Why Darden Restaurants Lowered its Outlook

The restaurant chain sees a slightly tougher selling environment ahead.

The restaurant chain sees a slightly tougher selling environment ahead.

It hasn’t been long since Darden Restaurants ( DRI -1.96% ) stock was popular with investors seeking to bet on a strong growth rebound associated with the waning of the pandemic. The idea was that the owner of major national brands, including Olive Garden, would see a huge traffic rebound as consumers returned to their pre-pandemic eating habits.

Darden’s latest earnings report did show sharp sales gains compared to late 2020. However, that surge was tempered by several negative trends that are threatening the chain’s short-term sales and earnings outlook.

Let’s dive right in.

Sales are up

The growth picture was mixed through late February. On the positive side, Darden enjoyed stronger sales gains than management had predicted back in December, with revenue jumping 41% to $2.45 billion. Most investors were looking for more modest gains of about 30%. Darden’s December selling month was especially strong, management said, as customers flocked back into restaurants after nearly two years of eating mostly at home.

Friends eating at a restaurant.

Image source: Getty Images.

Yet those gains started to reverse with the rise of the omicron variant of the coronavirus, which reduced customer traffic and amplified staffing challenges in January.

Overall, then, Darden’s average weekly sales hardly improved compared to 2019, before the pandemic struck. “This was a quarter of stark contrasts,” CEO Gene Lee said in a press release .

Expense challenges

Wall Street was bracing for bad news on the earnings front, and it turns out that those worries were justified. Darden faced higher costs on food inputs, labor, transportation, and most other expenses. Those spikes were only partly offset by higher menu prices since the company sees low prices as a key competitive advantage.

This situation resulted in shrinking profit margins, with third-quarter restaurant-level earnings falling to $467 million compared to $469 million two years earlier. The profit picture won’t improve quickly, either, as inflation is running at about 6% right now for most of Darden’s expenses.

Looking ahead

Darden’s updated growth outlook translated into a slight downgrade to reflect the weaker start to the 2022 calendar year. Revenue should grow by 9% to 10% overall, compared to the mid-December forecast range of between 9% and 11%. Darden’s comparable-store sales forecast saw a similarly small reduction.

The company is now planning to open about 35 new stores this fiscal year, putting it at the low end of the range it issued a few months ago. And inflation is running slightly faster than executives forecast, too, at 6% compared to 5.5% back in December.

None of those challenges mean that the business is losing its edge in the restaurant industry. On the contrary, Darden is almost sure to set sales and earnings records this year.

But the growth rebound is a bit less dramatic than many investors were expecting, and profits are likely to be pressured at least through 2022 by rising food and labor costs.

The stock’s decline in the past year already seems to reflect that slight downgrade to the outlook. Darden’s returns are also boosted by a quickly growing dividend that today yields over 3%. As a result, income investors might consider adding this restaurant giant to their watchlists.

Read this article on Motley Fool

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