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True Grits

|Includes: BH-OLD, Cracker Barrel Old Country Store, Inc. (CBRL)

Cracker Barrel recently flew on my radar, or more specifically in my car’s navigation system, while driving back home from Massachusetts.  The store is very different from other stops along the highway, in that each location includes both a restaurant that serves up a wide range of American home-style favorites, from chicken fried steak to collared greens, and a retail store that sells virtually any item that could be identified as Americana, including lawn chairs and Christmas lights.  Over the years Cracker Barrel has created an extraordinarily unique country restaurant brand with an extremely loyal following.  This fact alone gives it a competitive advantage that is key for a successful business, and great potential for a sound investment.

CBRL runs 600 stores, of which 85% are located directly off of interstate highways.  They have operations in 42 states around the country, serving an almost equal amount of breakfasts, lunches, and dinners, with an average check per guest increasing consistently over the last 5 years.  For the record, check per guest currently stands at just over $9.00, so we are looking at a fast food chain alternative that I would initially anticipate to hold up a bit better in stagnant economy than other consumer discretionary businesses.  They show consistent growth in earnings, and are expanding through recession (and the current year) at around 8-10 stores per year. 

In the MD&A section of their previous 10-K filing, management continues to emphasize that they have a unique business model that separates them from other restaurants.  CBRL takes pride in the community they created with both a home-style restaurant and retail core businesses that operate quite literally side-by-side.  They offer a few details to show that 20% of their revenues come from retail sales, and emphasize that they essentially operate two distinct businesses. 

There is no question that unique customer loyalty is irreplaceable in tough markets, and a quick look at the bottom line will show you that they have incredibly consistent earnings growth over the last 10 years.  In addition, they have consistently unlocked shareholder value by increasing dividends and continuing an aggressive buyback program over the last decade.  For a company that has lost 25.9% of its market value since the beginning of 2011, at surface level this looks to be a potentially generous gift from Mr. Market. 

However, a few notes to their financial position are concerning.  First, in the company presentation they show that Same Store Sales, a very telling statistic for business in retail, has been negative on an annual basis for the past 3 years, and their retail sales has become a diminishing proportion of total sales over the last 4 years.  Management is resolute in their success as a dual business, but I was unable to uncover any specific future strategy to address this.  They noted that a majority of their retail customers are those that have come to the location for the restaurant, but it seems to me that a crucial step in driving revenue would be to find ways to get new customers in the door who are more interested in their retail products than their menu.  


Further, I took a look at the last few quarters to look at what was driving such successful earnings growth, which on an annual basis looks near perfect.  One number jumped off the page for me as I perused the income statement.  Last quarter CBRL shows a $2 million impairment GAIN.  In the retail business you will often see impairment charges as a result of store closings, and in the last 4 years of quarterly statements CBRL does show a number of impairment charges, but a $2 million gain seemed odd.  Reading further through the notes it appears that the company did in fact take impairment charges, but they also had a location in Florida that was bought by a government agency and were given a “Condemnation Award” as is customary for cases of eminent domain.  While I don’t question the legitimacy of this impact on earnings, I do think that such a one-time charge would be very misleading when comparing earnings growth  over a period that has never seen such a benefit.  In fact, when I adjusted EPS by taking out this $4 million in gain from the Condemnation Award, I found that their EPS from continuing operations falls to $0.37, which would be by far their lowest reported EPS in almost 10 years. 

This definitely is of concern in my view, as a stagnant economy will discourage families from taking vacations on the road and eating out, and in this case the business does not appear to be in as strong a financial position to capitalize.  Additionally, if you take a look at CBRL’s performance in the recession their stock was certainly not recession proof.  If retail sales are falling, it would be helpful to then understand the costs and expenses that are attributed to their retail and restaurant unit’s separately.  Even management admits through various statements in their 10-K that their financial statements must be approached differently than other restaurants because of their retail operations. 

In comes Biglari Holdings (NYSE:BH), a 9-10% stockholder in CBRL who is actively fighting for a board spot over this exact issue of accounting transparency.  CBRL takes pride in the store community they created with both home-style restaurant and retail core businesses that operate quite literally side-by-side.  However, beyond a few numbers they offer little more segmentation in financial statements for analysts to get a true picture of both businesses.  The chairman and chief executive of Biglari Holdings Inc. last month sent a letter to the company repeating his call for it to separate its restaurants and retail operations in financial reports, a move he says will make the firm's performance more clear. Most recently, CBRL’s board rejected Biglari’s demand to be appointed to the board.   

I find evidence in favor of Biglari’s plees all over their previous annual statement, in which they express how imperative it is to balance both retail and restaurant operations.  More specifically, they even seem to advise investors to not be alarmed by financial ratios (that are misleading?) such as product turnover that come out a bit off-industry average, because their competitors in the restaurant space do not have retail operations that extend the average shelf life of inventories.  For example, they state “Because of our retail operations, which have a lower product turnover than the restaurant business, we carry larger inventories than many other companies in the restaurant industry.“  Sounds materially important enough for additional disclosure to me! 

This stock will be interesting to follow, but for now the company will announce less than ideal earnings as a result of macroeconomic factors that their business model has little protection against.  High gas prices and a dwindling U.S. consumer confidence level will have kept many families at home this summer, traditionally a strong quarter for CBRL. 

Disclosure:  I have no positions in any of the stocks discussed in this article, nor do I have any intention of taking a position in the next 72 hours.