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Weekly Wrap: Darden Turnaround on Track

Fri, 23 Dec 2016

The Olive Garden parent's rebound is one of the most interesting stories in restaurants today. Plus, strong results from a homebuilder and tepid sales from General Mills.


Video Transcript

Scott Halver: Homebuilder Lennar has a strong fourth-quarter, Darden's turnaround is in full swing, and General Mill struggles with tepid sales. This time on the Morningstar Weekly Wrap.

Morningstar analyst Brian Bernard thinks Lennar finished 2016 on a high note and sees demand for housing on an upward trajectory, but he sees shares of the homebuilder as fairly valued today.

Brian Bernard: Lennar finished its fiscal year off strong with nice fourth-quarter results. The homebuilder's fourth-quarter sales increased 15% year over year to $3.4 billion, and earnings grew 11%. As we expected, rising land and labor costs caused homebuilding gross margin to contract year over year, but the company's 23% fourth-quarter gross margin was in line with previous guidance, and is still well above the public homebuilder average of about 19.5%.

Forward-looking indicators point toward another strong year for Lennar in 2017. The dollar value of new orders increased 12% year over year as new order volume and price increased in each of Lennar's end markets. Lennar's backlog stands at $2.9 billion, which is 17% higher than at the end of fiscal 2015, and the homebuilder expects to grow its organic community count by 7% next year. Of course, the pending acquisition of WCI Communities should augment Lennar's growth.

Although we think Lennar will generate strong top-line growth and better cash flow in 2017, we do think that the stock is generally fairly valued here as its trading about 9% below our fair value estimate.

Halver: R.J. Hottovy thinks Darden is continuing to make the case for being one of the most interesting turnaround stories in some time.

R.J. Hottovy: Darden's fiscal 2017 second-quarter results reaffirmed its position as one of the more interesting turnaround stories in the restaurant space today. Comparable store sales, which were up 1.7%, outperformed the restaurant industry by about 4-5 points. The reason for this was a lot of menu changes the company has made in recent years, lower entry points, but also encouraging add-on sales was a big driver. But also things like getting people through the restaurant quicker through new operational and technology-driven process improvements. On top of that they've done a great job with takeout sales which now represent about 13% of the overall sales mix. The company has also done a great job on the cost-cutting side, getting rid of some unnecessary SG&A and supply chain costs which helped to drive margin expansion. 

That said, we think the valuation looks less compelling than it did--the stock is actually up 22% since Election Day alone. On the prospect of potentially increased discretionary spending power due to new administration policies. We're also a bit concerned that a lot things that Darden is doing across its chains will be replicated by its competitors over the next several years, making revenue growth and margin expansion less pronounced at this company. So while we think the turnaround story is promising, we think its probably worth taking a pass on this one until valuation looks a little bit more compelling.

Halver: General Mills showed tepid sales results, but cost-cutting measures helped boost profitability. Analyst Erin Lash thinks the poor sales are likely a result of reduced ad spending.

Erin Lash: Tepid sales continued to dog General Mills in its fiscal second quarter, falling 4% on an organic basis. This decline was particularly pronounced on its home turf where underlying sales slipped 6% in the most recent period. Management attributed this shortfall to its decision to ratchet back advertising spending, which was down 20% in the quarter. We've been saying for quite some time that firms throughout the space have been looking to artificially inflate profit levels by pulling back brand spending and we viewed these outsize gains as unsustainable. And General Mills' recent results support our sentiment. From our vantage point, intense competitive pressures amid a sluggish growth environment warrant increased spending by firms throughout the packaged-food industry. Behind both research and development as well as marketing spending. And we think that General Mills will look to take these steps. Shares trade in line with our valuation, and we'd suggest investors remain on the sidelines.

Halver: And in case you missed it, Russ Kinnel looked back at the 11 biggest fund manager changes of 2016.

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