Fitch Upgrades Darden's IDRs to 'BBB/F2'; Outlook Stable

CHICAGO--()--Fitch Ratings has upgraded the Long-Term Issuer Default Rating (IDR) of Darden Restaurants, Inc. to 'BBB' from 'BBB-' and the Short-Term IDR to 'F2' from 'F3'. The Rating Outlook is Stable. A full list of ratings follows at the end of this release.

The upgrade reflects improvement in same-restaurant sales (SRS) trends at Olive Garden and Darden's reduced financial leverage due to improved operating performance and debt paydown. SRS at Olive Garden have grown for six straight quarters, rising 4.9% on a comparable calendar basis in the latest quarter. Blended SRS is forecast to approximate 3% in 2016 and 2% in 2017 due to Fitch's view that traffic trends at Olive Garden will be at least in line with the industry.

Total adjusted debt/EBITDAR (defined as total debt plus 8x gross rent-to-operating EBITDA plus gross rent) pro forma for a full year of incremental rent expense (~ $115 million) following the monetization of Darden's real estate was approximately 2.3x for the LTM period ended Feb. 28, 2016. Fitch believes total adjusted debt/EBITDAR is more likely to increase and be sustained in the mid-to-high 2.0x range over the intermediate term.

KEY RATING DRIVERS

Positive Sales Traction at Olive Garden: SRS growth at Olive Garden has been driven by higher average check and improving traffic. The casual dining chain, which represented 56% of Darden's $6.8 billion of total sales and 60% of its $1.2 billion of segment operating profit in 2015, 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 represent about 10.5% of total sales, are also meaningfully contributing to SRS.

While traffic trends for the casual dining industry have been experiencing low single-digit declines, Fitch believes Darden's diverse portfolio of brands helps partially mitigate this risk. SRS growth of 1% - 2% is viewed as achievable in most years assuming positive price/mix and traffic trends that are at least in line with the industry at Olive Garden.

Meaningful Margin Expansion: Darden reported an operating margin of 8.5% during the nine months ended Feb. 28, 2016, versus 4.4% in the comparable period last year. Profitability is benefiting from improved SRS, cost reductions, and less commodity inflation. Darden is on track to realize $145 million - $165 million of cumulative expense savings by the end of fiscal 2017, after realizing $35 million in 2015 and an expected $80 million - $90 million in 2016.

Substantially Reduced Debt, Leverage: Darden 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. Total debt at Feb. 28, 2016 was $448 million, down from $2.8 billion at May 25, 2014. The company does not have any maturities until 2035.

Total adjusted debt/EBITDAR pro forma for the monetization of 489 owned properties is approximately 2.3x, down from 3.3x at May 26, 2013. Fitch projects total adjusted debt/EBITDAR will increase and be maintained in the mid-to-high 2.0x range over the intermediate term, assuming blended SRS of about 1% - 2% and potentially higher debt.

Strong Free Cash Flow: Darden generated $219 million of FCF during the nine-months ended Feb. 28, 2016. Fitch projects FCF will exceed $250 million in 2016 and approximate $200 million in 2017 as the company increases capex related to remodelling and new unit development. FCF is expected to be deployed towards share buybacks.

KEY ASSUMPTIONS

Fitch's key assumptions within the agency's rating case for the issuer include:

--Annual blended SRS of 3% in fiscal 2016, and approximately 2% in 2017;

--Operating margin expand over 200 bps, exceeding 9% in fiscal 2016, and by over 50 bps in 2017;

--Total adjusted debt-to-operating EBITDAR is sustained in the mid-to-high 2.0x range over the intermediate term;

--FCF exceeds $250 million in 2016 and approximates $200 million in 2017 and is used towards share buybacks.

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. Fitch views operating leases as debt-like obligations so capitalizes gross rent expense using a multiple of 8x.

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 - 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;

--Consistently positive SRS performance, particularly at Olive Garden, with traffic trends at least in line with the industry;

--Sustained annual FCF of $200 million or more.

Future developments that may, individually or collectively, lead to a negative rating action include:

--Total adjusted debt-to-operating EBITDAR above 3.0x due to significantly higher debt to fund share buybacks, which would indicate a change in financial strategy, and/or declining sales and operating earnings;

--Persistent SRS declines and market share loss at Olive Garden.

LIQUIDITY

Darden had $966 million of liquidity at Feb. 28, 2016, consisting of $216 million of cash and full availability under a $750 million revolver. 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. 28, 2016. 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 upgrades the following ratings

Daren Restaurants, Inc.

--Long-term IDR to 'BBB' from 'BBB-';

--Bank credit facilities to 'BBB' from 'BBB-';

--Senior unsecured notes to 'BBB' from 'BBB-';

--Short-term IDR to 'F2' from 'F3';

--Commercial Paper to 'F2' from 'F3'.

The Rating Outlook is Stable.

Media Relations:

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

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Contacts

Fitch Ratings
Primary Analyst
Carla Norfleet Taylor, CFA
Senior Director
+1-312-368-3195
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Bill Densmore
Senior Director
+1-312-368-3125
or
Committee Chairperson
Monica Aggarwal, CFA
Managing Director
+1-212-908-0282
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Carla Norfleet Taylor, CFA
Senior Director
+1-312-368-3195
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Bill Densmore
Senior Director
+1-312-368-3125
or
Committee Chairperson
Monica Aggarwal, CFA
Managing Director
+1-212-908-0282
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com