Financial Analysis of Darden Restaurants

Abstract

The financial statements of Darden International, Inc. restaurants were examined, in the context of individualized and standardized statements. Common-sized statements of past performance revealed improved financials in 2009. Financial ratios show evidence that Darden has strengthened in the most current fiscal year. In contrast, however, benchmarked analyses illustrate Darden's weaknesses compared to the competition. Together, these findings suggest that Darden Restaurants Inc. only conservatively possesses the financial strength and stability to be considered for investment.

Financial Analysis of Darden Restaurants, Inc.

Darden Restaurants, Inc. is the world's largest full-service restaurant company, operating 1,773 restaurants as of May 31, 2009 in the United States and Canada, to include subsidiaries such as Red Lobster, Olive Garden, LongHorn Steakhouse, and five lesser-known restaurants. The firm was originally incorporated in 1968 as Red Lobster Inns of America, Inc, was acquired by General Mills in 1970, and became a separately publicly held company in 1995 when it was incorporated as Darden Restaurants, Inc. as the parent company of GMRI, Inc. and other subsidiaries. In 2007, Darden acquired RARE Hospitality International, Inc. and its LongHorn Steakhouse chain.

Darden's direct competitors in the full-service restaurant industry include Brinker International Inc. who owns, operates, or franchises 1,689 restaurants including Chili's Grill & Bar, On The Border Mexican Grill & Cantina, and Maggiano's Little Italy. DineEquity, Inc., another strong competitor, operates 3,400 restaurants under the names Applebee's Neighborhood Grill and Bar and International House of Pancakes. YahooFinance ranked Darden as third strongest leader in market capitalization in the restaurant industry, with Brinker falling in seventh (it is important to recognized that seven of the ten listed are considered fast food, instead of full-service restaurants). The restaurant industry is extremely competitive and is very sensitive to the type and quality of food, location, personnel, price, service, attractiveness of facilities, and effectiveness of advertising and marketing, consumer tastes, economic conditions, and many other conditions that can be both controlled and out of the control of the individual company.

Method

In order to gain a better understanding of the financial strengths and weaknesses of Darden, their 10-K and financial statements were examined. An analysis of the statements from fiscal years 2006-2009 was necessary to give an accurate representation of their status. It is also important to standardize the statements in order to get a better understanding of their meanings. For this, common-size standardization was used to convert dollars to percentages. Total assets will be the denominator for the balance sheet, total sales as the denominator on the income statement, and net income on the statement of cash flows (Ross et al., 2008).

Also, two other companies were chosen to benchmark against Darden, in order to compare financials and get a better understanding of industry standards. For this portion, Brinker and DineEquity were chosen as benchmark firms because of the size of their company and level of their sales. They were also chosen because of the nature of their business as a full-service restaurant who's costs and business strategies would be more similar to Darden than that of fast food chains, specialty dining facilities, etc.

A series of financial ratios were then computed to determine short-term solvency, long-term solvency, asset management, and profitability. A careful Du Pont Analysis was used to reveal information about the firm's return on equity.

Lastly, a sales trend analysis of the past four fiscal years was created in order to complete a projection for the upcoming year. The percentage of sales method was used to obtain trend information for sales and net income. This information in conjunction with a simplified income statement for 2009 was used to create a pro forma income statement that projects 2010's sales, costs, and net income.

Results

Careful examination of the 2006-2009 financial statements reveals a number of very important things. Darden's financial strength held stable through 2006, took a sharp decline in 2007, and has been steadily increasing since then. This is the result of a substantial number of discontinued operations in which the firm incurred non-cash impairment charges and other costs that was reported on the income statement and accompanying financials. This needs to be kept in mind when reviewing the reports.

The balance sheet reveals some positive information about the firm. First, it is important to note that Darden's assets are increasing at a faster rate than their liabilities. In fact, current liabilities are decreasing when compared to total assets. Owner's equity is increasing, as is necessary to maintain balance in the situation when assets are increasing more than liabilities. This speaks strongly on the firm's growth. The income statement also reveals some key points. Sales are increasing at a steady rate, while costs of goods sold is remaining stable at around 77-78%. Net income is increasing at a decreasing rate. This is partially the result of interest expenses increasing more than double its original amount. The statement of cash flow shows extreme fluctuations in net cash from investment and financing activities, while cash from operating activities in 2009 increased almost 15% from the previous year. Overall, while the financial statements are soft, they do show growth in the firm.

The careful comparison of our two benchmark firms, DineEquity and Brinker reveals a less optimistic view of Darden Restaurants, Inc. While all of the financial statements contain immensely larger numbers than our benchmark companies, the common-size evaluation shows some weaknesses compared to the other firms. To begin, their current assets to total assets is significantly less, with Darden at 11% and Brinker at almost 19%, while their current liabilities are much higher, with Darden at almost 22% and DineEquity at only 6%. This reflects a liquidity issue. And while their annual sales are double that of Brinker and almost 22 times that if DineEquity, their cost of goods sold as a percentage of sales is 10% higher. This reveals some possible cost control issues. Darden's cash from operating activities as shown in the cash flow statement is significantly smaller than the other firms. This analysis can be concluded with the assumption that Darden