Showdown at Cracker Barrel

In our analysis of the case “Showdown at Cracker Barrel”, we have decided that we would not vote for Biglari in the election. We believe that Biglari’s claims against management’s poor performance were misleadingly taken out of context in order to support his claim for a board seat. Additionally, Biglari’s significant ownership in a direct competitor, Steak n Shake, represents an apparent conflict of interest, and may indicate a potential hidden agenda. Despite our recommendation, we believe there are problems at Cracker Barrel that merit further investigation, specifically these include: poor executive compensation plan, and overly high SG&A costs.  We also explore areas that Cracker Barrel can potentially change in order to improve business, these include a recommendation to start franchising new stores, and to reconsider the inclusion of retail operations in all current and future Cracker Barrel stores.

Benchmark Group

In determining the validity of Biglari’s claims, we determined a competitive set of companies in which to benchmark Cracker Barrel’s performance against. This set of comparable companies satisfied the following criteria: small cap, domestic operations only, and more than 50% company owned. We decided that the three characteristics above represented highly similar companies with similar business models, and consequently should have similar performance and metrics.

An Examination of Biglari’s Complaints

Declining customer traffic. While Biglari’s claim that customer traffic has declined may be true, we believe that this weakening sign may be a common trend amongst similar companies. Using the competitive set defined above, we discovered that the compounded same store sales growth from 2009 to 2011 were about 2% for our comparable set, and -1% for Cracker Barrel (Table 1). Despite not having data from earlier years, this potentially validates management’s claim that the cause of customer traffic reduction was the recession, which is corroborated by the similarly weak same store sales growth from our competitive set.

Poor executive compensation plan. We agree with Biglari that the current compensation plan seems to be misaligned with superior performance. The bonus target should undoubtedly be much higher than the current $90 million in operating income, considering the company has not dipped below that since 1994. When comparing SG&A as a percentage of total revenue, we discovered that Cracker Barrel proportion is almost three times greater than our competitive set (Figure 1). While we do not know exactly why, this could be an indication of a skewed compensation plan. Perhaps they should modify the payment structure so that superior performance is awarded in the form of stock options instead of cash payments, thereby aligning the incentives of board members and shareholders.

Poor operating performance. Biglari claims that Cracker Barrel’s board has been ineffective in terms of operation and that leads to underperformance of the company’s stock versus its competitors. However, when comparing Cracker Barrel’s stock to our own benchmark group, we found this claim to be false. The company’s return of stock performance has been similar to our competitor’s performance except for the 1-year return (Figure 2). Moreover, the lower 1-year return was not due to poor operating performance. According to the income statement, Cracker Barrel’s earnings per share has increased steadily from 2008 to 2011, from $2.88 to $3.70. The lower return on the stock was due to the fact that the market has been giving the company a lower price over earnings ratio, from 14.0 in 2010 to 12.2 in 2011. During the same period, the price earnings ratio for the peer group increased from 20.5 to 23.2. Market’s expectation over the stock determines the price over earnings ratio and it is not solely affected by the operating performance. While taking into the consideration of the steady growth of company’s net earnings and earnings per share, we believe that the company did not underperform in terms of operation.

Suggestions for Strategic Improvements

Consider conversion into a franchise-model. We believe that a franchise-model will help Cracker Barrel to provide more value to its shareholders. There are two benefits for the company. The first benefit is low initial cost, and a higher price to earnings ratio. Since the brand is a well-established brand with a sophisticated business model, there will not be a lot of necessary research and development in order to create a successful franchise model. Moreover, the future costs will be covered by the franchise fees collected from the franchisees. In addition to that, the company can use its $50million to repurchase stock instead of building new units. Currently the price earnings ratio for the Cracker Barrel is 12.2, whereas the average price to earnings ratio for franchising companies is 23.2. Once the company proves to the market that it will continue to perform well and keep up with its competitors, the price of the company stock will almost double, thus providing shareholders more value. The second benefit is a higher NOPAT / Sales and Operating ROA, and a lower SG&A cost. According to the data, franchise model provides a higher NOPAT / Sales (Figure 3) and Operating ROA when compared to non-franchise. The SG&A cost of 10.6% is almost a 50% reduction in Cracker Barrel’s current SG&A cost of 24.3%. This can ultimately translate into a higher return on equity for the company, assuming an efficient use of positive financial leverage. In the long run, a higher return on equity will also give shareholders more value.