Darden Restaurants, Inc. (NYSE:DRI) has not yet made any final decision for Red Lobster, but it is planning to execute a tax-free spinoff to shareholders. The restaurant operator is also considering the option of selling it in early 2015, according to analysts at Citi Research.

Darden Restaurants

Darden’s Red Lobster spinoff to boost growth

The management of the restaurant operator believe that a spinoff or sale of Red Lobster enables Darden Restaurants, Inc. (NYSE:DRI) to boost and maintain a consistent SSS/EPX growth and generate significant FCF.

According to Citi Research analyts, Alvin C. Concepcion and Gregory R. Badishkanian, the restaurant operator is also planning to reduce its cap spending by $100 million per year by reducing the unit expansion at Olive Garden, LongHorn and Special Restaurant Growth. The company will also stay away from acquisitions of additional brands.

Darden Restaurants, Inc. (NYSE:DRI) plans to raise its cost savings to $60 million starting FY2015, and maintain its $0.55 quarterly dividend after divesting Red Lobster. It will also continue strengthening its credit profile, share repos, improve its compensation and incentive programs for senior management to give more direct emphasis on same-restaurant sales growth and free cash flow.

Proceeds will be used to pay down debt

The management plans to use the proceeds from the new debt raised at the New Red Lobster to pay some of the existing debt of Darden Restaurants, Inc. (NYSE:DRI) after the spinoff. The analysts opine that such move would provide a flat to modest improvement on the company’s leverage, and maintain its investment grade rating.

Darden Restaurants, Inc. (NYSE:DRI) expects to achieve a consistently growing dividend and earnings over time. In addition, the company also believes that it would be able to slowly reduce its dividend payout ratio despite the expected dividend growth.

Concepcion and Badishkanian noted that the priority of the management of the restaurant operator after the spinoff is to return capital to shareholders though shares repurchases. The company expects to increase the amount of its shares buyback program in the near term.

According to the analysts, Darden Restaurants, Inc. (NYSE:DRI) will enhance the capital structure of the new Red Lobster to leverage the strong cash flow generation of the business. The management projected that the strategy would result to a strong non investment grade credit rating. The company’s main priority under the new Red Lobster is to return capital to shareholders through dividends and shares buyback. In addition, the company also plans to reduce its advertising expenses for the new Red Lobster. The previous marketing budget for the brand was higher than sustainable.

For the FY2014, Darden Restaurants, Inc. (NYSE:DRI) projected that its EPS would decline by 15% to 20%. Its SSS for its top three brands are expected to decline by -1% to -2% mainly due to the weakness of Red Lobster, fewer new restaurants, and impact from cost reduction initiatives.

The analysts recommended a Buy rating for the shares of Darden Restaurants, Inc. (NYSE:DRI) and raised their price target for the stock to $65.