Fast Profits: Darden Restaurants

Let’s return to our Walk Down Main Street with another Fast Profits trade idea. Yesterday, we talked about my recent visit to Chipotle (CMG) as part of my bullish outlook on the stock. Today, we talk about another “Walk.”

Living in a downtown area that was just named “one of America's next great food cities,” I find myself staying away from the typical suburban eateries. That includes those that make up the portfolio of Darden Restaurants (DRI).

If you’re not familiar with their more popular restaurants, they include Olive Garden and Outback Steakhouse as their “anchor” franchises. In addition, the company owns Ruth’s Chris Steakhouses and Seasons 52, among a few other finer dining establishment chains.

Looking at the company’s financials, the “anchors” do exactly what you expect; they lay the foundation for Darden’s operations. And it’s one of those that I found myself walking into just a few weeks ago.

Fundamentals: Bearish

Just like Chipotle, I found myself walking into a local Olive Garden a few weeks ago. The choice wasn’t mine, but it was convenient for the situation.

I hadn’t been to an Olive Garden for more than a decade, so while the experience was “new,” I was also very familiar.

For some background, we used to frequent Olive Garden when my children were young. Free breadsticks, salad, and their inexpensive menu were the perfect “night out” with a family of five.

Things have changed.

What was an $8 menu item is now $21. This was all I needed to know as everything else around me was completely different compared to my experience at Chipotle or any other restaurant I’ve visited lately.

What had been crowded any night of the week was relatively empty on a Friday night. There was another chain restaurant of the same price range next door that was crowded, so this was an Olive Garden problem, not a demand for dining problem.

Let me get away from keeping it personal with a few fundamentals.

Darden Restaurants were an oasis starting in 2021. During the pandemic, diners flocked to any restaurant they could get a seat in. Then things slowed down as we saw inflation bite into our wallets in 2022. But because of the restaurant company’s size and cash flow, they could afford to lure diners in by holding off on raising prices on the menu while everyone else suffered at the hand of rising food costs.

That bought Darden a solid 60% rally that started in mid-2022 as consumers were shrugging off inflation and still dining out.

Things have now taken a turn. Like everyone else in the group, Darden had to push menu prices higher. They’re paying more to their staff, and fewer diners are coming through the door as we all cut back on our discretionary spending.

That combination is now showing in the company’s financials.

Last quarter, Darden missed their earnings per share mark by $0.02. It’s only the second time that the company missed expectations in the last five years.

The company also missed their revenue target. That represented the second quarter in a row that the company missed revenue guidance.

Looking deeper into the financials, Darden’s margins dropped to 21% last quarter. That number is 42% lower than the industry average.

Earnings guidance for the next report – to be released on June 20 – sees the company expecting even lower revenue and earnings per share.

Outside of the financials, consumer discretionary stocks are seeing growing pressure as consumers have stretched their credit and are cutting back on their spending.

Sentiment: Neutral to Bearish

A check of investor sentiment shows that investors and analysts are in the process of changing their outlook on the stock.

Wall Street analysts have held a relatively strong buy recommendation on the stock despite its underperformance.

The current price target on the stock sits at $176.91, the highest target from Wall Street. The stock price has now moved almost 20% below analysts’ average target, which will begin to put pressure on the group to start reassessing their outlook. That action is likely to draw downgrades on Darden stock.

A year ago, the options market had been overly bullish on the stock as it was heading towards new highs. More recently, we’ve seen put option activity increase on the stock, which makes sense as shares are moving into a long-term bear market trend.

That shift in sentiment in the options market suggests that we are seeing more selling of the stock instead of buying as the “crowd” becomes more bearish on Darden stock.

Short sellers have started to increase their activity on Darden stock as well.

Currently, the short interest ratio for DRI sits above 4. That number tells me that there is a growing crowd of short sellers betting against the stock. At the same time, the shorting crowd hasn’t become so large that the stock is positioned for a short squeeze rally.

In general, sentiment towards the stock is clearly transitioning from greed to fear, which is consistent with a stock that is set to extend its bearish trend lower.

Technicals: Bearish

There are three critical technical signals that are currently bearish on Darden stocks.

First, the stock’s 50-day moving average.

This trendline is one of the most important in gauging the intermediate-term direction of a stock.

Darden’s 50-day moving average is currently trending lower, putting it in a bearish trend. As of now, this popular trendline is positioned just below $155, in place to act as resistance for any short-term rallies the stock may see.

Next, the Death Cross.

Darden’s 50-day moving average just crossed below the slower-moving 200-day trendline. This pattern forms a Death Cross pattern known to indicate long-term negative momentum.

dri stock chart

The last time we saw this pattern form on the stock was October 2023, when the market was amid a deep correction. In that case, the stock was able to recover from its lows as the market’s strength lifted most stocks.

Today, the market’s strength hasn’t translated into strength for Darden. This is due to the degrading strength in consumer discretionary stocks. Expect this Death Cross to play out more negatively for Darden stock.

Finally, Darden’s stock price is below its 20-month moving average. This cross puts the stock into a long-term bear market.

The last move into a bear market trend happened in March 2022, resulting in an additional 16% decline in Darden shares over a three-month period.

dri stock chart with technical indicators

Before that, the stock saw a 52% decline in 2020 as it moved into a bear market as a result of the pandemic.

Historically, Darden has been somewhat “bear market proof” because of the company’s restaurant focus on discount menus with wide margins, but per the fundamental discussion above, that scenario has changed dramatically.

The Bottom Line

First, if I’m an owner of the stock, I either reduce my position or protect it with protective puts.

As a speculator of lower prices on the stock, I consider a longer-term put option as the way to effectively leverage a -20% move or more.

Here’s the option I consider a good alternative.

The January 17, 2024, DRI $150 put is an at-the-money put that will provide leveraged profit potential for my initial target price of $125.

The option currently trades for $11.40 a contract ($1140).

If Darden shares move to my first bear market target of $125 before October 1, this option would hold a theoretical value of $25.67. That represents a 125% profit.

Darden will announce their next earnings results on June 20, 2024. If the option is trading with a return of 30% or more ahead of that date, I would suggest taking profits to avoid earnings risk for the position.

Always make sure that you have a basic education and understanding of how options are traded before opening a position like this.

About the Author

Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.

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