CBRL 6.25.25
Analyst 2
So for quick context for readers who don’t know this name, CBRL is a family restaurant rooted in southern culture. So they serve things like meatloaf and chicken and dumplings and blueberry pancakes. They serve breakfast, lunch, and dinner. And the food is very good, and it's still very much of a value. It's kind of a down-home atmosphere with old Coke signs on the wall, the floors creak, and there's a fireplace inside.
There's not much like it, really. At least in the areas I've been, I can't think of a restaurant that directly competes with them. I think they have a unique franchise and a good brand.
They're mainly located off of highways, so they get a lot of business from travelers, vacationers, as well as people traveling on business just pulling off the highway to get a hot meal, something better than a QSR restaurant. And so that's a big part of their identity as well.
Analyst 1
We are bearish, but for the sake of full disclosure, we are contemplating maybe covering a small short position for a variety of reasons.
We’ve been bearish for a couple of months, just based on the company's core demographic being challenged and just generally it being sort of a challenged concept. Notwithstanding the efforts at the turnaround, which I'm sure we'll spend some time discussing on the call.
Our short thesis is predicated on a couple of other points as well. We knew the company had to refi their debt this year. They actually did that pretty recently, replacing old out-of-the-money converts with another set of converts. So that's part of the reason why we're considering maybe moving off from our position - that catalyst is behind us.
And then maybe more recently, part of the attraction to the short thesis or part of the premise of the short thesis became just how tariffs would impact the roughly 20% of the company's revenue that was coming from their merchandise. At least a third of which, or one-third of which, was directly sourced from China, and it's a greater share of that if you count some indirect China sourcing. I mean, the one-third only describes what the company is directly buying from vendors sourced out of China, basically.
So if there were to be, first of all, the retail business recently - the comps are not great anyway. But if you were to see some combination of margin pressure or just revenue declines there, on what's actually little more gross margin than the company's food sales just given the largely fixed OpEx base and store cost base, that could be very difficult to deal with for a model that's already struggling with the impacts of declines in traffic flowing through the model.
So those are the big reasons. I'm sure in the course of conversation, we'll maybe talk about some of the factors that have led to us potentially contemplating moving on. I mean, one of the other things is, honestly, just the high short interest, which has made it difficult for the short to work irrespective of what's going on in terms of fundamentals. But yeah, that's just a bit of background from our end.
Analyst 2
Yeah. I don't own the stock. I've owned it before, and given the decline in the stock price this year, I dusted it off and did a lot of work on the company this year, but have not bought the stock - kind of on the fence.
I do see it as a very unique franchise, and similar to a lot of other people, it's an iconic brand, particularly in the Southeast. It's very identifiable. It's rooted in southern culture. I do think they have great affordable food, and that's all intact. It's a very disarming environment to walk into. There's no pretense. Kind of come as you are.
So I think all that's still intact despite all their current problems. But the turnaround they're facing, I think, is a pretty heavy lift. And so the way I look at it is really pre-COVID versus post-COVID. Pre-COVID, all was well. They're mature. They're not growing much, but they were humming along as a mature, well-run family restaurant. And then post-COVID, the wheels fell off.
So I looked at, okay, what happened? What's the big difference today versus pre-COVID? Relative to other restaurants, all restaurants have been impacted by inflation. It's hit Cracker Barrel, I think, a bit harder. But I look at the issues, the main issues of what they're facing. It's pretty much all in their gross margin line where gross margins have fallen from 14% pre-COVID to 8% today, and they've declined every year since 2021.
So gross income was $440 million roughly in 2019. Today, it's $280 million. It's a massive decline. And so to fix it, they have a semi-new CEO they hired about a year and a half, two years ago, I think. And they rolled out a fancy strategic transformation plan to refresh the brand and make a whole host of changes.
But I think that the four things that they're trying to tackle, which we can talk about, are: how do you - when you have a somewhat fixed labor model and you've had a huge spike in labor costs - what can you do about it? Menu prices just can't keep up without alienating the customers that look to them for value. They're testing pricing strategies and some things like that.
They also saw, after COVID, a decline in traffic, and so they're trying to refresh the brand and make a lot of changes to tackle that, which I think is a big heavy lift. The dinner day part - they've lost a lot of market share in. That's actually 35% of their sales, but it's the highest margin part of the business, so that's hurt.
And just anecdotally, I've seen for breakfast, there's just a lot of new concepts. I mean, First Watch and Snooze and Another Broken Egg have popped up all around us in the past several years.
And then third would be relevance. They talk a lot about relevance. I'm not as concerned about that, I think, as they are. I think they still have a strong core demographic they can draw from. But it is an older demographic. They do have old restaurants, and so I think they fell behind on maintenance, CapEx, and technology and doing a lot of needed spending that just wasn't done.
And so they're spending, I think, something like $650 million over the next three years from 2025 to 2027, which is like half their market cap. So it's going to cost a lot to get back to where they want to be and have every one of their restaurants meet their standards of what they want to look like.
And then lastly, which I think is something very different from pre-COVID, is how people eat, which is through all the food delivery apps. 20% of their sales are takeout. And Cracker Barrel, as mentioned, is not just a restaurant, but it's a retailer. 20% of their sales are from that store that you walk through when you come in and leave. And if you're ordering through a food delivery app, you're not going to go shopping in their stores.
So work from home and growth in food delivery, I think, has probably impacted their business. And they were behind on digital loyalty programs, things like that, so I think they're spending a lot to catch up there.
But if there's one issue that's the biggest, it's going back to the labor cost. I mean, it's just so big, and it's somewhat fixed. And I've seen companies that have been able to reprice for that inflationary impact, and some companies have not been able to reprice for it without damaging sales, whether it's traffic or just consumer product.
So that's kind of the way I've been thinking about it. I think there is huge upside if they can come close to hitting their EBITDA goal of $400 million in three years. But their turnaround is really contingent mainly on driving traffic, and that's a lot harder than just simply cutting costs. Driving traffic is gonna be, I think, pretty difficult. But anyway, I'll leave it there and open it up, and we can come back to some of those issues.
Analyst 1
I mean, I agree with a lot of your points. Those are a lot of things that we're thinking about. The one about just the difficulty of offsetting labor cost pressures with price - yeah, I mean, that's one of the big challenges that this brand clearly has, right?
Their average check per guest in 2024 was something like $14, right? Like, even though this is a sit-down casual restaurant, it's almost a bit closer to fast food as far as the price point. Not really, I guess. And some of that $14 is probably brought down by the fact that they do serve quite a bit of breakfast, and that tends to just generally be a bit cheaper.
But you've seen it with the fast food brands, right? Like, when your historical value proposition was just known for providing a relatively cheap meal, that model is going to be much harder to maintain that value proposition in an inflationary cost environment, which is part of the reason why, again, a lot of the big QSRs have struggled with traffic. You just can't pull the pricing lever as much in that demographic when basically all you're offering is a relatively affordable meal.
I mean, obviously, these guys are more sit-down and it's not as much takeout, but I think there are similar issues at play.
As far as just the general demographic profile, I mean, as you noted, it's an older demographic. And not to be quite literally morbid, but there is literally some natural churn that probably exists in this business just because of the demographic profile of their core customer base. But at the same time, you can't exactly go and alienate that customer base.
It's hard to make a judgment that translates into a forecast, but there clearly is some underlying tension here where their turnaround is trying to avoid alienating their core customer base. At the same time, it's hard to attract newer, younger guests to the store without changing something. And there's been some discussion that certain changes the company has been making to its stores have alienated some of the core customer base.
So I agree. I think I mean, there's no question, right, sitting with probably just like a $2 billion EV today, that there's enormous upside if they can hit on this turnaround and the targets they've articulated. Again, it's just consumer nature is always hard and turnarounds are hard to predict whether they work or not. Most of the time, they don't work. But for every couple that don't work, there's something like Chipotle, which was a massive home run.
The fact is that traffic has been consistently under pressure for these guys. I mean, the most recent quarter is pretty bad. They say a lot of it was due to weather and some other issues. When people are talking about the second half of this calendar year, maybe it looks a little bit better. But the fact remains that traffic has been under pressure for these guys for a while.
And just given some of the factors that I just mentioned, whatever lift they need to get from their turnaround plan is going to have to make up for all of those things. So it's really hard for me to buy the turnaround and the secular case for the company.
I mentioned that we're inclined towards covering our short position - why we're considering doing that is because our thinking on just a fundamental longer-term traffic outlook for the company has changed. We think the problems they have in front of them are quite challenging.
Analyst 2
Yeah. In terms of the inflationary impact, just trailing on your comments, I was thinking that these are mainly off-highway restaurants. And when you pull off the highway to look at your food alternatives, it's usually like Cracker Barrel might be the best food on the exit, right? There are a lot of cheap alternatives. And so when you're in an inflationary environment, people are going to trade down and go to something cheaper.
Analyst 1
They might even go to a Sheetz or something, right?
Analyst 2
Yeah. So that could be part of the traffic. I mean, the whole industry has seen this problem. But I think with Cracker Barrel, it's like they've been hit a little bit harder. That could be part of the issue. A transcript I was reading this week said that they're planning on raising prices above inflation each year for the next few years. They have this barbell pricing strategy they're testing out. So the higher prices are a little higher, the lower ones are a little lower. And I don't know if that will work or not, but that's going to be really critical to getting their margins back, getting the gross margins back. Labor costs are not going to cut back down. Finding ways to cut labor, I think, is very limited.
So they need to find a way to raise prices - to get a bigger check, as you alluded to, without alienating their customers. The CEO, she has this long list of things they're doing. It makes me a little nervous. If I were a shareholder, I'd be a little bit nervous.
Some of these propositions are pretty tricky, like changing the menus. Restaurant customers want consistency in their food, but I think to some extent, they want consistency in the menu, and they've come to expect something when they go to a restaurant, right?
They don't have much of a marketing budget to market new items. So they keep talking about some of their new products they're putting on the menu and changing the menu up, especially at dinner. So they've been talking about this hash brown shepherd's pie and how it's going to be a big hit.
But they're not McDonald's. They don't have a huge ad budget to go on TV and talk about it. Most of their marketing is billboards. And so if McDonald's is bringing back the McRib, we all know about it because we see it during the football game on TV. But with Cracker Barrel, it's like, okay, you're going to change the menu. I know when they took some items off the menu right after COVID, it was on the news. They were talking about how there was so much pushback on different forums - social forums, online forums - about people up in arms that Cracker Barrel moved something from their menu and people were upset.
And they better tread very lightly here. I think they're pretty good at testing their concepts, so hopefully, they're testing these things out well. But that's a really hard way to get people to come back to the restaurant and to drive traffic because how are you going to know what's on the menu without actually going first?
Analyst 1
I agree. I had seen the same thing, and that was part of what I was alluding to. I think there was also some pushback when they were making some aesthetic changes to the knickknacks and stuff sitting on the wall. But yeah, it's just hard, right? Turnarounds are hard enough in restaurants, and then this company is arguably deeply pressured in the current inflationary cost environment.
But then on top of all of that, doing a turnaround with their demographic - it's just hard, right? Because restaurant customers don't like change, and restaurant goers over 50 absolutely hate change. So how do you reinvent yourself while maintaining that core customer base? And with largely being an off-highway guy with not a big advertising budget, I think it's really hard.
Analyst 2
Right. Yeah, I mean, they’ve labeled half of that $650 million in CapEx as defensive spending. So it's not growth CapEx. It's stuff like refresh and remodel, basically getting their stores back to where they want them to be.
Analyst 1
Yeah. And all that CapEx, even if it works, the stock may respond, but their cash flow is going to be weak. And it's going to get weaker and weaker as they progress in 2025, '26, and '27 because the CapEx is a ramp-up over the next three years.
Analyst 2
Yeah. And the CapEx is large. And then eventually, that CapEx is going to turn into higher depreciation that will hit the income statement. So they guide to $400 million EBITDA, but that's not recognizing all the new depreciation that's going to be coming on the income statement.
Analyst 1
The other thing you talked about is them pulling on price. But I mean, here's the thing - and granted, this is average check, right? I don't have all their numbers, but I know they do disclose separately in MD&A the breakdown of average check - or at least they tell you what their menu pricing was. Obviously, you can figure out what the mix or basket component is.
But if you look at their average check, in their 2020 fiscal year, their July 2020 fiscal year, average check was up 3%, but then 7%, 9.8%, 4.9%, and then the last two quarters, 7.4% and 6.6%. And in those last two quarters, I think menu pricing was 4.9% year over year and 6% year over year in the January quarter.
So it's just like, they've already been pulling that lever a little bit, and the impact on traffic is plain to see, right? There are already pressures on traffic, so how much more can you really pull on that? At the end of the day, if you're trying to charge $20 for bacon and eggs - and maybe you have to because if you have a store, you need to have cooks and employees and servers in there - but that's just not going to work. It's going to be very difficult to work.
So yeah, I think we're probably covering a lot of the same ground here, but everything about the historical positioning and the profile of this business makes it very uniquely challenged in this environment and uniquely difficult to successfully execute a turnaround, even if you were looking at the base rate of consumer or restaurant turnarounds. Whatever the base rate probability is there, it's not a high number.
Analyst 2
Yeah. I was reading an expert network transcript yesterday, and he pretty much said all this CapEx that goes into refurbishing restaurants, it never works. Like, whatever you have today, that's kind of what you're stuck with. No amount of fixing the restaurants - I don't know if that's true or not, but that was his observation.
I do find it interesting that there are some restaurants that have been able to refresh their brands, their cultural image, like Chili's, which I didn't know until recently. But apparently, Chili's is doing great now and has embraced the ‘80s concept or image. Denny's is a diner. They've tried to embrace that, and I think they've been doing a little bit better.
So when you spend this much money trying to fix things, it's going to make some improvements. I would definitely expect to see some improvement at Cracker Barrel. But I don't know what kind of ROI you're going to get on all that spending.
Analyst 1
Yeah. I don't think it's great. I mean, there are a lot of factors. But a lot of what Chili’s has done is positioned themselves in opposition to, at this point, McDonald's. They’re saying hey, you can get a much better cheeseburger here for, let’s say, a buck or two more. Versus you pay a dollar or two less, but you're getting a McDonald's hamburger.
So that's part of how they’ve oriented themselves. Just operations in general - they've obviously just improved, right? But a lot of how they've tried to reposition the brand is towards finding value, which you can't do or it's very hard to do. You can have things like the barbell strategy or creative ways of handling promotions and stuff like that. But you can't have average check - not as much as Cracker Barrel is trying to take that up while having that sort of positioning.
I get that Chili's playbook is not necessarily the right playbook for Cracker Barrel. But the point is, even in that one most recent example of really fantastic casual restaurant performance, I think the playbook that they executed isn't really something that's feasible for Cracker Barrel. So it's tough. Yeah, it's really tough.
Analyst 2
How are you thinking about just the upside/downside? Because when I model it, I'm like, man, consensus is not buying into management's guidance at all. Not much of a turnaround baked into the numbers.
And so if you assume a little bit of improvement, you can get pretty big numbers here. Even though it's going to be hard to do, it's like, okay, there's a 20% chance that they turn this around, but in that scenario, they’re going to be making $7 or $8 EPS.