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Tuesday, January 5, 1999

An Investment Opinion
by Warren Gump

CBRL: A Slowing Ship Adding New Propellers

With the excitement and phenomenal growth potential of Internet and other go-go stocks, many investors will find today's column boring. Is there anyone out there besides myself who wants to invest in a company trading for only 14x earnings that has strong cash flow and a history of spectacular growth? I'm beginning to lose faith that other value-oriented compatriots are there. Maybe if I just made it a little sexier. Well, it does have a pretty powerful name brand. In fact, Restaurants and Institutions has selected Cracker Barrel, its core restaurant operation, as the Best Family Dining chain eight years in a row. The company of which I speak is CBRL Group (Nasdaq: CBRL).

Most of you may know this company as Cracker Barrel Old Country Stores Inc., but as 1998 rolled into 1999, a new holding company, CBRL, was created to hold Cracker Barrel as well as future acquisitions. While a small, technical maneuver, this transformation into a holding company structure signals CBRL's future strategy. Cracker Barrel will remain an integral part of the organization, but a significant portion of future growth will come from acquired chains. The holding company already owns a small gourmet market and restaurant called Carmine Giardini's Gourmet Market and La Trattoria Ristorante. It has also announced plans for a more significant purchase, Logan's Roadhouse (Nasdaq: RDHS).

For those of you not familiar with Cracker Barrel, this chain of 369 restaurants, primarily located off interstates, offers moderately priced "home-styled country cooking." Some of the menu items include country ham, chicken, fish, sandwiches, vegetables, pancakes, and (of course) grits. In addition, each restaurant has a gift shop that sells toys, glassware, jelly, candy, and other trinkets. This chain was a big growth story in the late 1980s and early 1990s, but has fallen way out of favor over the past five years.

Throughout its rapid growth phase, Cracker Barrel consistently grew its store at 20%+ per year. Combining that unit growth with gains in same-store sales, the company posted stellar earnings growth. As the chain became larger, it became harder to continue growing its store base at the same pace, due to both management logistics and fear of chain saturation. Over the past couple of years, Cracker Barrel has added about 50 units a year, which is a decreasing percentage gain off an increasing store base. In 1999, the 50 new units will result in roughly 14% unit growth.

If you look at the company's stock price, you would probably think the past five years have been disastrous. Since mid-1993, while the S&P 500 increased 173%, CBRL fell 20%. Ughhh. What happened to earnings per share (EPS) at the company? They actually grew at a 16% compound annual rate during that period, rising from $0.78 to $1.65. What changed is the price/earnings (P/E) ratio, which fell from 37x in 1993 to 14x today? Lesson #1: The market can be manic depressive with a growth stock that is slowing down. Excessive joy on the upside can easily turn into overly pessimistic expectations on the downside.

The compelling fact of the investment story is that earnings are still increasing, albeit at a significantly slower rate in the short-term. Last year's earnings per share (EPS) increased 17% to $1.65. Earnings growth this year will be much more modest. Same-store sales have turned negative (falling 1.6% in fiscal Q1, ending in October) as store-level management turnover hindered operations and several years of price increases finally hurt the Cracker Barrel's price/value perception. In Q1, EPS increased only 11%. Management also commented that they expect EPS for this fiscal year to be flat to up 6% as it implements changes to restore positive momentum at the core chain.

If results from CBRL are flat (or declining) for the rest of time, its stock at $23 would not be a bargain. I would encourage you to shun the stock and watch it stumble along in the years ahead. Needless to say, I don't expect that will happen. The company has steadily generated increasing cash flow, with operations producing $151 million of the green stuff last year. While capital expenditures were $180 million, it is important to remember that unlike most restaurant chains, Cracker Barrel owns rather than leases a significant majority of its stores. This causes investment per restaurant to soar, but means that the company has hard assets that can be used to secure financing at reasonable terms if necessary.

CBRL expects capital expenditure to remain around $180 million this year to fund new restaurants and land purchases (this does not exclude expenditures for Logan's). Given its very strong balance sheet and seemingly low stock price, in early September the company also announced a 3 million share repurchase authorization (5% of outstanding shares). Over 1.3 million of these shares had already been bought back by the end of October.

Share repurchases are an effective use of excess cash when better investment alternatives are not available. Even more exciting, however, is a company that redeploys its cash into businesses that generate even higher returns. Here is where the purchase of Carmine's and Logan's come into play. These vehicles for future growth provide attractive opportunities for the company to invest its capital to maintain long-term growth prospects. The company didn't purchase Logan's, which has created a niche below Outback and Lone Star in the $12 check average range, until it demonstrated that it was able to successfully operate restaurants in several markets. With 41 restaurants, the chain has reached a size that demonstrates its feasibility, yet provides significant potential for future growth.

Such a strategy is appropriate for CBRL. A couple of years ago, it internally developed Cracker Barrel Corner Market as a way to cater to the then-trendy home meal replacement market. This test concept was shuttered during its market test due to lackluster results. Failing with a test concept is always disappointing, but those companies that never take risks are unlikely to be leaders. While taken to task by investors who feared the company didn't have a new growth concept, CBRL should be given credit for not pursuing a concept that didn't offer sufficient returns.

Many investors wait to invest in a stock until management has proven they are adept businesspeople. CBRL has clearly done that over the past fifteen years. Nonetheless, this year's expected slowdown in earnings growth does mean investors will have to closely monitor results over the next year to ensure that management is steadying Cracker Barrel. With its immense share of company's current revenue and profits, CBRL cannot move into higher earnings waters with its main engine failing. But if you believe in management's ability to refurbish that engine, the new propellers that the company will deploy might just kick the ship back on its growth trajectory. It may take a year or two for earnings growth to get back to 12%-15%, but the stock price will undoubtedly be much higher if it does.

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