Fitch Affirms Darden's IDRs at 'BBB/F2'; Outlook Negative

Wed Jun 26, 2013 2:38pm EDT

(The following statement was released by the rating agency) CHICAGO, June 26 (Fitch) 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 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. Contact: Primary Analyst Carla Norfleet Taylor, CFA Director +1-312-368-3195 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst William Densmore Senior Director +1-312-368-3125 Committee Chairperson Wesley E. Moultrie II, CPA Managing Director +1-312-368-3186 Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: brian.bertsch@fitchratings.com. 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 here Short-Term Ratings Criteria for Non-Financial Corporates here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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