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Established in Lebanon, Tennessee in 1969, Cracker Barrel (NASDAQ:CBRL) is famous for its half restaurant and half country store concept, as well as checkers, peg games, and comfortable front porch rocking chairs. With 595 company-owned locations in 41 states, 2009 marked the Fortieth Anniversary for the restaurant chain, which maintains the long-term vision of becoming the “best restaurant company in America”.

Moreover, Cracker Barrel recently raised their dividend 10% as a result of improved efficiencies enacted during the financial downturn and rising net income. Their average restaurant serves 7,000 guests per week and generates $4.05 million in annual sales. With a P/E of approximately 14.6 and estimated double-digit earnings growth on the horizon, who could resist Cracker Barrel’s shares?

Unfortunately however, Cracker Barrel does possess significant risks, which is perhaps why the company trades at such a mild multiple to earnings. The company has $573.79 million in long-term debt, but only $47.7 million in cash/short-term investments and $85.26 in net income for fiscal 2010. With a 6.7+ leverage ratio, Cracker Barrel also receives a Standard and Poor’s debt rating of BB-, which accordingly is “speculative grade”.

In addition, the company had to conduct several sale-and-leaseback transactions totaling close to $60 million during fiscal 2009 in order to make debt payments without cutting the dividend or halting more store openings. Cracker Barrel is now paying down its debt, but all at a considerable opportunity cost. Lastly, the company has only one retail distribution center. If the company plans to grow farther from its base, more infrastructures will be needed and additional financing may be hard to come by for a company already substantially in debt.

On the other hand, management claims that the Cracker Barrel chain has potential for 1,100+ company-owned locations. If the company opens 100+ new stores successfully over the next five years, investors could witness double-digit earnings growth and a possible annual return in the range of 15-17%. Currently, the company is opening 11 new locations during fiscal 2011 (estimated). Most of their growth would likely originate from expanding farther west as Cracker Barrel appears to be well established across the Southeast. Cracker Barrel only operates 4 locations in Colorado, 2 in Nebraska, and 4 in Kansas.

Consequently, the future holds the possibility of high returns for Cracker Barrel shareholders; however, with extensive debt on the books, perhaps a lower P/E ratio is warranted before the investor decides to allocate capital to a company in the highly competitive restaurant industry. After all, overwhelming debt usually has the profound effect of tarnishing a company’s high growth plans.

Disclosure: The author has no positions in CBRL at the time of writing.

Source: Cracker Barrel: Down-Home Stock at a Discount?