Cracker Barrel: Fixable, But The Visibility Of The Turnaround Plan Is Still Limited

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Cracker Barrel Old Country Store is undergoing a full revamp of its strategy to improve its operating performance.The company has historically been a high-dividend paying stock but experienced a ...

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The company has largely underperformed over the last 2.5 years, and is currently facing short-term headwinds while simultaneously trying to stabilize its operating performance and implement a full revamp of its strategy (including brand repositioning) under a new CEO. In turn, this has hampered the assessment of potential margin recovery over the long-term. In my view, a lack of short-term catalysts and limited visibility on the outcome of the recent turnaround plan may continue to prevent a re-rate from materializing. The investment thesis might turn more positive if the new management provides more details of the strategy and begins to deliver consistent performance, with margins stabilizing or improving. In this scenario, a re-rate may occur. The company will hold a standalone investor presentation in May (before Q3 earnings call), during which it will share more details of the strategy and potentially discuss progress on various initiatives.  A high-dividend-paying company that's gone off track Cracker Barrel Old Country Store is a full-service restaurant chain with 663 company-owned units, offering a menu of home-style country food. The company has an unique concept, with a retail store inside each restaurant where customers can shop while waiting for their table. The restaurant segment accounts for c.80% of sales, with lunch as the most popular day part (40% of sales), followed by dinner (35%), and breakfast (25%).  CBRL has historically been a high-dividend paying stock (c.90% payout before the pandemic), enabled by consistent free cash flow and return on invested capital. Yet, due to the COVID-19 pandemic, the company experienced a significant impact on its operating performance, largely driven by a sharp decline in traffic (c.80% of stores located along interstate highways) and input cost pressure. As a result, the stock has declined -62% since mid-2021 while the dividend yield stands at 6.8%. In response to the lagging performance, the company decided to appoint a new CEO, Julie Masino (effective in November, 2023), with the stock up +5% on the date of the announcement. Since then, the company has been trying to stabilize its operating performance while also working on enhancing its financial performance for the longer term, thereby ensuring a sustained return of capital to shareholders. Image created by author with data from Cracker Barrel  CBRL is undergoing a full review of strategy The appointment of a CEO with a background on culinary and business model innovation suggests that CBRL aims for a full revamp of its brand strategy, centered on technology, loyalty, employee and guest experience. This move would also prepare CBRL for a phase of higher unit growth in the medium-term. Notably, Julie Masino delivered solid results during her 5 years as the President of International Taco Bell, even amidst the negative impact of COVID-19: SSS increased on average by +5.4%, operating margin improved by +200bps, and store expansion grew on average by +3.7% (800+ units). While this showcases a solid track record, the fact that she has recently joined CBRL means that initial signs of improved operating performance have yet to be proven. Moreover, Taco Bell operates in the quick-service industry, with a focus on a younger population compared to that of CBRL, where the guest mix is largely skewed towards the older population (55+ accounts for c.43%). Given this context, while the strategic move seems sound, the path the company will follow is still unclear (i.e., brand positioning, menu innovation, adoption of new technology, etc.). Moreover, the path should encompass a period of testing different initiatives to gauge their appeal to both core guests and people newer to the brand. In my opinion, this currently poses a high execution risk.  Image created by author with data from YUM! Brands The low hanging fruit lies in strategic pricing Cracker Barrel has historically demonstrated the ability to pass-through prices and effectively managed COGS pressure in its P&L. For example, from 2011 to 2019, average ticket grew by +2.5%, in-line with input costs. However, from 2020 to 2023, the company experienced a significant margin pressure, particularly in gross margin, which contracted by -244bps. While much of the headwinds were beyond control, it is clear that management's lag in pricing contributed to the underperformance. For instance, from 2021 to 2023, COGS inflation averaged +13.2%, yet CBRL grew ticket on average by +6.6%. Moreover, comparing CBRL's average ticket in 2023 with that of peers in the full-service sector showed that the company ranked last, with an average ticket of $13.36, which compares to a median ticket of $25.00 for peers (-47% gap). Also, from 2019 to 2023, CBRL's average ticket gap remained consistent when compared to that of peers in the lower end of the group. Yet, the gap remained wide, with the average ticket for peers still being approximately 50% to 60% higher than that of CBRL's average ticket.  With that said, addressing the margin issue partially relies on pricing, which also has the benefit of directly flowing to the bottom-line. However, in my view, management will likely do pricing in a thoughtful and careful manner to preserve value, a key piece of their value proposition. More assertive pricing/mix could be supported by enhanced customer insights as CBRL has been gradually accumulating data from digital usage and its loyalty program, potentially driving more client engagement and traffic. Instead, if the company were to fully close the pricing gap versus peers, there could be a high risk of backfiring on traffic and brand image, especially considering that its largest clientele comprises an older population that tends to be more value-conscious. In fact, from 2011 to 2019, despite CBRL growing ticket only in-line with inflation, traffic contracted on average by -0.7%. Alternatively, in my view, management should focus on sustaining positive traffic trends and consistently growing ticket ahead of inflation. This strategy could help margin recovery, especially with COGS inflation showing some signs of improvement.  Image created by author with data from Cracker Barrel While labor is a mid-term opportunity Labor cost has been another key concern. From 2011 to 2019, restaurant-level labor cost grew on average by +1.9% (driven by both increased staff and average wages), lagging the top-line growth of +2.8%. As a result, labor costs as a percentage of sales decreased by -200bps. However, since 2021, management has chosen to invest more in labor to improve guest experience, resulting in a higher labor count per store. This, combined with higher average wages, have added pressure on the P&L. Despite efforts to improve guest experience, the increased number of employees per store has not consistently translated into productivity gains, with sales per total employees decreasing -0.4% during the period (-0.1% in 2023). Consequently, corrective measures should focus on productivity gains to partially offset the impact of higher wages and labor count per store. In fact, CBRL's labor costs as a percentage of sales stand at 35.1%, ranking high among peers, with a median of -120bps below the upper group compared to a median of +240bps above the lower group. Image created by author with data from Cracker Barrel 2Q24 results point into this direction  During the 2Q24 earnings call, management mentioned that they are initiating a full review of brand strategy (from menu and marketing to digital and store experience) and exploring optimization initiatives across the entire P&L. Regarding pricing, the guidance encompasses approximately +5% for the full year, while commodity and wage inflation are expected to range from 0% to +2% and +5%, respectively. Although margin pressure is expected in the near-term (mainly in Q3), margins may begin to improve in Q4. Notably, the guidance for pricing in 2024E may already indicate a shift towards strategic pricing, as it surpasses commodity inflation and aligns with wage increases. Moreover, the guidance follows a ticket increase of +9.8% from last year (versus COGS of +7.4%), with comments that they are doubling down on building their strategic pricing capabilities, including in the off-premise channel which commands the lowest margins, and where they see the biggest near-term opportunities.  On traffic, management noted that the softest cohort has been the 65+, but they saw significant improvement versus fiscal 2023 and 1Q24, while the income cohort has remained consistent. To improve traffic, strategies encompass testing changes to restaurant décor, innovating with menu items, and offering day-parted promotions along with marketing efforts. Regarding labor, management sees it as a mid-term fix, where they see a significant opportunity for margin recapture through operating leverage and adjustments to reduce fixed labor by making the business model more variable. At the same time, these initiatives should benefit from tailwinds in commodity and wage inflation, which have been gradually moderating.  Image created by author with data from Cracker Barrel, U.S. Bureau of Labor Statistics and U.S. Bureau of Economic Analysis The full revamp management has been implementing may at least partially restore margins (following expectations of bottoming out at the end of this fiscal year), and help maintain dividend payments. A scenario where dividends are fully cut would be concerning as investors could potentially seek other investment opportunities. Moreover, the company guided for CAPEX at/above the levels in 2023 ($120mn-$135mn versus $127mn in 2023), while leverage stood at 1.8X in 2Q24. At this level, the company remained compliant with debt covenants under the 2022 Revolving Credit Facility, while the $300,000 notes issued in June 2021 are unsecured obligations and do not contain any financial or operating covenants or restrictions on dividend payments.  Valuation: CBRL is trading at a large discount  CBRL is down -62% from mid-2021 and has underperformed peers YTD (-7% versus +6%, respectively). Also, from 2019 to 2023, CBRL's operating performance lagged that of peers: gross/EBIT margin decreased -244/-570bps, respectively, versus the 2019 baseline. At current prices, CBRL is trading at -25% discount to its historical median EV/EBITDA. Furthermore, median consensus for EBITDA margin in 2024E stands at -140bps, but there are downside risks given the lower band stands at -210bps.  Image created by author with data from Cracker Barrel and peers. Estimates from author and Factset  Given the significant underperformance, the market seems to be attributing a value to the company below its replacement cost or without growth value. The replacement cost would encompass the expense to build CBRL restaurants (ex-pre-opening costs). According to the company, the average cost to build each restaurant is ~$5.5mn, or $3.6bn total cost to build all 663 restaurants. This compares to an enterprise value of $2.0bn, or ~40% discount to replacement cost. Under the earnings power value (EPV) approach, one can assess whether current prices incorporate any growth value. Assuming 2023 fiscal year revenue as a baseline, EBIT margin of 7.5% (-200bp below the average during the 2015-2019), a tax rate of 25%, and a cost of capital of 9.0%, this results in an EPV of equity of +8% versus the current market capitalization of CBRL. So, under these assumptions, the market would be pricing in CBRL stock without growth value. Both scenarios disregard operating leases, net operating loss carryforwards, and land CBRL owns (358 properties in 2023).    Image created by author with data from Cracker Barrel and own estimates Image created by author with data from Cracker Barrel and own estimates  In a base case scenario where traffic remains under pressure at -0.7% and ticket grows slightly ahead of COGS inflation, this results in gross margin reaching 68.0% over the long-run versus the current 67.2% (or an average of 68.8% from 2015 to 2019). In addition, better control over labor cost and gains in productivity would slightly reduce labor cost over time to 34.9% (-21bp versus current levels). The scenario also assumes some pressure within operating expenses from increased off-premise sales and higher levels of advertising spending at 3.3% (versus 2.7% historically), as indicated by management's aim to increase marketing spending. All in, this results in an EBIT margin of 7.5% in 2033E (-200bps versus 2015-2019 levels). Assuming a methodology of 50%/50% blend of a DCF model (terminal growth at 2.0%, WACC at 9.0%, cost of equity at 11.5%, cost of debt at 7.0%, tax rate at 25% and risk-free at 4.3%) and an exit EV/EBITDA multiple of 9.7X (-10% discount to historical median to incorporate lower margins), this yields a share price of $86.00, implying +21% potential upside. These estimates could be viewed as conservative. In my view, however, there is limited visibility on the turnaround plan and the potential for margin recovery over the long-term. Moreover, there is also a lack of short-term catalysts for a re-rate to materialize, while trends still point to significant margin pressure in Q3.   Image created by author with data from Cracker Barrel and own estimates Image created by author with data from Cracker Barrel and own estimates   Image created by author from own estimates Key risks In my view, the biggest risk for Cracker Barrel concerns execution, especially considering a recently appointed CEO implementing a full revamp strategy. Within the turnaround plan, it is key for management to determine the optimal pricing architecture, which in turn could help stabilize margins and mitigate the risk of dividend reductions or cuts. Should the opposite occurs, investors may seek other investment opportunities. Additionally, sustained cost pressure without adequate pricing could potentially impact top-line growth. Such case would lead to CAPEX revisions, resulting in lower forecasted units. Another risk concerns how the new initiatives, especially the brand repositioning, will resonate with the core consumer base (55+ cohort). A negative reception from these customers following the implementation of such changes could negatively impact traffic if the perceived value proposition undergoes significant changes. Concluding thoughts  The remedy for the current issues faced by Cracker Barrel resides mostly in-house. The company has an unique concept, but must address performance gaps to reverse the decline in margins. Although the strategic plan seems sound, there is still limited visibility on the outcome of new initiatives, especially concerning pricing. This aspect is important for improving margins and mitigating the risk of dividend cuts, which would be unfortunate for a company that has historically delivered high returns to shareholders. In my view, until there is greater visibility on these matters, it will remain challenging to assess the potential for margin recovery over the long-term. With that, the market may remain on the sidelines.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2424394161"}