On its face, it was a fine quarter for Darden Restaurants : The company posted a modest 3-cent earnings beat and revenues were a bit above estimates. But let’s dive deeper to reveal some concerns. The restaurant operator, whose brands include Olive Garden and The Capital Grille, just completed its fiscal year and reported its fourth-quarter results. Same-store sales in the quarter were solidly above estimates (up 11.7% versus up 9.2%, according to StreetAccount’s estimates). Those strong comps really helped propel the bottom-line beat — because margins were below estimates due to inflation pressures. Restaurant margin came in at 20.1% versus estimates of 21.8%, and that also put operating margin below consensus (13.0% versus estimates of 13.6%). Look for margin pressure as Darden’s new fiscal year starts. While the midpoints of sales and comps guidance are above consensus for the year, per-share earnings guidance of $7.40 to $8 is solidly below $8.11 consensus. So why the margin problem? Inflation looks to be coming to a head in the current quarter before moderating. On a call with analysts, chief financial officer Raj Vennam said, “We expect the commodities inflation rates to increase in the first quarter from the 12% we had in Q4 and then to moderate significantly, ending the year roughly flat.” The company has been raising menu prices to help offset inflation, but it’ll only push the limit so far. For this reason, price hikes aren’t covering all the inflation Darden is facing. Vennam elaborated on the call. “We’re choosing not to pass along all of our inflation to our guests. And for a couple of reasons, right? We don’t think all of this cost is permanent — for example, chicken, dairy and wheat, which are a significant portion of our basket, especially at Olive Garden, are highly — at a very high level right now,” he said. “We don’t believe that’s very sticky over the long term.” Darden hopes that by keeping prices in check, it’ll be at a competitive advantage if a recession comes along, and guests are more closely scrutinizing their spending. Customer bifurcation Investors also got some insights on the state of Darden’s guests. What’s noticeable is that there is a bit of a bifurcation happening with the consumer. In the fourth quarter, same-store sales at the more modestly priced Olive Garden were up 6.5% — below estimates. Higher-priced LongHorn Steakhouse comps were up 10.6% — nearly double estimates. The company’s fine dining segment (think Eddie V’s and The Capital Grille) saw comps soar 34.5% versus an estimated increase of 21.3%. The high-end customer is not hesitating to spend money. On the call, Darden CEO Rick Cardenas said, “Our data indicates that higher-end consumer hasn’t seen the same impact as consumers at the lower end of the spectrum.” He noted that lower-end consumers, especially at the more value-oriented Cheddar’s Scratch Kitchen, have “shown signs of check management… So the impact that inflation is having on that-lower end [consumer] is showing a little bit.” That echoes the sentiment Kroger’s CEO Rodney McMullen described last week. He discussed how the grocer has seen two types of customers emerging. “Many customers continue to shop premium products throughout the store, including Private Selection, Murray’s Cheese, and deluxe meal solutions,” he said. “For other customers, whose [budgets] are more directly impacted by food and fuel inflation, they are actively looking for ways to save.” Ultimately, the diverse portfolio of brands could help Darden endure an economic slowdown — particularly if the higher-end customer continues to spend. On the analysts’ call, Darden’s Cardenas said, “We would price our higher-end brands or more affluent consumer that can absorb some of that pricing and is a little less elastic than we would on the lower-end brands.”
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