The eroding middle market
Darden’s core brands—Olive Garden, Red Lobster, and LongHorn Steakhouse—face a macro shift in an ever-widening spread in US average income. The graph below shows the difference in household income between the second highest 20% and the second lowest 20% income earnings. The difference is divided by the average income of the population’s mid 20% to account for fluctuations in household income. All data is adjusted for inflation—urban CPI.
An increase in spread means the income distribution is widening, which is what we’ve been seeing. This doesn’t mean households with below-median income didn’t see income gains. Rather, they were increasing slower than those who were earning above median. The US as a whole has seen income gain up to 2000, but since 2000, that has stalled, and there has been a slight decline since 2005, when adjusted for inflation.
If household income starts to grow again, then restaurants that serve the middle market could benefit. However, as long as the income distribution continues to widen, consumers will flock to eating affordable but decent food, or occasional expensive dishes. So most of the time, you can expect consumers to cook at home or trade down to fast casuals like Chipotle or Panera. When they do want to spend, they’ll likely spend on fine dining and well-differentiated restaurants rather than Olive Garden or Red Lobster.
Darden needs to lower its average check or go premium
This means Darden has to transform Olive Garden and Red Lobster to a lower-average-check-per-guest restaurant or higher, towards premium product offers—like it does with Season 52, Capital Grille, and Eddie V’s within its Specialty Group segment. The course that Darden takes will impact how the company should split (which we’ll discuss later on). In the meantime, which will likely bring Darden more success? With an average check of $20, Red Lobster brand could move up into upscale brands, like the Cheesecake Factory (CAKE). Olive Garden, however, only gets an average check per guest of $16. So it may be more appropriate to move away from the upscale full-service Bravo Cucina Italiana and Brio Tuscan Grille, held under Bravo Brio Restaurant Group Inc. (BBRG).
As we’ve seen in previous articles in this series, Olive Garden and Red Lobster’s guest count has been deteriorating. Without price reduction and promotions, investors likely would have seen guest count fall by a larger amount. It looks like management understands they have to use promotions to attract customers. Most customers head out for a casual dining experience when they feel like treating themselves or there’s a promotion going on. But these promotions and discounts are a temporary bandage, which isn’t enough—as we’ve seen in the first quarter of fiscal year 2014’s results.