by $1. 98 billion in assets. The resulting Figure 3: Turnover Equation number, 1. 65617 times means that for every one dollar of assets, there was $1. 66 in sales generated. | |FY 1998 |FY 1997 | |Sales | $3,287. 0 | $3,171. 8 | |Assets | $1,984. 7 | $1,963. 7 | |Turnover (times) | 1. 65617 | 1. 61522 |
Table 2: Darden’s Turnover Ratio, FY 1997-1998 As shown in Table 2, the turnover ratio at Darden increased by a mere five hundredths of one time per year. This represents an increase in turnover of approximately 2. 5%. This is almost entirely attributed to the above-mentioned sales push by Red Lobster and The Olive Garden, as assets only grew by $20 million, but sales increased by over $100 million. Therefore, turnover only increased by a small amount. The final component of the return on equity equation is leverage. Also called the equity multiplier, leverage is a profitability ratio that reflects how extensive a company uses debt in the
Figure 4: Leverage Equation (Equity Multiplier) company’s operations. As shown in Figure 4, Darden had an equity multiplier of 1. 946078. This means that for every one dollar of equity, Darden holds $1. 95 in assets. This equation will be further addressed in the next section: The Use of Leverage. | |FY 1998 |FY 1997 | |Assets | $ 1,985 | $ 1,964 | |Equity | $ 1,020 | $ 1,081 | |Equity Multiplier |1. 946078 |1. 816836 | Table 3: Darden’s Equity Multiplier, FY 1997-1998
The above table (Table 3) shows the history of Darden’s Leverage Ratios. From FY 1997 to FY 1998, Darden shed 6% in assets, while sales only dropped by 1%. As will be seen in the next section, this also affected several other ratios. However, in this section, the only relevance is the fact that this caused the equity multiplier to increase by 7. 1% from FY 1997 to FY 1998. The three components of equity: Efficiency, Turnover, and Leverage (Equity Multiplier) have all been analyzed individually. On an individual basis, Darden Restaurants has shown improvement in all three of these areas.
As a result, we expected to see a great deal of improvement in the return on equity from Fiscal Year 1997 to Fiscal Year 1998. While it is possible to use each individual element (efficiency, leverage, and equity multiplier) Figure 5: Return on Equity Equation of the return on equity equation to determine the return of equity, we chose to use the abbreviated equation (Figure 5) which consists solely of net income divided by equity. The resulting number, 9. 971%, reflects that for every one dollar of stockholders equity, the company netted a 9. 971-cent profit.
However, as we also had made a prediction that FY 1998’s return on equity would be an improvement over FY 1997’s. Upon comparison in Table 4, it is shown that in fact, Darden’s | |FY 1998 |FY 1997 |FY 1996 | |Net Income |$101. 7 | $ 54. 3 | $119. 2 | |Equity |$1,020 | $1,081 | $1,223 | |Return on Equity | 0. 0997 | 0. 0502 | 0. 0975 | Table 4: Darden’s Return on Equity FY 1996-1998 nearly doubled.
Furthermore, in fiscal year 1996, a more profitable year for Darden than fiscal year 1997, return on equity was still below the level in 1998. This improvement is a direct result of the tactics used by Darden management to improve each of the above components. And, while each of the individual equations improved, more importantly, Return on Equity improved, thus Darden Restaurants effectively made better use of their stockholders money. Use of Leverage The term leverage refers to the extent to which Darden Restaurants, Inc. employs debt to finance its operations. The more debt employed by Darden, the more highly leveraged they are said to be.
The four ratios we used to examine the extent to which Darden uses leverage were the debt ratio, long-term current ratio, debt to total assets ratio, and the debt equity ratio. The debt ratio measures the relationship between total assets and the amount of debt used to finance those assets. Figure 6: Total Debt to Total Assets Equation This number illustrates that approximately 48. 62% of Darden’s assets are leveraged through the use of some sort of debt. While this is not a negative relationship, it is worth noting that this debt ratio is in fact an increase from the debt ratio at the end of FY 1997.
This is almost entirely attributable to substantial increases in short-term debt. For example, from end of FY 1997 to end of FY 1998, Darden increased their accounts payable, short-term debt, and accrued payroll by over 15% each! This, when combined with other smaller increased in short-term liabilities resulted in a 16. 25% increase in current liabilities. Table 5: Darden’s Total Liabilities to Total Assets Ratio, FY 1997-FY 1998 A more effective ratio to examine a direction that Darden is taking with their leverage is the Current Ratio. The current ratio is the ratio of current assets to current liabilities.
Figure 7: Current Ratio Equation This number shows that for every dollar of current liabilities, the company only has 71. 16 cents of assets to help pay for it. As a group, we feel this a poor number, as the company has current liabilities beyond what the company has in current assets. Table 6: Darden’s Current Ratio, FY 1997-1998 This number is more reflective of the changes in Darden’s leverage. When one looks at the history of the current ratio, it is apparent that there is an increase from FY 1997. While there was a substantial increase in current liabilities, there was some increase in current assets as well.
However, this is a result of higher inventory levels. After studying these two numbers, we felt the best way to get a good idea of the leverage position of Darden was to examine the three ratios, Total Debt to Total Assets, Current Ratio, and Quick Ratio (Current Assets less Inventory). This table makes it more apparent that Darden is quickly beginning to fail the “acid test. ” The Table 7: Darden’s Leverage Ratios, FY 1997-1998 quick ratio is dropped drastically when compared to the current ration. Again, this is the result of nearly 40% increase in inventories, the least liquid of the current assets.
Total debt is all debt owed by the company, short term and long term. However, there is a substantial difference between the short-term debt of accounts payable and the long-term debt of commercial paper. In the same way, there are differences in how a company views their leverage through all debt, and through merely long-term debt. The long-term debt to total assets ratio measures the percentage of total assets that is financed by long-term debt. Figure 8: Long-Term Debt to Total Assets Equation This means that around twenty cents of every dollar in assets is financed with leverage. The remainder is financed through equity.
This number has not changed very much since the end of Table 8: Long-Term Debt to Assets Ratio, FY 1997-1998 Fiscal Year 1997. This can be attributed to minimal changes in assets and in long-term liabilities. As just mentioned, the remainder of the assets owned by Darden that are not financed through debt are financed through equity. The debt-equity ratio measures the relationship between capital supplied by the lenders (Darden’s debt) and capital supplied by stockholders (equity). Figure 9: Total Debt to Equity Equation This equation shows us that Darden for every dollar of stockholder equity, Darden is leveraged for ninety-four cents.
We determined that this was an acceptable level based on the strong performance of Darden stock in the past. As reflected in Table 9, this number has changed drastically for Darden in the past two years. This is a result of the increased short-term debt, while experiencing a minimal increase in Stockholders Equity. Table 9: Debt to Equity Ratio, FY 1997-1998 While it is apparent that Darden is able to handle its debt, the dramatic increases in some areas left us a bit concerned as to the stability of Darden Restaurants into the future.
Without responsible use of debt, investors are going to be weary of Darden commercial paper, and the longevity of Darden stock. Investment Decision Techniques Obviously, with the development of a third concept (Bahama Breezes), Darden Restaurants is encountering a great deal of investment decisions right now. It is important that the proper decisions be made to justify the opening of a new property or the development of a new concept. However, DRI also has the recent failure of China Coast in 1995, and in Fiscal Year 1998, DRI closed almost 50 Red Lobster and Olive Garden properties.
These actions underline the need to have a grasp on the goings-on in your business so as to know when to pull the plug on a failing portion of the business. Darden Restaurants, Inc. is divided into three divisions: Red Lobster, The Olive Garden, and Bahama Breezes. Bahama Breezes is structured differently from The Olive Garden and Red Lobster. This is a result of CEO Joe Lee’s desire to have controlled, structured growth of this division in order to avoid a fiasco similar to the China Coast in 1995. However, the investment decisions of Red Lobster and The Olive Garden are similar.
Each of these two divisions is set up into districts similar to most any restaurant chain. At the top of each district is a senior financial officer, this officer is responsible for taking individual store profit and loss statements and compiling them into one master profit and loss for the district. This information is then compiled to provide the profit and loss statements for the entire division, and then the corporation. The decision to make a store closure is decided at the division level, and not by the senior financial officer at the district level.
All investment, capital, and leverage decisions are made at the division level, though, as it is our understanding, must be approved at the corporate level. A significant investment that we noticed on the balance sheet was a $66. 9 million loan to the Employee Stock Options Program (ESOP). This loan was made in FY 1997 to assist the ESOP in refinancing an original loan used to purchase stock for distribution to employees. The loan was refinanced through a loan to Darden Restaurants from a third-party commercial bank, and then a corresponding loan to the ESOP.
The loan is paid off to Darden from ESOP through employee contributions and dividends on stock held through the plan. As these monies are received to ESOP, they are used immediately to pay off principal to Darden. The ESOP currently holds 12. 5 million shares of Darden. This loan was merely made to benefit the ESOP, and while it generates revenue through interest payments, these payments are equal to the interest due to a commercial bank on the original loan to Darden. Another crucial investing decision made by Darden Restaurants occurred in January, 1996.
At this time, Darden issued $250,000 worth of commercial paper with $150,000 due in 2006, and $100,000 due in 2016. This issuance of commercial paper was made in order to pay off other commercial paper borrowings and take advantage of new interest rates. This buyout cost the company $200,000, however, we were unable to determine the interest savings achieved through the refinancing. Currently, Darden does not issue preferred stock, however, over the past three years, Darden has issued nearly 600 shares of restricted stock.
However, we were unable to find the rights, and investment benefits of holding said stock. Darden is authorized to issue up to 25,000 shares of preferred stock, however, there are currently none outstanding. The company does hold approximately 27,500 shares of common stock. Stockholders equity has remained fairly constant over the past three years at approximately one million dollars. Strategic Planning Appropriately, this section is the final section of the analysis. With the rest of the project complete, it is logical to flip back and review our analysis of the current position on of Darden Restaurants.
The conclusions we have reached, when combined with the background information provided with the annual report should enable us to share some insight into the strategic plan of Darden. With the closure of some of its properties in Fiscal Year 1998, it is obvious that Darden is refocusing on quality, not quantity in their two largest brands. However, Bahama Breezes is a rising star, not only in Darden, but also in the restaurant industry. Bahama Breezes was recently heralded in Nation’s Restaurant News as a force to be reckoned with now that nationwide expansion plans are underway.
With lessons learned from the failure of China Coast, Darden is gearing up to begin full-scale development of this concept. Darden’s current plans for major growth rest almost entirely on the shoulders of Bahama Breezes. In Fiscal Year 1998, Red Lobster and The Olive Garden both encountered sales increases, but, they were a result of same-store sales increases. In the same way, income increases experienced by Darden were not the result of new store openings, but rather, refinements, of existing concepts and properties. Darden calls this strategy “brilliant with the basics. This is the guiding strategy as Darden strives to improve performance standards throughout all divisions. Just as they attempt to raise the bar to a level that will make them the envy of the full-service restaurant industry, they are aware of the expenses that will accompany this. That is why Darden is developing new continuing education programs. Darden is also improving benefits and quality of life for management in order to lower turnover and maximize their investment. While the future of the restaurant industry may lie with concepts such as Bahama Breezes, that is the long-term future.
The short-term and the present stature of Darden Restaurants will continue to lie in the hands of the chain that started it all, Red Lobster, and the chain that set the standard for the rest of the industry, The Olive Garden. And, judging from the commitment Darden is making to this investment, it would appear that this suits them just fine.