Key takeaways from Barington Group's 84-page Darden proposal

Part 3

Darden’s poor margins show divergence from management’s expectation

EBITDAR margin

Another key metric that Barington Capital Group showed was EBITDAR (earnings before interest, tax, depreciation, amortization, and rent). This is a key ratio that restaurant analysts often look at because it ignore differences in companies’ real estate holdings, which allows a fairer comparison of the restaurant’s “core business.”

EBITDAR marginEnlarge Graph

Economies of scale and scope

Basic economics tells us that as a company becomes larger, some economies of scale should be attainable: as the number of products sold increases, the fixed cost can be covered over a larger volume, which tends to be positive for earnings. A similar concept is economies of scope—when a company receives cost benefits from selling more than one type of product (brands). Despite Darden being almost twice as large as its next biggest peer, Barington’s page 24 shows that  Darden’s last 12 months of EBITDAR margin of 13.4% is lower than its combined peer average of 16.1%.

Not operating efficiently or no benefit?

This makes investors question whether Darden is operating efficiently or whether there’s really any benefit from a cost standpoint of having a larger number of units. JP Morgan’s October 8 research report highlighted, “Darden is well known in the industry for its well-fed infrastructure including its [$152] million state-of-the-art corporate HQ opened 2009.”

Declining EBITDAR marginEnlarge Graph

Since 2004, Barington notes that Darden’s EBITDAR margin hasn’t improved significantly after it started acquiring several brands. This contrasts with a period of strong organic growth before 2004, when margins grew from 10.6% to 14.0%.

Failure to Capture Economies of ScaleEnlarge Graph

Limited synergies and benefits

A further breakdown of Darden’s costs shows that the company hasn’t been able to deliver much of the promised synergy that management spoke of when it started its portfolio expansion in 2007. Labor and benefits costs aren’t likely to achieve economies of scale or scope because these costs tend to be more variable on the number of restaurants opening and customers.

As it grows bigger and makes larger purchases, Darden could benefit from some discounts on food and beverages. Yet the cost of sales, which includes food and beverage expenses, didn’t show much improvement. SG&A (selling, general, and administrative expenses), the one place most likely to achieve economies of scale or scope (take Apple as an example) even rose during the portfolio acquisition stage. In Barington’s view, and to several investors and analysts out there, synergy is limited.

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