March 28, 2017 / 4:11 PM / 3 years ago

Fitch Affirms Darden's IDRS at 'BBB/F2'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, March 28 (Fitch) Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) of Darden Restaurants, Inc. at 'BBB' and the Short-Term IDR at 'F2' following the company's definitive agreement to acquire Cheddar's Scratch Kitchen (Cheddar's) for $780 million. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release. Cheddar's is a regional casual dining restaurant chain with 165 locations that generate approximately $625 million of revenue. The purchase price $780 million represents a 10.4x multiple of LTM EBITDA net of certain tax benefits estimated at $30 million and will be funded with $500 million of incremental debt and cash on hand. Fitch views the acquisition, which is expected to close in April 2017, as complementary to Darden's brand portfolio and expects Cheddar's to provide an additional opportunity for growth. Total adjusted debt/EBITDAR pro forma for the acquisition is approximately 2.4x versus 2x times currently. The higher leverage is consistent with Fitch's expectations that total adjusted debt/EBITDAR (total debt plus 8x gross rent-to-operating EBITDA plus gross rent) will be sustained in the mid 2.0x range over the intermediate term. Darden's ratings also reflect the company's outperformance of the broader casual dining industry, which has been in a secular downturn, and its significant scale and diversification with more than 1,500 restaurants across a portfolio of leading brands. The ratings incorporate Fitch's expectation that annual same-restaurant sales (SRS) will grow in the 1% to 2% range. KEY RATING DRIVERS Positive Comps at Olive Garden: SRS at Olive Garden, which represented over 50% of Darden's restaurants, $6.9 billion of sales, and $1.3 billion of segment operating profit in fiscal 2016 (ended May), have been positive for 10 consecutive quarters due to higher average check and improving traffic. Olive Garden has enhanced its core menu and reengaged guests with effective promotions such as Create Your Own Tour of Italy and Buy One, Take One. Olive Garden To Go orders, which are growing at a high double-digit rate, are also meaningfully contributing to SRS, which rose 1.4% during the third quarter ended Feb. 26, 2017. While traffic trends for the casual dining industry are experiencing low single-digit declines, Fitch believes Darden's diverse portfolio of brands helps partially mitigate this risk. SRS growth of 1% to 2% is viewed as achievable assuming positive price/mix and traffic trends that are at least in line with the industry at Olive Garden. According to Darden, its two largest brands, Olive Garden and LongHorn Steakhouse, outperformed the casual dining industry by approximately 400 to 500 basis points during the latest quarter. Improved Profitability: Darden reported an operating margin of 9.7% during the nine months ended Feb. 26, 2017, versus 8.5% in the comparable period last year. Profitability is benefiting from SRS growth, cost reductions, and less commodity inflation. Darden has realized over $165 million of cumulative expense savings since fiscal 2015 and continues to find cost savings throughout its operations. Fitch's base case model assumes operating margins can increase to and be sustained in the 10% range over the forecast period. Conservative Capital Structure: Darden has paid off more than $2 billion of debt over the past two years using proceeds from the sale of Red Lobster in fiscal 2015 and the monetization of real estate in 2015 and 2016. At Feb. 26, 2017, Darden had approximately $440 million of total debt with total adjusted debt/EBITDAR for the LTM being 2.0x. Darden's goal is to maintain lease-adjusted leverage in the 2.0x to 2.5x range (based on 6.25x minimum rent), which is equivalent to the mid-to-high 2.0x range based on Fitch's calculations. Fitch projects total adjusted debt/EBITDAR of 2.7x in fiscal 2017 and 2.5x in fiscal 2018. Strong Free Cash Flow: Darden generated over $300 million of FCF during the LTM ended Feb. 26, 2017. Fitch projects FCF to approximate $200 million or more annually in fiscal 2017 and fiscal 2018 as the company increases capex related to new unit development and remodelling. FCF is expected to be deployed mainly towards share buybacks. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Darden include: --Annual blended SRS of 1.5% in fiscal 2017 and fiscal 2018; --Operating margin expands to and is sustained over 10% beginning in fiscal 2017; --Total adjusted debt-to-operating EBITDAR approximates 2.7x in fiscal 2017 and 2.5x in fiscal 2018; --FCF approximates $200 million or more in both fiscal 2017 and fiscal 2018. RATING SENSITIVITIES Future developments that may, individually or collectively, lead to a positive rating action include: --A public commitment to maintain lease-adjusted leverage at the low end of management's 2.0x to 2.5x target (based on capitalizing rent expense at 6.25x minimum rents) such that total adjusted debt/EBITDAR (defined as total debt plus 8x gross rent-to-operating EBITDA plus gross rent) is sustained below 2.5x; --Continued market share gains with positive SRS and traffic performance. Future developments that may, individually or collectively, lead to a negative rating action include: --A change in financial strategy such that total adjusted debt-to-operating EBITDAR (based on 8x rent expense) is sustained above 3.0x due to significantly higher debt; --Persistent SRS and operating earnings declines or market share loss at Olive Garden. LIQUIDITY Darden had $391 million of cash and an undrawn $750 million revolver at Feb. 26, 2017. The senior unsecured revolver serves as backup to the company's commercial paper program (CP) and expires Oct. 24, 2018. Darden did not have any CP outstanding at the quarter ended Feb. 26, 2017. Darden does not have any near-term maturities. The company has $150 million of 6% senior unsecured notes due August 2035 and $350 million of 6.8% senior unsecured notes due October 2037. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Darden Restaurants, Inc. --Long-term IDR at 'BBB'; --Bank credit facilities at 'BBB'; --Senior unsecured notes at 'BBB'; --Short-term IDR at 'F2'; --CP at 'F2'. Contact: Primary Analyst Carla Norfleet Taylor, CFA +1-312-368-3195 70 W. Madison St. Chicago, IL 60602 Secondary Analyst Bill Densmore Senior Director +1-312-368-3025 Committee Chairperson Phil Zahn Senior Director +1-312-606-2336 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock based compensation expense as reported in financials. Darden incurred costs related to the proxy contest and strategic actions over the past few years that have not been reflected as adjustments. 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