Thursday, December 18, 2014

Hedge Funds - How Capitalism is Supposed to Work?

A hedge fund has taken a position in Darden Restaurants and is turning it around.  Isn't this how Capitalism is supposed to work?

Darden restaurants made a lot of news earlier this year, when talk emerged of spinning off the Red Lobster brand.  They eventually did that, after Starboard Value took a stake in the company and made a 294-slide powerpoint presentation on what was wrong with the chain.

The CEO was forced out, along with a lot of top management. The the use of private jets was discontinued - and the company announced they will sell off the fleet shortly.

Capitalism at work.

What happens in a lot of companies - and other organizations - is that over time, the people running things start to think it is all about them and what is really important is what they can get out of the company in terms of salaries, perks, and whatnot.  Shareholders are treated as peasants, not to mention the lower employees.

Or worse yet, as at GM, they pander to the employees, so that no one "rocks the boat" and then they sweep long-term liabilities and other chronic problems under the rug.  What really killed GM in the long run was the reliance on SUVs for profits in the 1990's - and management's caving in to the UAW by signing a contract that guaranteed a fixed number of workers per plant, even if they weren't needed.  They didn't want to "rock the boat" and kill off all that lucrative SUV sales profits.  When the market tanked, they were screwed, big time.

Darden, like any other company, had some good fundamentals.  The real problem was, no one was paying attention to the details.  And like with McDonanld's, they had way too many menu items - a sure sign of flop sweat in the restaurant business.  Other than Chinese restaurants, a good restaurant shouldn't have more than a dozen entrees (if that).  Do a few things and do them well.  Trying to do too many things and you will do them all poorly.

Darden restaurants also owns high-end chains like Seasons 52. I went to visit one in Jacksonville and the line was out the door.  Valet parking.  There was a Ford GT-40 parked out front.  This was not "Lobster for Rednecks" - they were attracting an upscale clientele.   Clearly the chain knows how to make good food and a good profit.

(UPDATE:  I went there again this afternoon, which is a good time to go as they have drink specials  and tapas-like appetizers.  While the server at Red Lobster struggled to open a bottle of wine, Seasons 52 has wine flights.  This time a new Lamborghini and Ferrari were parked out front.  The food was good, although it is still a chain - and the target market is the "strivers" - people who think they are rich but really aren't. The last time we went, we sat at the bar by the wait station, and you'd be surprised how much white zinfandel they sell there.  Yes, you can lead a horse to water, but they still want lobster for rednecks - served on a fancy plate with valet parking.)

I bought Darden stock at the nadir. There seemed to me to be good basic fundamentals here, and dumping Red Lobster freed them up to concentrate on the remaining chains and also their other brands.  Now that it has gone up, of course, it is too late to buy.   But all the plebes will buy, hearing how the chain is turning things around.  The same plebes sold, back in June, when they heard about all the problems with the chain.   Buy high, sell low - go bankrupt.

I am not a chain restaurant fan.   I probably still won't go to Olive Garden, even if the food is better than it used to be.   But I know a lot of people who live and die for these chains.   And the parking lot at the local store is full again, now that it is no longer a 50/50 Olive Garden/Red Lobster, but all Olive Garden.  People love the free breadsticks.

I think they are in turnaround.

Of course, they still have a long way to go.  With a P/E ratio of 90, they obviously have to get earnings up (and they are up from 0.81 to 0.82, but that is just a start).  They are paying a dividend of about 4% which is stellar - but more than actual profits would justify.   Someone, it seems, was trying to keep the stock price artificially high - no doubt some executive whose compensation was based on stock options.

What will be interesting to see is whether the new Red Lobster can turn around as well, now that it is privately owned.   Funny thing, but when you own something, you tend to take better care of it.

Buy low, sell high.  And the time to sell high is when the folks at Starboard start to sell their stock....

UPDATE 2020: I sold my Darden stock last year for a tidy profit.  The P/E ratio has come down considerably, to the more rational 20 range.  Of course, all that is out the door with the virus - the P/E ratio is down to 7, but only because the stock price has tanked.  As new earnings reports come out, the ratio will go back up again.   But down the road, I suspect once the virus scare is over, it will recover.