(This is a correction of a release originally issued June 26, 2013. It
clarifies that Darden's 7.125% 2016 and 6% 2035 notes do not include
change of control provisions.)
Fitch Ratings has affirmed the ratings of Darden Restaurants, Inc.
(Darden; NYSE:DRI) as follows:
--Long-term Issuer Default Rating (IDR) at 'BBB';
--Bank credit facilities at 'BBB';
--Senior unsecured notes at 'BBB';
--Short-term IDR at 'F2';
--Commercial Paper (CP) at 'F2'.
The Rating Outlook is Negative.
At May 26, 2013 Darden had approximately $2.7 billion of total debt.
KEY RATING DRIVERS:
Darden's ratings reflect its moderate leverage, substantial operating
cash flow, and the diversification provided by its portfolio of leading
restaurant chains. At the fiscal year ended May 26, 2013, Darden had
2,138 mainly U.S.-based company-operated units. Olive Garden, Red
Lobster, and LongHorn Steakhouse (LongHorn) represented 92% of these
units while the remaining 8% consisted of the firm's Specialty
Restaurant Group (SRG), which includes The Capital Grille, Yard House,
Bahama Breeze, Seasons 52, and Eddie V's.
The Negative Outlook is due to the fact that Darden's leverage is high
for current ratings and the firm's weak but improving free cash flow
(FCF - defined as operating cash flow less capital expenditures and
dividends). Additionally, same-restaurant sales (SRS) were negative and
margins deteriorated considerably in fiscal 2013 while at the same time
Darden continued to increase its dividend. Darden has doubled its annual
dividend since 2010 to about $290 million for fiscal 2014. Fitch views
the firm's current payout as aggressive.
At May 26, 2013, total debt-to-operating EBITDA was 2.5x and total
adjusted debt-to-operating EBITDAR (defined as total debt plus 8 times
(x) gross rent to operating EBITDA plus gross rent) was approximately
3.2x. For the comparable period last year, these ratios were 1.9x and
2.6x, respectively. Cash flow from operations for the latest fiscal year
totaled $950 million, growing at a 4% compound annual growth since 2008.
FCF improved to $5.7 million, after being negative $101.4 million in
fiscal 2012. Darden's cash flow priorities include investing in its
business, paying a competitive dividend, and reducing debt.
Darden's Outlook could be revised to Stable with several quarters of
better SRS results, evidence of stabilizing margins, and further
improvements in FCF. Fitch projects that total adjusted
debt-to-operating EBITDAR can approximate 3.0x in fiscal 2014 and 2.8x
in fiscal 2015. Drivers include low single-digit SRS and mid-single
digit EBITDA growth. Fitch anticipates FCF of at least $100 million
annually beginning in fiscal 2014.
Darden's ratings and Outlook consider the competitiveness and economic
sensitivity of the U.S. restaurant industry. These external factors are
balanced against the strong brand awareness enjoyed by Darden's chains
and the fact that Darden's restaurant margin remains among the highest
in the casual dining industry at over 17.6% for the fiscal year ended
May 26, 2013. Management's historical ability to grow traffic and
outperform the broader industry is also a consideration.
Financial Policies
Fitch views Darden's financial strategy as the biggest driver of the
firm's credit profile. Total debt increased to $2.7 billion at May 26,
2013 from $1.7 billion at the end of fiscal 2010 to help finance share
repurchases and the acquisition of Yard House, Inc. In addition to
aggressively increasing dividends, as mentioned earlier, annual capital
expenditures rose 59% to $686 million over the past three years. Over
50% of this spending has been for new unit development.
In order to improve its leverage ratios, Darden has pulled back on
capital expenditures, with $600 million - $650 million projected for
fiscal 2014, and plans to use excess cash for debt reduction in lieu of
share repurchases. The firm's target rent-adjusted leverage range is
2.0x - 2.5x based on 6.25x minimum rents. Fitch believes Darden leverage
can approximate the top end of this range by the end of fiscal 2015 via
a combination of cash flow growth and debt reduction.
Same-Restaurant Sales and Margins
During the fourth quarter ended May 26, 2013, blended SRS at Olive
Garden, Red Lobster, and LongHorn grew 2.2%, after being negative for
four consecutive quarters. SRS at each of these core brands was positive
in the latest quarter with traffic increasing 3.2% on a blended basis.
Darden remains focused on driving traffic as it continues to emphasize
menu affordability, maintain the quality of its food, and refine the
guest experience.
Fiscal 2014 guidance, which Fitch views as achievable, includes blended
SRS of 0% to +2% for Darden's three primary brands. Operating income is
expected to be negatively affected by accruing annual management
incentives at a normal level in 2014, costs associated with
implementation of the Affordable Care Act, and approximately 2% to 2.5%
of net food cost inflation. Margin pressure is projected to continue in
fiscal 2014 but at a slower rate versus fiscal 2013 due mainly to
improved SRS and more effective promotional activity.
Liquidity, Maturities and Financial Covenants
At May 26, 2013, Darden had $88.2 million of cash and an undrawn $750
million revolver. The revolving facility, which serves as backup to the
company's commercial paper program, expires Oct. 3, 2016. Significant
maturities over the next three fiscal years are limited to $100 million
of 7.125% senior unsecured notes due Feb. 1, 2016 and modest term loan
amortization payments. Darden's $300 million term loan amortizes
annually at 5% of principal or $15 million beginning in August 2014
until maturity on Aug. 22, 2017.
Darden's revolver, term loan, 3.79% senior notes due Aug. 28, 2019, and
4.52% senior notes due Aug. 28, 2024 subject the firm to a maximum
consolidated lease adjusted total debt to capitalization ratio of 0.75
to 1.00. Darden has remained in compliance with this covenant. At May
26, 2013, the ratio was 65%. All of Darden's publicly traded notes,
excluding the 7.125% 2016 and 6% 2035 notes, include change of control
provisions while the firm's 6.2% senior notes due Oct. 15, 2017 and 6.8%
notes due Oct. 15, 2037 are subject to coupon step ups if ratings fall
below investment grade.
Rating Sensitivities:
Future developments that may individually or collectively lead to a
positive rating action include:
--Darden's Outlook could be revised to Stable after several quarters of
improved SRS performance, evidence of stabilizing margins, improving
FCF, and a bias towards debt reduction over share repurchases;
--An upgrade of Darden's IDRs is not anticipated in the
near-to-intermediate term.
Future developments that may individually or collectively lead to a
negative rating action include:
--A material decline in operating cash flow due to persistent SRS
declines or significant additional margin contraction;
--FCF that is significantly below Fitch's expectations;
--A continued increase in total adjusted debt-to-operating EBITDA; such
that total adjusted debt-to-operating EBITDA is materially above 3.0x
for a prolonged period.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Short-Term Ratings Criteria for Non-Financial Corporates' (April 2,
2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460
Short-Term Ratings Criteria for Non-Financial Corporates
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685553
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