Where Are the Red Flags in the Cracker Barrel Investment Thesis?

Cracker Barrel (CBRL 3.22%) has treated its shareholders with a huge dose of southern hospitality, as shares have gained 24% annually on a total return basis over the last five years. The organization's relatively stable business model of attracting recurring restaurant visits from highway travelers, and enticing them to visit adjoining gift stores, implies a level of safety versus faster-growth companies. Still, red flags exist, and in the following segment from a recent Motley Fool Industry Focus podcast, we outline problem areas investors should be aware of.

A full transcript follows the video.

Check out the latest Cracker Barrel earnings call transcript.

This video was recorded on Feb. 19, 2019.

Nick Sciple: Asit, let's talk about some, I don't know about red flags, but things to keep in mind for Cracker Barrel. The first thing to watch for Cracker Barrel is their same-store sales. The red flag for me is that traffic has been declining over time. You've seen this at restaurants in general, but for Cracker Barrel, it's particularly important because as we mentioned, the retail strategy of the business depends on bringing folks into the restaurant to eat and then selling them retail merchandise in connection with that visit.

Last year, traffic declined 1.9% and resulted in retail sales being essentially flat for the year. However, in the most recent quarter, we have seen things tick up a little bit with restaurant sales up 1.4% in the most recent quarter, driven by an average check increase of 3%. One percent of that was actually folks buying more off the menu, from an increase in menu prices resulting from new menu items, not just increasing the price of items left on the menu. They also had really powerful retail sales driven by strong performance in apparel and accessories and toys, which I thought was particularly interesting given the Toys R Us bankruptcy over the past year.

When you look at these same-store sales figures, Asit, and the way they have performed in the recent past for Cracker Barrel, what stands out to you from those numbers?

Asit Sharma: What stands out to me is management's analysis of the traffic decrease. You said, Nick, that the traffic trends have been decreasing over time. That's certainly the case. But when you listen to management's calls last year -- actually, I usually read transcripts, a shortcut. Listeners, we often talk about management calls. You can find transcripts online to search for the transcript of an earnings call for a company and skim over it. It is such a great thing to do if you own shares of any company. Sorry for that little bit of diversion there, but important point.

I was skimming these, reading these transcripts from quarters two through four of last year. What took me by surprise was that management itself seemed a little bit surprised at why traffic had declined. Some of these are longer-term factors for the company that management should be dealing with.

I'm going to read you a few of the traffic factors that management cited. First was underperformance of the Campfire menu. This was a menu that was introduced about three years ago which was very popular. Cracker Barrel introduced new items that, in its own words, didn't resonate with customers. So, possibly we're seeing some customer fatigue there. Cracker Barrel also changed its media strategy in the middle of last year with the idea of running fewer weeks of promotion and marketing but with a higher intensity. That did not pan out, so they've gone back to their more regular cadence. Higher gas prices which hit customers' discretionary income and reduced miles traveled in core Cracker Barrel states was also cited. This is what I was talking about earlier. Gas prices can have a pretty quick effect on the company's financials in any given quarter. Again, it's not a cyclical business, but you always have to be ready to hear this for management, "Well, gas prices shot up, so traffic decreased."

And this was, again, surprising -- a decline in guest experience metrics. This is an execution item. Whenever you see customer satisfaction results declining or customers not interested in the menu, that's a little bit of lack of execution on management's part. I think management pretty much realized that. Good on them to dig into it, talk about it on the call. They offered some solutions. I should actually say; one last factor was lack of emphasis on value offerings and craveable offerings. Again, this idea of the menu not being replenished with stuff that appealed to customers.

These are the solutions that management offered. They now have a new innovation called bone-in fried chicken, which is part of their craveable menu approach. They also have shifted back to a value offering cadence. We see this in the quick-service restaurant industry quite a bit. When results suffer, companies will come with limited-time offerings. Two for $5, you've seen that on all the major quick-service restaurants. Cracker Barrel doesn't quite have this type of offering, but it will give specials. It has a messaging for a daily special, which it's doing. It's also trying to leverage its off-premises business, which is an interesting trend. Again, this is something we'll talk about in just a bit. It's trying to increase its catering business and add items to the menu that are conducive to having people order. They're actually adding trucks in major markets to facilitate this off-premises business.

Sciple: Yeah. Interesting to see the issues with the menu. When you look at a business that's been around as long as Cracker Barrel, to think that maybe the menu is not resonating as much as it has in the past, maybe is a source of concern. Definitely something to watch for the business, particularly the traffic numbers that I mentioned, the connection of that to the retail side of the business.

Another part of the business that's emerging and maybe has some question marks for investors when you take a look at it is this Holler & Dash fast casual concept that Cracker Barrel has begun rolling out. They have seven stores across the country today. This is a fast-casual concept that sells biscuits and biscuit-type sandwiches. Interestingly, it only addresses the breakfast and lunch parts of the day, when typically the dinner part is the most profitable daypart. I've actually been to one of these. They opened one in my college town, Tuscaloosa, Alabama, right down from the football stadium a couple of years ago. It was pretty good. For someone who was born and bred in the South, I didn't think it was the best biscuit I've ever had, but it was an interesting concept. It's crowded much of the time. From what you've looked at relating to Holler & Dash, what red flags or what stands out to you in connection to this concept that Cracker Barrel is experimenting with?

Sharma: First, let's talk about the green flags. The good part of this equation is, I mentioned earlier, the company is trying to reach out to the younger demographic, millennials, Gen X, Gen Y. This is the embodiment of that strategy. I think that it's necessary to perhaps have, either within the Cracker Barrel stores or a spin-off concept like this, something that will entice the younger consumer.

It's problematic, though. If you look at the major urban cities -- these are located in Atlanta, Charlotte, of course Birmingham, major Southern cities. We should describe what's actually on the menu. Many of the entree-like dishes are actually biscuit preparations. You have a biscuit served with a protein and a side that's served up as an entree. Nick, what did that run you? Maybe $8, $9 for a biscuit?

Sciple: Yeah, I'd say between $8 and $12. I've only been once, so don't quote me on that, but that sounds accurate.

Sharma: Listeners, tweet at us if you've been to one or if you happen to be from the South. We're going to talk a little bit here. Indulge me, those who aren't from the South, about biscuit culture. I'm here in the middle of it in North Carolina, obviously home of Bojangles. As you go further south to Nick's territory, I think it only becomes more intense.

As the...forgive me, as the hipsters have delved into food culture, and as millennials have become interested in cuisine in major Southern cities -- and I live in Raleigh, so that's a great example -- there's quite a bit of new takes on classical Southern fare in any number of great restaurants. It's difficult, if you live in one of these cities with so much great biscuit cuisine -- and to back me up, I just noticed last night in my grocery store that we have a magazine called Our State, which is a gloss of major stuff going on in North Carolina. A really fun magazine. A whole issue devoted to restaurants that are just like Holler & Dash. These are restaurants which have outré takes on biscuits. It's a hard concept to parachute in -- not that it's parachuting. Obviously, Cracker Barrel is from this area and they worked with two local restauranteurs to begin the concept, so I shouldn't call it parachuting. But to originate this concept here, it's tough. This is a place where there are so many great interpretations on biscuits. I understand why they did it. The biscuit is part of a core menu in Cracker Barrel. In fact, one of the things that management mentioned that it would do to increase traffic is work on its biscuits in Cracker Barrel locations.

I understand it, but I think the red flag here is there's fierce competition in this area. Nick, you mentioned, the company has slowed its pace from the initial few that it opened. They're opening at a very slow rate now. Maybe they're taking some learnings from the first few restaurants and tweaking the concept.

Sciple: Yeah. It's going to be interesting to see how it plays out. Definitely a growth opportunity for a business that appears to be maturing. We'll have to see how things play out.