Sunday, December 25, 2016

Has DRI Bottomed After Two Mixed Quarters?

Darden Restaurants (NYSE: DRI) continued to defy gravity after two consecutive quarters of missed revenue.  The owner of Olive Garden, Capital Grille, Longhorn Steakhouse and other well known chains posted earnings on 20 December.  While they beat EPS again, revenue was a miss by $10 million for the second consecutive quarter.  What appears to be the saving grace for the restaurant giant is strong same-store sales growth, with all but Season 52 posting positive numbers for the quarter. 

The company also reaffirmed their Fiscal Year 2017 guidance of EPS between $3.87 and $3.97, up from the current $3.44.  Given the current chart pattern and the Elliott Wave count we'll discuss in a bit, that increased guidance is of significance.  Let's take a look at the chart.

DRI Daily Chart
Let's take a look at that long black candle on 4 October, 2016.  That coincides with last quarter's earnings release in which Darden also beat on EPS but missed by $10 million in revenue.  Shareholders shrugged off the news, and DRI - which had traded in a very tight consolidation for the previous three months - continued its sideways movement.  There wasn't a hint of selling despite the negative revenue miss.

Less than a month after mixed earnings, Darden begins a strong upward climb, completing five sub-waves between 26 October and 12 December.  This is where the Elliott Wave count gets interesting, however.  The five-wave impulse is fairly straightforward, and while other counts are possible, the one marked i though v is the most likely given the pattern.  I'm comfortable with that count. 

From 12 December to the close on 23 December, a possible a-b-c correction played itself out.  The bottom of c ends just above the 38.2% retracement of the entire wave.  It also ends just above the prior wave iii top and is just over a 61.8% retrace of wave v.  This means that it's a deep but consistent zig-zag pattern.  I'm also comfortable with that count.

So what's the challenge?  Well, the challenge is where Darden may go from here, and how we should play it.  That's always the challenge, when you stop to think about it.  We are always forced to trade to the right of the final bar; we must always trade into what has yet to happen.  The past is crystal clear, but the future?  Not so much.

Notice the long wick candle I have highlighted on 20 December.  That's the candle that drew after this quarter's earnings announcement.  Volume was typical of an earnings release, and just like last quarter, the stock made no headway in either direction despite the mixed report.  The decline over the next three days was subtle and somewhat negligible given the current price. 

This brings us to the question at hand.  Has DRI bottomed and is it ready for another impulse wave,   or have the large institutions lost patience with the revenue misses and is DRI poised to plummet?  Consider the following signals on the chart:
  • The RSI(9) Oscillator continues to signal a strong bearish divergence. The divergence started with the Wave iii completion high on 15 November and it has yet to abate.  This is a definite bearish indicator.
  • A trend-line drawn from the start of the impulse wave, through the wave ii low ends right at the current low of our possible wave c.  It has provided strong support through the impulse and has yet to be breached.  This is a bullish indicator.
  • Friday's candle is a hammer at what may be the wave c low.  Now, this signal would be much better on higher volume, however the volume on the close before Christmas was extremely low across the board.  We're forced to ignore volume due to the date.  The hammer in this position, with a long shadow that touches the support line, is a bullish indicator.
  • The Elliott Wave count suggests the completion of an a-b-c correction following a five-wave impulse.  This could result in the start of a new impulse, or it could evolve into an x-y-z corrective pattern.  Either way, the most likely direction from here is up.  This is a bullish indicator.
  • There is a very viable resistance line drawn parallel to the current support line we discussed earlier.  That resistance line takes us well above the 52-week high and is not a factor in the short to medium term horizon.  This is a bullish indicator.
  • The short range candle on 16 December was accompanied by very high volume.  This candle bounced off the 23.6% retracement level.  This is a bullish indicator and may represent the amount of demand that exists at this level.
  • The nearest horizontal support coincides with the 61.8% pattern retracement.  Other than the diagonal trend-lines, there's not much support upon which we can depend without a very deep correction in the stock price.  This is a bearish indicator.
  • The short float is 8.65% and days to cover is 6.3.  If a downward move does not manifest, the amount of short covering we can expect will add a fair amount of upward pressure on the price.  This is a bullish indicator.
So how do we play this pattern?  Well, for openers, despite the RSI divergence, our bias is to the upside.  What we are looking for at this point is a bullish reversal pattern in the short term that holds us above the support line.  On such a pattern, we would enter long and set a price target that coincides with the top of wave b.  Our protective stop will be just below the green support line.

A downside break, however, would be signaled by a close below the support line, preferably with confirming volume.  In that case, we would enter short with a protective stop just above the green line that would suddenly represent resistance.  Our price target to the downside will be the horizontal support line just above that 61.8% retrace.  Be aware, however, that DRI trades ex-dividend on 6 January 2017, and the $0.56 dividend is significant enough that we don't want to be in a short position at the close on that date.  (We don't have that same concern on a long trade.)  So for the moment, there's a brief window in which a short trade would be viable. 

Keep in mind that volume next week will be low, so we will not be able to rely on volume confirmation as we normally would.  It won't negate the signals, however the additional uncertainty increases risk, and we'll adjust our position sizes down a bit as a mitigator.  Let's see how this one develops.

Happy Trading.

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