Description

Thesis – Bigger, Faster, Stronger Post Covid. Margins, Market Share, M&A and Material Pent-Up Demand for Indoor Dining will result in multiple EPS revisions up for best in-class operator and 37% upside to $192/share on FY '23 (with capital allocation upside potential).

As the largest casual restaurant in the U.S., DRI’s pent-up demand and recovery for indoor dining is happening a lot sooner than expected. Consensus had DRI reaching flat comps by November and they just did a +5.7% OG comp on 3/21. This acceleration is 6 months faster than expected and with larger operating leverage, which will continue to push revenues, EBITDA and EPS higher than conservative street estimates in FY 21, FY 22 and FY 23

Price Target

FY ’23 EPS of $9.6/share* 20x P/E Multiple = $192/share + 2.6% dividend (37% upside w/dividend).

Consensus for FY 23 is at $7.87/share vs. my $9.60/share and our number assumes:

-          No incremental M&A even though DRI is focused on bolting on another $500-$1bn sales brand amongst the distressed restaurant chains out there

Darden Background:

DRI is the largest casual dining restaurant chain in the U.S with $8.5bn in sales (8.5% of the $100bn casual restaurant market as defined by management). The business spans across 8 unique brands with Olive Garden driving a significant majority of the value:

1)      Olive Garden – 874 units

2)      Longhorn – 528 units

3)      Cheddars – 170 units

4)      Yard House – 81 units

5)      Capital Grille – 60 units

6)      Sessions 52 – 43 units

7)      Bahama Breeze – 41 units

8)      Eddie V’s –25 units

Recent Company Trends

DRI reported sales in last week and outside of a new $500mm buyback authorization (not in consensus numbers), doubling of dividend (2.5% yield), and 3Q beat (-26% comp vs. -30% consensus, EBITDA of $236mm vs. $204mm and EPS of 98 cents vs. 71 cents consensus), all eyes were on the sharp turn from -25% comps in 3Q to positive +5.7% (week ending 3/21) vs. 2019. Consensus is at -LDD% negative for 4Q21.

The combination of the vaccine rollout (U.S. cases are down 80% from recent highs) coupled with stimulus and pent-up demand is driving DRI’s sales and margins higher than expected. As management alluded to on the earnings call, “sales are growing faster than costs can keep up.”

For the 4Q guide, DRI guided sales conservatively in-line with consensus (-11% comp) while EBITDA 22% above street ($345 to $360mm) and EPS 50% above consensus ($1.60 to $1.70) and I believe that this is conservative guidance that can be beatable forcing the street to come up over the next couple of quarters for the below reasons.

Catalysts

Near-term numbers too low ~ DRI just got back above pre-covid sales in the 3Q21.

Consensus had DRI doing it by the end of November this year. DRI comp’ed +5.6% in the 3Q off the back of vax roll-out, pent-up demand and stimulus. I estimate that DRI will continue to see strength and can comp positive in the 4Q and beat the EBITDA/EPS guidance provided above.

Out year numbers too low as well given pent--up demand for indoor dining, faster unit rollout (moving to 3%) and market share gain.

Post 3Q, consensus moved up to $9bn (from $8.8bn in sales) for FY 22 vs. $8.5bn in FY 2019 or 5.8% above. I believe this is conservative as I believe DRI can exceed $9.5bn given the following:

·      Unit Growth - 3%-unit growth translates into an incremental $300mm.

·      Market Share Gains ~ NRA as of Dec estimates that 17% of restaurants will close while DRI thinks it is closer to 10 to 15%.  The US casual dining segment is $100bn and DRI believes they can get more than their currently market share of 8.5%. Assuming 12.5% closures and DRI gets 10% of that, the incremental sales could be $1.25bn. DRI is the largest Casual diner in the U.S and over two years this could translate into $600mm+ of sales in FY 22.   

·     Pent-Up Demand ~ DRI and CAKE on their calls talked about the pent-up demand they were seeing as certain restaurants were at max capacity. When indoor opens up above the 50% on average for DRI, there will be an almost immediate uplift to sales. It is important to remember that the experience economy pre-covid was growing HSD vs. slight decline for goods. Given a 1.5-year lack of indoor dining, it is safe to assume that the core consumer for DRI could be willing to spend say 3% additional per year more on dining resulting in $255mm higher sales in FY.

Sum it up…FY ’22 Revenues shake out to $9.7bn if we take pre-covid sales and layer on the above 3 assumptions ($8.5bn + $300mm + $625mm + $255mm = $9.7bn vs. $9bn consensus ~8% above). 

When we roll this to FY 23, I assume comps of 6% plus 3% additional unit growth, which puts me at FY ’23 Sales of $10.6bn vs. $9.7bn consensus.

Higher Post-Covid Margin Structure 

DRI has already talked about 150bps of margin expansion at 90% of sales. We know on a full sales recovery that max EBITDA margin expansion could be close to 300bps. We need to assume that DRI reinvests some of this (higher wages, food inflation). Let’s say 200bps sticks on our $9.7bn in sales in FY 22.

FY 22 ~ Assuming 16.1% margin (14.1% pre-covid), we are at $1.56bn in EBITDA vs. $1.45bn consensus (7 above).

FY ’23 ~ DRI talks about continued margin expansion each year of at least 10bps (I’m at 25bps for FY ’23 ~ 16.35%), which puts EBITDA at $1.733bn vs. $1.57bn (10% above).

FCF Walk

Historically, 65% of EBITDA converted to FCF, but I believe that this is closer to 70% today improved working capital learnings from the pandemic and incremental sales coming from take-out that come with less capex ~ translates into a $1.1bn of FCF in FY 22 and $1.2bn in FY 23

Using the 130mm shares outstanding and reducing this by the buyback of $500mm for FY 22 (127mm) and FY 23 (second $500mm ~ 124mm shares), we get FY 22 FCF per share of $8.56/share and $9.60/share in FY ‘23

Price Target (37% upside to $192/share with upside on M&A & multiple expansion given 5x discount to Texas Roadhouse)  

 FY 23 (Aug ’23) ~ $9.60/share of FCF * 20x = $192/share = +32% upside

Dividend of 2.5% * 2 years = 5%

Total Return = 37% today for most likely the most near-term recovery trade in consumer discretionary 

Catalyst

Margins

Market Share gains

Pent up demand

Buyback

M&A