Cracker Barrel's Business Model at 10,000 Feet: What Makes It Unique

The Motley Fool's Industry Focus podcast recently took a deep dive into Cracker Barrel's (CBRL 0.75%) business. The southern-themed restaurant chain has churned out reliable share growth and admirable cash flow over the last several years -- but can it adapt as consumer preferences evolve?

Check out the latest Cracker Barrel earnings call transcript.

In this first segment from our show, we discuss Cracker Barrel's unique business model. Learn about the company's real estate advantage, its retail strategy, expansion opportunities, and more in the video below.

A full transcript follows the video.

This video was recorded on Feb. 19, 2019.

Nick Sciple: Asit, now let's move on and talk about our main topic for this show, which is Cracker Barrel Old Country Stores, ticker CBRL. It's a really interesting business to me because it's so unique. It sells Southern-style food. There's not that many national restaurants that sell that. And it has a very, very aggressive theme, the classic old country store that you might see in Mayberry off Andy Griffith or something like that. And each one of them has an associated gift shop with it where you can go in and buy little knickknacks. They target travelers. Over 80% of their stores are located along interstate highways. They advertise primarily through billboards.

When I describe to you, Asit, that business model for Cracker Barrel, from a 10,000-foot view, this niche food genre targeting a niche part of the market, what do you think about Cracker Barrel's business model?

Asit Sharma: I think it's unique. Maybe it has a precursor in the South in a place called Stuckey's. I don't know if you've ever seen those old locations. When I was a kid traveling along the interstates with my family, that was maybe the model of these locations, located off the interstate that were a chain offering food and convenience, other items, and also a gift shop. But beyond that, I haven't seen this model implemented. I do think it's a very strong model.

I've been told that it's hard to discern that I'm from the South, but I grew up here in a small town east of Raleigh not far from Interstate 95, which runs north-south, as everyone knows, all the way from the top of the country down to Florida. I'm used to this rhythm of traveling down for vacations and seeing billboards along the highway.

I think the model itself makes so much sense for two reasons. One is the real estate located along the interstate is clever. The location of being just off of major cities, but on the interstate, that enables a company to ensure that it's going to have traffic flows for long periods of time. Now, in my lifetime, I've seen traffic trends shift from exit to exit along the interstate, so it's not a slam dunk. But when you think about the way, in urban areas, neighborhoods shift and demographics shift even within five or 10 years if it's a fast-growing city, the interstate comparatively is much more stable. So, that's a great part of this model.

The other thing that's interesting to me is, I think it makes for a recurring business. When you have your local chain that you love to eat at, or a local nonchain restaurant in your own town, familiarity can breed contempt. But this rhythm of traveling down, as I said, on a vacation or maybe for business, if you're encountering these signs only a few times a year, it can be something novel, especially with the gift shop, which we're going to talk a lot about today. When you add this element of a gift shop beside the restaurant, with novelties, and Cracker Barrel frequently rotates merchandise and adds seasonal items, that's another draw.

Now, some of you listeners, younger listeners, may think, "Well, that sounds like a kitschy place to me. Who would want to stop at a restaurant like that? Who would want to go to this gift store and buy this merchandise?" Well, it turns out, there's a lot of people like that. They may be slightly aging as a demographic, but these have been solid numbers for a year, which makes this company a cash cow, another reason why I'm drawn to this business model. Maybe not the most exciting investment, but an intriguing one, nonetheless.

Sciple: Right, Asit! They're in such a tight niche that it's tough to see anyone coming after their area of the market. It's really a difficult model to replicate. You mentioned on the interstate highways. The interstates aren't going anywhere. Those were built during the Eisenhower administration and they're going to continue out into forever. These routes are particularly valuable places to locate a restaurant.

Let's move to talking a little bit about the business and its strategy, where it's come to date. Cracker Barrel today owns 659 stores in 45 states. Given the cuisine that it serves, Southern homestyle fare, you would expect most of the stores to be in the South and Midwest, and they are. Roughly two-thirds of its stores are located there. However, they're beginning to move out into the West. They just opened their first stores in California.

You had an interesting comparison to this, a restaurant that maybe hasn't expanded to its full geographical potential that may be an interesting comp for Cracker Barrel. Do you want to talk a little bit about that, Asit?

Sharma: Absolutely. Investors who are listening who have shares in Dunkin' Donuts also watched the company become what was first a regional chain. And now, this isn't Northern cuisine, but it might as well be -- doughnuts, coffee. First, it extended in a Southerly direction, then toward the Midwest. There's this huge white space opportunity for Dunkin' Donuts on the West Coast. The question is, will that concept to take in California? I think a similar question can be asked of this rather niche concept. We've seen Dunkin' change its name from Dunkin' Donuts to Dunkin', streamline its stores, bring in a really new and renovated model of stores, to be this what they call on-the-go beverage-led company. I'm not saying that there's some causality here, but looking at how people approach fast food on the West Coast and what their preferences are, you can see that some of this shift is changing how they present themselves to appeal to that greater West Coast audience.

I wonder, too, as Cracker Barrel expands, what kind of obstacles it may run into in terms of consumer preferences. How might it change the look of it stores at all? That's a big draw to its fans. I'm fascinated by this comparison. We'll have to see as we go forward how this westward expansion works for Cracker Barrel.

Sciple: Yes. It's an interesting case where what makes it unique also maybe caps the upside of the investment over the long term, given that its core demographic is limited geographically.

Let's talk about how the business makes money. About 80% of its revenue comes from the restaurant portion of the business, while 20% comes from the gift shop. I mentioned that they primarily target travelers. Over 80% of their stores are located along highways, and most of their advertising is outdoor advertising, billboards on the side of the highway, "Hey, come visit Cracker Barrel!" As a result of them primarily targeting travelers, the business can be correlated with rates of highway travel and the effect of gas prices on people's tendencies to travel on the highways, Asit. What have we seen in the past from this business when it relates to its correlation with gas prices and the amount of travel that people choose to do?

Sharma: Absolutely. You couldn't call Cracker Barrel a cyclical business, but it is affected by cyclical factors in the economy. When economic growth slows and consumer discretionary spending crimps back a bit, that tends to hit Cracker Barrel's results. You'll hear management discuss it from time to time. They talk a lot about consumer discretionary income. I believe Sandra Cochran, the CEO, is very attuned to how the economy is doing in terms of GDP growth and what effect that might have. Commerce is going to go on and on, but this company's business is primarily that of leisure travelers -- and, we should mention, recurring visits from people who are located near a Cracker Barrel. Not all of their business is this drive-by on the interstate. They do have a smaller group of customers. I'm not sure if we've come across this statistic yet, but maybe four-fifths of their business is this highway travel, and then you have a pretty sizable group of people who are drawn to the store in that fashion.

Sciple: Right. You're always going to have that Sunday-after-church crowd. It really caters to that demographic as well. Another important factor when it comes to folks traveling is, the retail strategy really depends on folks getting into the store. You want to get folks into the store to eat your food, and then you want to convert them into paying customers. They operate across several verticals. Apparel is their largest demographic.

The most interesting part of their retail strategy is their music program. They have some exclusive music sold through CDs. Typically, as you would expect from the fare of the food, it's Christian and country-style music. What was really fascinating to me is, you go on their website, and there are four tabs on the Cracker Barrel website -- Menu, Shop, Catering, and Music. So, they really view this as something that attracts folks into the store and attracts loyalty. What thoughts, if any, do you have on Cracker Barrel's music program and how much of an asset it may or may not be to the business?

Sharma: I think it's a good asset. Whenever you can make a connection with your customer beyond your core offering, some type of emotional connection, or artistic in this case, that's strong for recurring business and opening up new channels of revenue.

I wanted to point out, similar to the music, one thing that Cracker Barrel is done is to get their merchandise into retail stores. Mostly, you'll see these food items in grocery stores, which is a more recent development. We're going to talk about an activist shareholder later in the show, and I think that's a result of this activist shareholder pushing the company to expand channels. Cracker Barrel has been very methodical in the way it's looked at expanding to other channels. If I can use a metaphor, if they have four tabs on the website, you don't see a gazillion tabs, so Cracker Barrel isn't trying to be everything to everyone. It's trying to have this one niche. I think that the music draw is a good one for their demographic.

Now, maybe that says to you an older demographic, primarily a white demographic, country music. But what we should say about Cracker Barrel is they've been working really hard to expand their customer base. They've bought advertising on Hispanic channels because there's a growing Hispanic population in the South. They've reached out to millennials, which we'll talk about later in the show. So even though this music niche seems geared toward a very specific type of customer, there's no reason that they can't add some Hispanic programming music to that in the future, and maybe some stuff that appeals to a younger crowd as well. I'll be watching that tab in the coming years to see how that changes.