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Should Darden buy BJ’s?

The casual-dining operator plans to make more acquisitions, says RB’s The Bottom Line. One analyst says BJ’s Restaurants would make a good target.
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In January, Darden Restaurants CEO Gene Lee told an audience of investors and analysts that the industry has to consolidate and that his company is going to be one of them—building a platform that it could simply plug other brands into.

Could one of those brands be BJ’s Restaurants?

One analyst thinks so. In a note over the weekend, Stifel analyst Chris O’Cull suggested that BJ’s is ripe for a takeout after its stock price has declined over the past few months. He wrote that it “could make a compelling acquisition target for Darden.”

BJ’s has said that it can grow to 400 locations in the U.S., but it has struggled to manage faster growth, O’Cull wrote, because it puts pressure on its operational and financial resources. Darden, which operates several brands, including Olive Garden, LongHorn Steakhouse and Cheddar’s Scratch Kitchen, has the financial resources to speed that growth.

“Moreover, we believe Darden has advantages in advertising, supply chain and real estate” that could improve BJ’s performance, he wrote.

The restaurant industry is at the outset of a multiple-decade trend toward brand consolidation. Ultimately, pressure will grow on midsized or even larger stand-alone brands to either acquire other concepts or be acquired.

BJ’s situation is a perfect example of why stand-alone companies will face this type of pressure.

Smaller chains are having a tough time keeping up with the growing amount of investment required to compete in the saturated restaurant industry. In this instance, the investment required for BJ’s to grow, and satisfy Wall Street, is too much for those investors to stomach.

BJ’s same-store sales have risen 6.9% and 4.5% in the past two quarters, respectively. Net income last year increased 13.5% to $50.8 million.

And yet the stock is down by 36% since peaking at nearly $76 a share in late August.

That has put BJ’s enterprise valuation multiple—or the multiple a buyer would have to pay to acquire the brand—at just 8.3 times earnings before interest, taxes, depreciation and amortization, according to financial documents firm Sentieo.

To put that into perspective, Darden paid a multiple of 10.4 for Cheddar’s.

BJ’s stock has struggled largely because its earnings haven’t met investors’ expectations. But a buyer, and especially a strategic buyer, is almost certainly going to look favorably upon that sales growth and the potential for unit growth, compared with that multiple.

And Darden, as O’Cull noted, has the resources necessary to drive that unit growth.

Wall Street is clearly OK with the idea. Darden stock is up by a quarter since the Cheddar’s acquisition, for instance, and it was up more than 1% on Monday in the wake of the O’Cull note (as was BJ’s, for that matter).

This, despite consistent sales challenges at Cheddar’s—including a 4% same-store sales decline for the chain in Darden’s fiscal second quarter. Darden is still clearly swallowing that deal. Wall Street is OK with that brand’s challenges because the other brands are doing great. Such is the benefit of a multibrand operator.

We do wonder whether Darden would acquire a chain so similar to its Yard House concept—both of which are varied menu, higher-end, beer-centric concepts. Acquiring BJ’s on top of Yard House on top of Cheddar’s would be an even bigger bet on varied-menu casual dining, which is not necessarily the best subsector in which to operate.

Outside of BJ’s specialty pizzas, for instance, its menu looks similar to that of Cheddar’s, down to the two brands’ signature large cookie-based desserts.

O’Cull, for his part, says there is little overlap between BJ’s and Yard House, noting that there are only 38 BJ’s within 5 miles of a Yard House, and many of those are in California, where both chains grew up.

Plus, demands for consolidation can potentially lead to combinations of similar concepts. And any chain is a potential competitor to Darden—it operates eight concepts, after all. At some point you run out of menus.

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