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Darden Gains More Than 20% Over a Year: More Room to Run?

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Darden Restaurants, Inc.’s (DRI - Free Report) effective sales-boosting initiatives and synergies from Cheddar’s acquisition put the company on growth trajectory. However, high costs related to restaurant operations and stiff competition remain major concerns.

Last month, the company reported better-than-expected results in the fourth quarter of fiscal 2018. Earnings and revenues not only surpassed analysts’ expectation but also grew 17.8% and 10.3%, respectively, from the year-ago quarter. The upside was driven by sales growth across every brand. Notably, the quarter marked the 15th consecutive earnings beat for the company.

Darden’s shares have rallied 23.3% in the past year, outpacing its industry’s collective growth of 1%. Earnings estimates for the current fiscal have also climbed 2.4% over the past month. This reflects ongoing optimism in the stock. Given management’s progress on improving core operating fundamentals, the stock is anticipated to keep performing well in the quarters ahead.

Positive Synergies to be Realized From Cheddar’s Integration

Darden’s acquisition of the small restaurant chain, Cheddar's Scratch Kitchen (Cheddar's) in April 2017 added an undisputed casual dining value to the company’s portfolio of differentiated brands. It also helped Darden to further enhance its scale. In the fiscal fourth quarter of 2018, total sales were favored by 8.1% growth from the integration of Cheddar’s into the other segment.

Apart from making significant progress with the integration of Cheddar’s, the company seems to gain more confidence of its outcome. In fiscal 2018, management realized roughly $10 million of cost synergies and expects to realize the same in the range of $22-$27 million by the end of fiscal 2019. Over the current fiscal, Darden plans to make significant non-guest facing changes that are expected to have an impact on restaurant-level execution. Moving forward, Darden expects Cheddar to bring in incredible opportunity for long-term growth. Given the brand is already delivering higher growth rate compared with Olive Garden, Darden expects Cheddar’s integration to add to the company’s overall growth.

High Costs & Intense Competition Hurt

Darden’s non-franchised model makes the company susceptible to increased expenses. Since all the restaurants are owned and operated by Darden, the company is solely responsible for the expenses of operating the business, instead of signing franchise agreements and putting the burden of costs onto the franchisee. Total operating costs and expenses increased 7.9% year over year in the fourth quarter to $1.9 billion. This was caused by an overall increase in food, beverage and marketing costs, as well as restaurant labor and expenses. As a result, operating margin in the quarter contracted 198 basis points (bps) on a year-over-year basis.

The retail restaurant space is highly competitive as numerous restaurant operators are adapting advanced and prudent strategies to increase their sales. Amid such stiff competition, Darden is missing out on international presence that other restaurant chains like McDonald's (MCD - Free Report) , Domino’s (DPZ - Free Report) and Yum! Brands (YUM - Free Report) are aggressively pursuing. We believe that the company needs to expand its presence beyond the United States in order to offset the impact of cut-throat competition in the saturated domestic market.

Currently, Darden carries a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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