Darden Restaurants wants to set Red Lobster adrift.
The company said Thursday that it is looking to either spin off or sell Red Lobster as part of its plan to boost value for its shareholders. Those plans also include suspending the opening of new Olive Garden locations and limiting the launch of new LongHorn Steakhouse restaurants. Darden Restaurants Inc. also won't make any acquisitions of additional brands "for the foreseeable future" and will review senior management's compensation and incentive programs to put greater emphasis on same-store restaurant sales growth and free cash flow.
Its stock fell about 4 percent to close at $51.02 Thursday.
Red Lobster has 705 restaurants in the U.S. and Canada and is the biggest full service dining seafood specialty restaurant operator in North America. Its fiscal 2013 sales were about $2.6 billion. Restaurant chains such as Olive Garden and Red Lobster have suffered since the downturn, with customers being more careful about their spending. People are also increasingly heading to chains such as Chipotle, where food tends to cost less and the experience takes less time than a sit-down meal at a restaurant.
Darden Chairman and CEO Clarence Otis said during a conference call on Thursday that Red Lobster has been unable to capture high-income customers as much as its other brands have. A separation will give Red Lobster the opportunity to focus more on its core audience. He also said changing market conditions prompted action, noting the "relatively low levels of consumer demand in each of the past several years for restaurants generally, and for casual dining in particular, as well as additional unexpected softness since June." Otis added that the company has been considering its options for Red Lobster for some time and shareholders wanted changes.
In September investment firm Barington Capital LP, which represents a group that owns more than 2 percent of Darden's stock, recommended that Darden consider splitting into two separate companies, with one company housing Olive Garden and Red Lobster and the other its remaining brands. Barington made the contents of the proposal public in October.
Darden anticipates that after separating from Red Lobster it will be able to report higher and more consistent same-restaurant sales, new restaurant sales growth and increased and more consistent earnings per share growth. It expects to use proceeds from new debt raised by the spun-off Red Lobster to retire part of Darden's debt. Darden expects that after the separation, Red Lobster will likely report low single-digit revenue growth driven by modestly higher same-restaurant sales.
The company said that its cost-cutting efforts will bring about at least $60 million in annual savings starting in fiscal 2015. This is up from the $50 million in savings it previously predicted. Darden said it will use the increased cash flow from lowering capital spending and operating support expenses for dividends, stock buybacks and to help strengthen its credit profile.
The planned Red Lobster separation and other potential actions are a step in the right direction, but may result in only modest changes in performance, said Sara Senatore of Bernstein Research in a client note. She reaffirmed a "Market Perform" rating. Sterne, Agee & Leach's Lynne Collier is encouraged by the Red Lobster plans, however, saying the brand has been a drag on Darden's performance for the past several years. The analyst kept a "Buy" rating for Darden.
Standard & Poor's Ratings Services said Thursday that it is reviewing Darden's ratings. The rating agency said that it will evaluate the financial impact of the transaction and financing details during the review process.
Darden named Kim Lopdrup, president of its specialty restaurant group and new business, to serve as Red Lobster's CEO after the separation. Harald Herrmann, president of Yard House, will become president of the specialty restaurant group in January. Red Lobster President Salli Setta will remain in that position. If Red Lobster is spun off, Darden Chief Financial Officer Brad Richmond will become chief financial and administrative officer for Red Lobster once the transaction is complete. Darden said it's started the process of identifying its board and a possible successor for Richmond.
Darden also announced Thursday that its second-quarter net income fell to $19.8 million, or 15 cents per share, from $33.6 million, or 26 cents per share, a year earlier. Excluding severance costs and other items, earnings were 20 cents per share. Revenue rose to $2.05 billion from $1.96 billion.
Analysts polled by FactSet predicted earnings of 20 cents per share on slightly higher revenue of $2.07 billion.
It lowered its forecast for 2014 profit and revenue. The company now foresees fiscal 2014 earnings per share falling 15 percent to 20 percent year-over-year, versus a prior estimate for a 3 percent to 5 percent decline. Revenue is now expected to climb just 4 percent to 5 percent versus a prior guidance for a 6 percent to 8 percent increase.
The planned Red Lobster spinoff still needs final approval from Darden's board. It does not require a shareholder vote. The company expects any possible separation to close in early fiscal 2015.