By The Valuentum Team
Cracker Barrel's Investment Considerations
• Cracker Barrel (NASDAQ:CBRL) is principally engaged in the operation of the Cracker Barrel Old Country Store concept. Stores consist of a rustic, old country-store design, offering a full-service restaurant menu featuring home-style country food. A typical store serves 1,000 guests a day and employs 100+ people. The company was founded in 1969 and is headquartered in Tennessee.
• The firm is laser focused on improving margins via re-engineering processes to reduce costs and creating a more efficient box for new stores. Yearly price increases to the tune of 2-3% should be expected. EPS is targeted to advance 7-8% on an annual basis.
• Cracker Barrel's business quality ranks among the best of the firms in our coverage universe. The firm has been generating economic value for shareholders with relatively stable operating results for the past few years, a combination we view very positively. Management is targeting $3.1 billion in revenue by 2017.
• We think Cracker Barrel is a differentiated concept. The company generates ~20% of revenue from its retail business while ~40% of its customers are travelers. The "Cracker Barrel" experience begins with rockers on its front porch, which are also a top seller in its retail shop. Customers continue to give the firm high marks for "uniqueness."
• CBRL is dedicated to growing its store base and has approximately 150 new site opportunities outside of its core Southeastern market. The firm has also opened a prototype for its take on fast-casual dining, called "Fusion."
• A strong balance sheet, solid free cash flow generation, and a lofty 3% yield offer the triumvirate why Cracker Barrel is one of our favorites in the full-service restaurant space, but an evaluation of other dividends of other companies in the full-service restaurant industry may be helpful as well. We make a distinction between full-service, fast-casual companies such as Chipotle (NYSE:CMG) and Panera (NASDAQ:PNRA), and quick-service restaurants such as McDonald's (NYSE:MCD) and Yum! Brands (NYSE:YUM).
• Valuentum makes a distinction between financially-engineered distributions, or those that are financed in part via the finance section of the cash flow statement, and strong, organically-derived ones, the latter what Cracker Barrel possesses. For a corporate that has a strong Dividend Cushion ratio, a 3% yield is quite attractive, in our view. REITs and MLPs often benefit from a re-circulation of capital from the equity and debt markets into unitholder pockets, but this dynamic has largely been exposed given the recent fallout in energy MLPs as of late. We like to stick with tried-and-true corporates that have a very bright future.
Economic Profit Analysis
In our opinion, the best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital with its weighted average cost of capital. The gap or difference between ROIC and WACC is called the firm's economic profit spread.
Cracker Barrel's three-year historical return on invested capital (without goodwill) is 17%, which is above the estimate of its cost of capital of 10.2%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT.
In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Cracker Barrel's free cash flow margin has averaged about 4.6% during the past three years. As such, we think the firm's cash flow generation is relatively MEDIUM.
The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At Cracker Barrel, cash flow from operations decreased about 19% from levels registered two years ago while capital expenditures expanded about 13% over the same time period.
In the first quarter of fiscal 2016, the company reported net cash flow from operating activities of approximately negative $4 million and capital expenditures of ~$17 million, resulting in a negative free cash flow of ~$21 million, a significant change from fiscal 2015 first-quarter positive free cash flow of ~$18 million.
This is the most important portion of our analysis. Below we outline our valuation assumptions and derive a fair value estimate.
Our discounted cash flow model indicates that Cracker Barrel's shares are worth between $106 and $158 each. Shares are currently trading at ~$132, in line with our fair value estimate. This indicates that we feel the upside potential and downside risk associated with shares are about the same at the moment.
We're big fans of Cracker Barrel's income growth potential, however. Substantial growth in net income was one of a number of factors that helped the company nearly triple free cash flow in fiscal 2015, to ~$244 million. Its cash flow generating capacity, coupled with the firm's manageable financial leverage, is in our view a healthy combination for future dividend expansion. We're expecting continued growth.
The margin of safety around our fair value estimate is derived from the historical volatility of key valuation drivers. The estimated fair value of $132 per share represents a price-to-earnings (P/E) ratio of about 23.9 times last year's earnings and an implied EV/EBITDA multiple of about 12.4 times last year's EBITDA.
Our model reflects a compound annual revenue growth rate of 3.6% during the next five years, a pace that is higher than the firm's three-year historical compound annual growth rate of 3.3%. Our model reflects a five-year projected average operating margin of 10.9%, which is above Cracker Barrel's trailing three-year average.
Beyond year five, we assume free cash flow will grow at an annual rate of 2.3% for the next 15 years and 3% in perpetuity. For Cracker Barrel, we use a 10.2% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $132 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.
In the graph above, we show this probable range of fair values for Cracker Barrel. We think the firm is attractive below $106 per share (the green line), but quite expensive above $158 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Cracker Barrel's fair value at this point in time to be about $132 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart above compares the firm's current share price with the path of its expected equity value per share over the next three years, assuming our long-term projections prove accurate.
The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change.
The expected fair value of $162 per share in Year 3 represents our existing fair value per share of $132 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Wrapping Things Up
We continue to believe balance sheet strength and solid future free cash flow generation are the building blocks of any company's dividend health. When looking for quality dividend ideas within the full-service restaurant space, a subset of the restaurant industry, it only makes sense, in our view, that dividend analysis should be rooted in balance sheet and free cash flow assessments, along with an evaluation of the sustainability of the business itself. One of our favorite dividend growth ideas in the full-service restaurant space is Cracker Barrel.
We believe CBRL is a differentiated concept and customers are drawn to its "uniqueness." Margin and process improvement are going to be key focuses in its strategy going forward. We are keeping a close eye on its free cash flow generation moving forward in fiscal 2016, but we are pleased the company is currently a holding in the Dividend Growth Newsletter portfolio. The firm is currently trading in line with our fair value estimate, and we will pay close attention to any bargain opportunities, at which time we may consider increasing its weighting.
Cracker Barrel currently registers a 4 on the Valuentum Buying Index.
This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.
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.
Additional disclosure: CBRL is currently included in the Dividend Growth Newsletter portfolio.