CHICAGO--(BUSINESS WIRE)--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.
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
2014 Outlook: U.S. Restaurants (Shareholder Demands to Rise, Even as Market Share Battle and Cost Pressures Continue)