Cheddar's value reputation, restaurant layout, and target audience complement the company's existing portfolio.
While no-moat Darden
's third-quarter update had a familiar feel--guest experience and takeout enhancements at Olive Garden helped drive consolidated comps of 0.9% (outpacing industry averages by 5 points) while adjusted operating margins came in at a respectable 12.2% (down 10 basis points but affected by the timing of certain marketing/preopening costs and an uptick in utilities costs)--the more interesting development consisted of plans to add Cheddar's to its brand portfolio.
R.J. Hottovy, CFA, is a consumer strategist for Morningstar.
Darden plans to purchase Cheddar's--a 165-unit American "made from scratch" casual-dining concept in 28 states--from L Catterton and Oak Investment Partners for $780 million (10.4 times trailing 12-month EBITDA). The transaction will be funded by new debt (leaving it with a reasonable adjusted debt/EBITDAR ratio of 2.3 times) and expected to close in the upcoming quarter. The deal is expected to be accretive to 2018 EPS by $0.12 and 2019 EPS by $0.20-$0.25, excluding acquisition/integration expenses. We don't find the announcement terribly surprising, as there had been market rumors that Darden was looking to add to its brand portfolio. Moreover, we believe Cheddar's value reputation, restaurant layout, and target audience complement Darden's existing portfolio and offer customer data/menu construction synergies, improved bargaining clout with suppliers and landlords, and other cost-reduction opportunities.
Factoring in the acquisition and expected synergies, we plan to add roughly $6 to our $68 fair value estimate, implying the market is appropriately valuing Darden. With three quarters of the year in the books, we find the updated full-year 2017 outlook--sales growth of 2.3%, comps of 1.5%, and EPS of $3.95-$4.00--realistic. With Cheddar's in tow, we have greater conviction in our five-year forecasts calling for mid-single-digit top-line growth and operating margins pushing 11%, with wage increases/tax law changes across the U.S. helping to offset persistent category competition.
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