Oct 1 - Fitch Ratings has assigned a 'BBB' rating to Darden Restaurants, Inc.'s
(Darden; NYSE: DRI) proposed $300 million senior unsecured notes due 2022. At Aug. 26, 2012, Darden had approximately $2.1 billion of total debt. The Rating Outlook is Negative.
Net proceeds from the issuance, which may be upsized, will be used for general corporate purposes, including toward the repayment of $350 million of 5.625% senior unsecured notes due Oct. 15, 2012. The proposed notes are being issued under Darden's indenture dated Jan. 1, 1996 and rank equally with the company's existing senior unsecured indebtedness.
Terms do not include financial covenants but contain a Change of Control Triggering Event provision. Upon the occurrence of both a change of control and ratings downgrades below investment grade, Darden is required, unless the company exercises its option to redeem the notes, to repurchase the notes at a price equal to 101% of the principal amount plus accrued and unpaid interest.
Rating Rationale and Negative Outlook: Darden's ratings reflect its significant operating cash flow, leading market share positions in the U.S. casual dining industry, and strong operating capabilities. Darden's cash flow from operations has averaged approximately $750 million annually since 2007 and its consolidated restaurant margin is among the highest in the casual dining industry at over 18% for the fiscal year ended May 27, 2012.
Essentially all of Darden's over 2,000 restaurants are in North America and are company-operated. Olive Garden, Red Lobster and LongHorn Steakhouse (LongHorn) are Darden's core restaurant chains comprising 94% of the firm's units. The Capital Grille, Bahama Breeze, Seasons 52, and Eddie V's are smaller niche brands in the firm's Specialty Restaurant Group (SRG), representing the remaining 6% of total units. On Aug. 29, 2012, Darden added Yard House USA, Inc. (Yard House) - a small upscale chain of 39 casual dining restaurants serving contemporary American cuisine and 130 plus taps of imported, craft, and specialty beer - to its SRG.
The Negative Outlook is due to the fact that Darden's rent-adjusted leverage, pro forma for its Aug. 29, 2012 acquisition of Yard House, is at the high end of the range acceptable for current ratings. Darden's leverage has also increased recently due to heightened share repurchases. Pro forma rent-adjusted leverage (defined as total debt plus 8 times gross rents-to-operating EBITDA plus gross rent) is approximately 3.0x. Furthermore, during the fiscal year ended May 27, 2012, Darden's FCF (defined as cash flow from operations less capital expenditures and dividends) was materially negative at $101.9 million. FCF during the latest twelve month period ended Aug. 26, 2012 improved to approximately $15 million but remains significantly lower than the firm's long-term historical annual average of $200 million.
Liquidity, Covenants, and Maturities: Darden's liquidity remains adequate. At Aug. 26, 2012, Darden had $51.5 million of cash and $495.8 million of availability under its undrawn $750 million revolver expiring Oct. 3, 2016. At Aug. 26, 2012, $245.7 million of commercial paper and $8.5 million of letters of credit were backed by the revolver. Darden's credit agreements subject the firm to a maximum consolidated lease adjusted total debt to total capitalization ratio of 0.75 to 1.00. As of Aug. 26, 2012, Darden was in compliance with this covenant. Following the repayment of the $350 million of 5.625% senior unsecured notes due Oct. 15, 2012, Darden has no other maturities until 2016.
Recent Operating Performance: During the first quarter ended Aug. 26, 2012, sales increased 4.8% to $2.0 billion and operating income increased 3.3% to $174.2 million. Net new unit development and blended same-restaurant sales (SRS) growth of 2.2% for The Capital Grille, Bahama Breeze, and Seasons 52 drove the sales increase. Blended SRS for Darden's core brands declined 0.3% as SRS grew 3.6% for LongHorn, were up 0.3% for Olive Garden, and declined 2.6% at Red Lobster. Operating profit benefited from lower food and beverage expenses as a percentage of sales at Olive Garden and Red Lobster and lower restaurant labor and other expenses as a percentage of sales at all three core brands. Over the next several quarters, Darden is implementing a phased introduction of core menu changes at Olive Garden and Red Lobster and has several initiatives to further differentiate LongHorn. Fitch views Darden's combined Olive Garden, Red Lobster, and LongHorn SRS guidance of approximately 1% to 2% as achievable because these changes should broaden the brands' appeal by providing consumers with more value and incremental menu variety. What Could Trigger A Rating Action Future developments that may, individually or collectively, lead to negative rating action include: --Rent-adjusted leverage consistently above 3.0x due to weaker than expected SRS and operating earnings; and/or --Multiple years of negative FCF due to weaker than expected operating cash flow, heightened capital spending, or large additional increases in the firm's dividend.
Darden's Rating Outlook could be revised to Stable if: --Rent-adjusted leverage is maintained in the 2.5x - 3.0x range due to operating income growth and/or debt reduction; and --Darden's FCF generation improves meaningfully due to growth in operating cash flow.
Fitch currently rates Darden's debt as follows: --Long-term Issuer Default Rating (IDR) 'BBB'; --Bank credit facility 'BBB'; --Senior unsecured debt 'BBB'; --Short-term IDR 'F2'; --Commercial paper 'F2'. Contact: Primary Analyst Carla Norfleet Taylor, CFA Director +1-312-368-3195 Fitch, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Judi M. Rossetti, CFA, CPA Senior Director +1-312-368-2077 Committee Chairperson David E. Peterson Senior Director +1-312-368-3177
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'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research: --'Short-term Ratings Criteria for Non-Financial Corporates' (Aug. 9, 2012); --'Corporate Rating Methodology' (Aug. 8, 2012); --'Fitch Affirms Darden's IDRs at 'BBB/F2'; Outlook Revised to Negative on Acquisition' (July 13, 2012).
Applicable Criteria and Related Research: Short-Term Ratings Criteria for Non-Financial Corporates Corporate Rating Methodology