Description

Cracker Barrel Old Country Restaurants was a high flying, conservatively managed growth stock prior to some management mis-steps. The stock peaked at $42 in 1998 when it earned $1.65 per share and was growing at 20% per year. I believe that as the company recovers from its problems the stock will rise dramatically. Even if the operational problems are insurmountable, the real estate value provides some nice downside protection.

The company is a Family Dining concept ($8.00 average ticket) competing with Shoney's and Denny's where it is handily outperfomring. In late 1998, the company initiated a series of changes designed to improve margins including price increases, labor cost reductions and changes to the store managers' compensation plans. This strategy turned out to be misguided as the reduction in service reduced the speed of table turns and the price hikes alienated customers. In order to correct the situation, management cut prices, and increased labor costs. Now the traffic is starting to return. Unfortunately, the cost of the recovery was a dramatic reduction in margin from 12 to 8%.

As customer count improves and labor productivity returns to normal, margins are starting to increase. In addition, since labor costs are a critical and widespread problem throughout the industry, all restaurants are raising prices. This is starting to help the top line.

Meanwhile, the company, which owns almost all of its own real estate, is beginning to sell and lease back its stores. Since the market doesn't distinguish between those restaurants that own and those that lease, the simple arithmetic of leasing is compelling (all leases are off book):

Sell 1/2 Real Estate for $350MM (roughly the current book)

Current Earnings $77 ($1.35 / share)
Increased Rent Expense (25)
Reduced Depreciation 6
New Earnings $58

Use Proceeds to Buy Back Shares at $15 /share. - New share count 34 million.

New EPS $1.70

While the magnitude of the real estate sales may wind up being lower than shown, the company is using leasing for its new stores. As a result, over time, the cash flow benefits of leasing will yield the same results. Since most of its competitors use leases, the valuation will become more comparable. Furthermore, if the company is successful in improving margins, say by 2% (half of the prior 2 year's deterioration), it will generate an additional $0.70 per share on the reduced share count. And then the company will resurrect its growth plans.

This quality franchise combined with management's actions to improve margins and more appropriately leverage the balance sheet make CBRL an interesting idea.

Catalyst

Improving sales trends, quality concept, rising margins, sale/leaseback of real estate.