Fitch Ratings has affirmed Darden Restaurants, Inc.'s (Darden; NYSE:DRI)
ratings and removed the ratings from Rating Watch Negative. Ratings are
as follows:
--Long-term Issuer Default Rating (IDR) at 'BBB-';
--Bank credit facilities at 'BBB-';
--Senior unsecured notes at 'BBB-';
--Short-term IDR at 'F3';
--Commercial Paper (CP) at 'F3'.
The Rating Outlook is Stable. At Feb. 23, 2014, Darden had approximately
$2.7 billion of total debt.
The action follows Darden's announcement that it has signed a definitive
agreement to sell Red Lobster for $2.1 billion or about 9x the brand's
latest 12-month (LTM) EBITDA at April 27, 2014. At Nov. 24, 2013, Red
Lobster had 705 units that generated roughly $2.6 billion of sales.
Darden expects net after-tax and transaction cost proceeds to be an
estimated $1.6 billion, of which approximately $1 billion will be used
for debt reduction and the remainder for share repurchases. Fitch views
the probability of completion as high because the transaction has been
approved by Darden's Board of Directors and the buyer has committed
financing. The transaction is expected to close during the first quarter
of fiscal 2015 or by the end of August 2014.
KEY RATING DRIVERS
Leverage and FCF
The affirmation and Stable Outlook reflect reduced uncertainty regarding
the separation of Red Lobster and the significant amount of targeted
debt reduction while considering negative same-restaurant sales (SRS)
trends at Olive Garden. Should SRS not improve meaningfully by the
second half of fiscal 2015, or the end of calendar 2014, the Ratings
Outlook will be revised to Negative. The rating action also incorporates
Fitch's expectation that total adjusted debt-to-operating EBITDAR
(rent-adjusted leverage) will be in the low-3.0x range and that free
cash flow (FCF) will approximate $100 million within one year of the
transaction. For the LTM period ended Feb. 23, 2014, rent-adjusted
leverage was 3.5x and FCF was negative $26 million.
Pro forma total debt and EBITDA, adjusted for stock-based compensation
expense and one-time charges, are approximately $1.7 billion and more
than $750 million, respectively. Pro forma rent-adjusted leverage is in
the low 3.0x range, after excluding roughly $35 million of rent expense
associated with Red Lobster's operating leases. Pro forma leverage does
not incorporate the full $60 million or more of annualized general and
administrative related cost savings Darden is on track to realize by the
end of 2015.
Darden's FCF will continue to be pressured by the firm's aggressive
dividend policy unless operating earnings growth resumes. However, capex
will be meaningfully lower absent Red Lobster and Darden plans to
curtail new unit development at Olive Garden and slow expansion at Long
Horn Steakhouse (LongHorn). Fitch also views plans to align executive
compensation to SRS and FCF favorably.
Performance at Olive Garden
Fitch expects the separation of Red Lobster to lessen the volatility in
Darden's SRS performance and operating cash flow. Darden will also
continue to benefit from a portfolio of brands with Olive Garden
representing about 60% of the firm's roughly $6.2 billion of annual
sales and nearly 1,500 restaurants. At Feb. 23, 2014, Darden's unit
count included 836 Olive Gardens, 453 LongHorns, and 189 restaurants in
its Specialty Restaurant Group (SRG). SRG brands include The Capital
Grille, Bahama Breeze, Seasons 52, Eddie V's, and Yard House.
SRS at Olive Garden have been weak for three consecutive fiscal years.
SRS declined 1.2% in 2012, 1.5% in 2013, and are projected by Darden to
decline 4%-4.5% in the fiscal year ended May 2014 inclusive of the
negative impact of severe winter weather. In March 2014, Darden
announced a new plan to restore SRS growth at Olive Garden which Fitch
views as comprehensive.
The six-point Brand Renaissance Plan includes: 1)a focus on food quality
and the dining experience, 2) more efficient restaurant operations, 3) a
core menu plan incorporating value, variety, and convenience, 4) using a
variety of media and targeted promotions when advertising, 5) better
restaurant service, and 6) reimaging. Should SRS not meaningfully
improve by the end of calendar 2014 (as mentioned previously), progress
on cost savings initiatives stall, and margins continue to contract,
Darden's Ratings Outlook will be revised to Negative.
Liquidity, Maturities and Debt Terms
At Feb. 23, 2014, Darden had $127 million of cash and $569 million of
availability under its undrawn $750 million revolver. The facility,
which expires Oct. 3, 2016, serves as backup to Darden's commercial
paper program (CP). CP totaled $182 million at Feb. 23, 2014.
Significant near-term maturities are limited to $100 million of 7.125%
senior unsecured notes due Feb. 1, 2016. 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 has not indicated which
tranches of debt it will redeem but Fitch anticipates that the firm
might tender for its highest cost debt first. Tranches with the highest
coupons include $100 million 7.125% 2016 notes, $300 million 6.8% 2037
bonds, $500 million 6.2% 2017 notes, and $150 million 6% 2035 bonds.
Coupons on Darden's other issuances range from 3.35% to 4.52%.
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 Feb
23, 2014 the ratio was approximately 65%.
All of Darden's publicly traded notes, excluding the 7.125% 2016 and 6%
2035 notes, include change of control provisions and sales-leaseback
limitations. 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
negative rating action include:
--Total adjusted debt-to-operating EBITDAR sustained near or above 3.5x
due to materially lower than expected operating income or unexpected
debt-financed acquisitions or share repurchases;
--Continued SRS weakness at Olive Garden, such that trends do not turn
positive or show meaningful sustainable improvement by the end of
calendar 2014 or the second half of fiscal 2015;
--Material continued margin deterioration due to SRS weakness at Olive
Garden, traffic declines, and/or stalled progress with G&A cost
reductions;
--Negligible or negative FCF in fiscal 2015 due to weaker than expected
operating performance and/or an aggressive financial strategy related to
both dividends and capex.
Future developments that may individually or collectively lead to a
positive rating action, although not anticipated in the near term,
include:
--Total adjusted debt-to-operating EBITDAR maintained below 3.0x due to
operating income growth and/or debt reduction;
--Consistently positive SRS performance and traffic gains, particularly
at Olive Garden;
--Sustained annual FCF of more than $100 million with FCF margin to
sales in the low- to mid-single-digit range.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'2014 Outlook: U.S. Restaurants - Shareholder Demands to Rise, Even as
Market Share Battle and Cost Pressures Continue (December 2013);
--'Fitch Places Darden's Ratings on Negative Watch' (December 2013)
--'Fitch Downgrades Darden's IDRS to 'BBB-/F3'; Outlook Stable (October
2013);
--'Corporate Rating Methodology' (August 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent
and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139
2014 Outlook: U.S. Restaurants (Shareholder Demands to Rise, Even as
Market Share Battle and Cost Pressures Continue)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724335
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=830518
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