How to Invest in Cracker Barrel ... the Smart Way

Despite its stock flying at multi-year highs and impressive earnings figures, Cracker Barrel Old Country Store (NASDAQ: CBRL  )  remains under attack by activist and takeover specialist Sardar Biglari of Biglari Holdings (NYSE: BH  ) . The company has resisted the investor's efforts every step of the way, recently swallowing a poison pill to prevent his firm from obtaining more than 20% ownership. With the recent earnings release, minority shareholders may not be likely to vote in favor of change-- ie. giving Biglari seats on the board. Still, some believe the investor holds solid suggestions for further enhancing shareholder value. With the most recent earnings in mind, and Biglari's annual meeting on the horizon, is Cracker Barrel a smart pick?

Brief history
Biglari owns $358 million worth of Cracker Barrel. That makes up all but $122 million on Biglari Holdings' market cap. Why such a concentrated portfolio for a holdings company Biglari has a history of doing well with quick-service restaurant chains. The investor owns Steak n Shake, as well as Western Sizzlin'. Both were in deep trouble before Biglari began his activist stake, and since then, both have recovered -- and even prospered.

The battle for Cracker Barrel seems to be a bit different though, as the stock has gained 60% in two years, and more than 23% in the last three months. Using the typical measure of what is a successful investment, Biglari has already far passed the satisfactory mark for his company's position in the roadside restaurant chain. So why are the two at such odds?

For one thing, Biglari believed, as recently as the third quarter of last year, that the company was misrepresenting its ROC for stores open less than one year -- by a fat margin. While Cracker Barrel boasts more than 16% returns, Biglari thinks its closer to 3%. This would dictate a vast difference on key performance indicators for management. In a letter to shareholders from last October, Biglari writes,

The Board has spent nearly $700 million in capital over the past eight years, while over the same time span operating income has grown by an insufficient $12.4 million. New stores have been opened, but they shroud the decrease in unit profit.

It's certainly an interesting point, given the stock's performance in recent years, and shareholders' adversity to Biglari's quest.

Recent earnings
For the recent quarter ended February 1, Cracker Barrel posted a 0.2% increase in comparable store traffic, with a 3.3% increase in same-restaurant sales. This is the fifth consecutive quarter of increased traffic and sales. On an adjusted basis, operating income margin grew by nearly one point, to 8.4%. Adjusted EPS for the quarter came in at $1.43, versus $1.20 in the year-ago quarter. Revenue grew nearly 4.5% to nearly $702.7 million.

The company adjusted its full year 2013 guidance downward to reflect a tepid environment. Annual EPS is now expected to come in the $4.60 to $4.80 range. Last year's full year EPS was $4.61. Analyst estimates remain at the high end at $4.77 per share. The latter price would suggest year-over-year growth of only 3.5%. Meanwhile, the company is opening eight new restaurants and stores.

Is Cracker Barrel management allocating capital poorly? That is the fundamental question. While over the past year, the market doesn't seem to think so, we all know that can mean very little over the long-term.

Cracker Barrel flooded the market with shares (called a poison pill) to prevent Biglari from obtaining more than his current 19.99% stake in the company. Sacrificing some shareholder value in the near-term, management clearly believes it has the right idea, and that investor's input and claimed board seats would be harmful.

How to invest in CBRL
Cracker Barrel trades at 14.25 projected forward earnings. Brinker, owner of Chili's and Maggiano's, trades cheaper at 13.22x, and has a much more favorable return on assets and equity (assuming Biglari is correct, for the latter). Given Cracker Barrel's tepid growth prospects, and the continued notion that it may be misrepresenting its ROC, I am not sure the company is a buy today.

That's not the end of the story, though. As mentioned before, Biglari Holdings has a $473 million market cap, and a price-to-book of 1.37x. Cracker Barrel's stock grew mid-double digits through 2012, and Biglari Holdings grew less than 5%. With nearly 80% of the holding company's market value in Cracker Barrel, why didn't the stock perform closer in-line?

Book value for Biglari grew by nearly 25% in 2012 -- far more than many other holding companies, including Berkshire Hathaway. Biglari trades at under 6.5x trailing EV/EBITDA. For comparison, Berkshire trades at 8.9 EV/EBITDA, and has a price to book of 1.35x. Berkshire, of course, has the Buffett name behind it, and a much more diversified holdings portfolio. Sardar Biglari does not have the kind-old-man image but, instead, he is a 35-year old with early success. However, some say he's an arrogant power-snatcher. While I disagree with the naysayers, Biglari's name likely does keep the company from holding anywhere near the reverie that Buffet does with Berkshire.

Given Biglari's successful track record in the industry, and the tempting evidence that Cracker Barrel could be performing much better than it is, I believe the wise investment here is to buy Biglari Holdings. It has less downside potential, and a manager with a solid record for increasing cash flows and successfully allocating capital.

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