Cracker Barrel: Unique Business Model Highlights Ongoing Risks (NASDAQ:CBRL)

Cracker Barrel Old Country Store, Inc. (CBRL) operates 651 full-service restaurants in the United States. The emergence of the coronavirus pandemic has forced the company to close all dining rooms across the country, while still operating limited takeout options at some locations. The stock has taken a hit with a significant 50% decline from the highs of this year, although it is recovering from deeper losses in March. We highlight that the restaurants typically feature attached retail stores at most locations that drive margins, meaning the restaurant closures are magnified with a larger earnings impact. While we are confident Cracker Barrel will survive this unprecedented situation, we take a more cautious outlook on the stock price, as growth and earnings may be pressured beyond this year.

(Source: Finviz)

Restaurant + Retail Concept

Before coronavirus pandemic, Cracker Barrel was on a roll with consistent earnings growth and trends in restaurant sales that outperformed the broader industry over the past decade. EPS reached $9.27 for the fiscal year 2019, doubling compared to EPS of $4.34 in 2012.

Cracker Barrel last reported its fiscal 2020 Q2 results in February, with comparable restaurant sales growth of 3.8% year over year. At the time, the company was guiding for full-year comparable sales growth between 2.0% and 2.5%. With the deterioration of the operating outlook, the guidance is likely to be revised lower or pulled when the company next reports its fiscal Q3 results in May.

(Source: Company IR)

Cracker Barrel, with a 51-year history, is recognized as a pioneer of the casual dining segment, and the company uses that tradition to operate retail stores at most locations with related merchandise. Approximately 20% of the total revenues are generated from the retail business. While Cracker Barrel does not break down the contribution of each segment to operating income, it’s simply a case where any merchandise sale at the retail store represents an incremental boost to top line revenue and the store-level economy.

(Source: Company IR)

The two business segments share employees and scale corporate resources. The company alludes to this dynamic in the annual report when it mentions the retail sales per square footage is significantly higher than that of most other retail businesses.

We believe that we achieve high retail sales per square foot of retail selling space (approximately $427 per square foot in 2019) as compared to mall stores both by offering appealing merchandise and by having a significant source of customers who are typically our restaurant guests.

Essentially, all the operating costs are associated with the core restaurant business, while the retail store functions as a profit center. This concept has allowed the company to maintain low food menu prices effectively subsidized by the retail operation.

The challenge for Cracker Barrel is that beyond the restaurant business, a surge in unemployment and weaker consumer spending dynamics expected to linger through 2021 may pressure the sales environment even when the pandemic is contained. People may still have budgets for meals supported by generous relief benefits and broader stimulus efforts, but this environment would have a greater impact on discretionary purchases in the company’s retail stores.

By this measure, we expect the retail segment to underperform any recovery in the restaurant unit. The need to run discounts and promotions to move inventory may pressure firm-wide margins as a separate trend from the restaurants, further diluting the earnings environment going forward.

Exposure to trends in Interstate Travel

Another unique aspect of the Cracker Barrel business is a relatively large concentration of its restaurants strategically located around highway exits and between major destinations. The thinking here is that interstate traveler can stop in at a restaurant with a familiar menu and reputation of quality for its affordable comfort foods. Visually, this theme can be seen with a map of the company’s footprint clustered in the Eastern United States along major interstate corridors along the South.

(Source: Company IR)

Our concern is that these near-highway locations are particularly pressured in the current environment with travel significantly reduced. It’s also recognized that tourist destinations that families would be traveling to will face more difficulties in restarting post the pandemic. This implies fewer opportunities to visit a Cracker Barrel restaurant for casual diners.

To be clear, the company has expanded diversified geographically with more suburban locations, but there is still a relatively high “rest-stop” strategy compared to other restaurant brands. Our point here is that Cracker Barrel has a different exposure within the restaurant industry and compared to more traditional neighborhood eateries. Our point here is that the company has a different exposure within the restaurant industry and compared to more traditional neighborhood eateries. At the margin, these factors can represent a weakness in its recovery process through 2021. Going back to the retail segment, lower restaurant traffic further pressures the retail segment.

Analysis and Forward-Looking Commentary

With a materially negative impact on earnings this year, we are looking at current valuation multiples based on the trailing twelve months’ results. Given the large selloff in shares, CBRL is trading at approximately 9.8x, compared to about 17x before the situation deteriorated. Separately, the EV-to-Revenue multiple is 0.8x compared to 1.2x in February.

ChartData by YCharts

While the current level represents a significant discount to the recent history of normalized earnings, the risk is that the company may not be able to recover its prior growth trajectory. If that’s the case, then CBRL should trade with structurally lower multiples. Notably, it traded at a lower EV-to-Revenue multiple of 0.8x back in 2013, suggesting the stock is not necessarily cheap based on that metric.

The bearish case for the stock is that fiscal 2019 represented a cyclical peak for the company in terms of sales, and the outlook is weaker going forward. Once we get into 2021, the year-over-year comparisons will look impressive consider the challenges now, but we believe investors should focus on a staked two-year comparison with 2019. At the margin, we think the weakness will linger given the macro challenges like higher unemployment and reduced consumer incomes.

To the upside, the stock will need to see improving sentiment towards the restaurant industry, which may take years to recover. The potential for a stronger-than-expected economic recovery and quickly improving labor market conditions would be bullish for the stock.

CBRL Dividend Deferment

The other consideration here is the recent news of CBRL’s dividend deferment and suspension of the stock buyback program. The regular quarterly dividend at $1.30 per share, which was declared on March 3rd, has been pushed back to a payment date of September 2nd. From the company’s 8-K filing:

To preserve available cash during the pandemic and in light of the uncertainties as to its duration and economic impact, the Board has determined that it is appropriate for the Company to defer payment of the dividend that was declared on March 3, 2020. Payment of such dividend, which was scheduled for May 5, 2020 to shareholders of record on April 17, 2020, will be deferred until September 2, 2020, to shareholders of record on August 14, 2020. The Board has also determined to suspend all further dividend payments under the Company’s historical dividend program until further notice.

We were surprised at this announcement, as the payout of $31 million is relatively manageable in the context of previously reported $73 million in cash on hand, along with an outstanding revolving credit agreement of $460 million at the end of the last quarter through January 31st. Management noted they have now drawn down the entire facility and had a cash position of $400 million as of March 24th.

Separately, the company also said it’s expected to report an impairment charge of $115 million on its equity investment in privately held specialty concept “Punch Bowl Social” acquired back in 2019.

Overall, the actions taken are consistent with the unprecedented challenges across the industry. Technically, if we assume the dividend will be reinstated with the next payment in Q3, there is still a yield associated with the stock. On a trailing twelve months basis, CBRL yields 5.8%. Investors have to assume they are “skipping” a payment, but it’s possible that by end of the year the regular schedule is restored.

ChartData by YCharts

As long as the operation can resume normalizing activities in the coming months, the organic cash flow should support future payouts. By this measure, the dividend could be reinstated at the current level even in a reduced earnings environment. Our point is that even as the financial conditions are very weak with operations mostly shut down, Cracker Barrel has some flexibility in terms of funding to manage its capital needs.

Verdict

Recognizing the deep selloff in shares of CBRL given the disruptions caused by the coronavirus pandemic, we expect significant volatility to continue. Without clear visibility for when operating conditions can return to normal, the stock remains speculative, and we rate CBRL as a Hold, taking a more cautious view on its particular recovery outlook with risks tilted to the downside. Beyond the cyclical pressures to the core restaurant business, Cracker Barrel’s exposure to retail and trends in interstate travel add to growth pressures we expect to linger through 2021. Monitoring points here include the next quarterly release expected in late May and update from management to forward guidance.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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