S&P Removes Darden Restaurants (DRI) from CreditWatch Negative

Standard & Poor's Ratings Services affirmed all of its ratings on Orlando, Fla.-based Darden Restaurants Inc. (NYSE: DRI), including the 'BBB-' corporate credit rating, and removed them from CreditWatch with developing implications, where we placed them on Dec. 19, 2013. The outlook is negative.

"The rating affirmation reflects our expectation that the company will make progress with improving results at Olive Garden and it will also maintain credit metrics in line with a low investment-grade rating, following its $1 billion debt repayment," said credit analyst Helena Song. "Pro forma for the sales transaction and debt repayment, we estimate adjusted debt to EBITDA to be about 3.0x at fiscal year-end 2014."

The negative outlook reflects our view that operating performance at the company’s key brand Olive Garden will remain relatively weak in the next several quarters and that Darden has limited room for prolonged operating underperformance. We believe the casual dining industry will remain difficult because of competition and consumer caution, and that Darden may not be able to adequately offset these trends.

Downside scenario

We could lower the ratings if it appears that activist shareholders gain board control and lead to more aggressive financial and/or operating strategies, or if management revises its strategies toward the same end. In such case, we could place the ratings on CreditWatch with a negative implications as an interim step, to assess the rating impact of the company's revised financial policy.

We could also lower the ratings if Darden's sales and profitability underperforms our expectation and debt leverage does not improve in fiscal 2015, remaining in the low- to mid-3x area. Such a scenario could occur if debt remains flat, sales decline 6%, and operating margins contract 100 basis points (bps) in fiscal 2015.

Upside scenario

We could revise the outlook to stable if Darden can restore sales and profit growth while lowering debt leverage to the mid-2x area on a sustained basis, and the trend is supported by the company’s financial policy. For this to occur, EBITDA would need to increase about 20% from a 200-bp margin expansion while sales remain flat. We would also need to believe that large shareholders are generally supportive of the company’s strategies and polices at that time, compared with the current activist situation.

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