Can Cracker Barrel's Red-Hot Dividend Growth Continue?

Can one of the decade's dividend all-stars continue its streak?

Gunnar Peterson
Gunnar Peterson
Jul 16, 2014 at 1:00PM
Consumer Goods

Not many retail operations are Amazon-proof. However, Amazon does not yet have a way to get you a hot meal by the side of a highway during a road trip, and this is where Cracker Barrel Old Country Stores (NASDAQ:CBRL) thrives. 

The company has an excellent track record of dividend growth, increasing its dividend over 600% during the last decade. Shareholders and share prices have benefited from this wise capital allocation.

Cracker Barrel had some outside "help" that convinced it to focus so much on its dividend policy. That help came from activist investor Sardar Biglari. Painful as it likely was for the board and management, the rising dividend has coincided with a rising valuation and a rising price for Cracker Barrel.

CBRL Chart

CBRL data by YCharts

The question to ponder now, with Cracker Barrel set to go ex-dividend on July 16, is can the dividend growth continue? 

A look at the past dividend growth shows that the growth has occurred primarily through a rising payout ratio.

CBRL Dividend Chart

CBRL Dividend data by YCharts

Growing the dividend by returning a higher percentage of income to shareholders through dividends isn't a bad thing; in fact it's shareholder-friendly. But at the same time this approach has limits. With the dividend payout ratio at around 52% it can only go so much higher. Generally speaking, dividends tend to top out in the 60%-70% range for most companies. This means that Cracker Barrel is more likely to grow its dividend in line with its earnings and cash flow growth instead of just management's capital allocation priorities.

The free cash flow coverage metric provides a little more room for optimism in regard to continued dividend growth. Cracker Barrel's dividend is still well covered by its free cash flow.

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CBRL Free Cash Flow Per Share (TTM) Chart

CBRL Free Cash Flow Per Share (TTM) data by YCharts

In comparison with peers like Wal-Mart (NYSE:WMT) and Yum! Brands (NYSE:YUM), Cracker Barrel still appears to have a payout on the higher side.

WMT Payout Ratio (TTM) Chart

WMT Payout Ratio (TTM) data by YCharts

Both Wal-Mart and Yum! generate free cash flow at a higher rate than their dividend payouts. This buffer protects their shareholders and ensure the companies can still pay their dividends if times get tough.

WMT Dividend Yield (TTM) Chart

WMT Dividend Yield (TTM) data by YCharts

The long run total return for investors is determined in large part through dividends. Safety for income investors means consistent free cash flow generation, and Cracker Barrel, Wal-Mart, and Yum! all deliver on this. For growth, the question is really around can the company grow their dividend as fast or faster than earnings? Faster than earnings is preferred, but this only applies usually if the company has had a lower payout ratio. In the case of Cracker Barrel, we saw that doubling the payout ratio led to a neat trifecta: higher dividend, higher valuation and higher share prices.

Cracker Barrel investors may now be entering a period of slower growth. Compared with Wal-Mart and Yum!, Cracker Barrel has the lowest dividend cover. The dividend cover limits the extent to which management can raise the dividend in excess of earnings and/or free cash growth. 

WMT Dividend Cover (Annual) Chart

WMT Dividend Cover (Annual) data by YCharts

Going forward its more prudent to expect that Cracker Barrel's dividend payout growth looks closer to the slowly rising mesas we see in Wal-Mart and Yum! rather than the Everest-like peaks of its recent performance. 

WMT Dividend Chart

WMT Dividend data by YCharts

This is not all bad for Cracker Barrel. Cracker Barrel's fundamental metrics are excellent. Its current yield is 3%, which is 50% higher than the S&P yield, debt/equity ratio is 0.8 and its return on equity is 27%. It's very unlikely that its dividend growth can continue at such a torrid pace, as trees don't grow to the sky. However, growth in line with earnings growth looks doable with support from a quality franchise. Income investors who are looking for yields in the neighborhood of 3% with a chance at high single-digit dividend growth should take a pit stop at Cracker Barrel and look around.