We continue to believe balance-sheet strength and solid future free cash flow generation are the building blocks of any company’s dividend health. When looking for quality dividend ideas within the full-service restaurant space, a subset of the restaurant industry, it only makes sense, in our view, that dividend analysis should be rooted in balance sheet and free cash flow assessments, along with an evaluation of the sustainability of the business, itself. One of our favorite dividend growth ideas in the full-service restaurant space, Cracker Barrel (CBRL), reported its fiscal 2015 results September 16. We think it’s one we may add to the Dividend Growth Newsletter portfolio at the right price. Our fair value is ~$130 per share.
Many of you may be quite familiar with the restaurant chain already, and we think it’s difficult to argue that Cracker Barrel doesn’t have a differentiated concept than most full-service restaurants. In our view, the unique combination of a home-cooking restaurant and old country store offers customers an experience found in very few places, if truly at all. There’s just something about the great food and the unique shopping experience that keeps bringing people back. Who can forget about those classic wooden rocking chairs on the front porch that have become a staple of its brand?
The retail portion of its restaurant is integral to the overall Cracker Barrel experience, and those same rockers also happen to be some of the best-selling items its store has to offer, a prime example of how value is added through the joint restaurant-store concept with unique items. The retail shop also doubles as a guest waiting area, so instead of sitting in a crowded waiting room or a dark and noisy bar while waiting for their tables, patrons can peruse the old country store, discovering hidden gems and special nuggets that may remind them of a simpler time—and most importantly, spend money on anything from candy, to knick-knacks, to music and beyond.
But the experience isn’t all about nostalgia for Cracker Barrel. With a large selection of items under $20, the firm is targeting higher-volume sales on lower-ticket items in order to capture impulse buys from customers that may not have initially come to shop. The strategy has been working wonderfully. The retail section produces sales-per-square-foot of approximately $400 and boasts gross margins of ~50%, adding significant value to the company’s overall operations.
Fiscal-year 2015, ended July 31, marked a year of financial success for Cracker Barrel. The company reported total revenue of $2.84 billion in the year, an increase of nearly 6% from fiscal 2014. The top-line growth was driven by comparable-store restaurant sales increasing 5.1% from the prior year, which included store traffic advancing 2.1%. Comparable-store retail sales grew 3.6% in the fiscal year.
Both aspects of its business are performing well, and Cracker Barrel experienced solid margin expansion during the fiscal year, too. Its adjusted operating margin grew 120 basis points, driven in part by falling cost of goods sold and labor related expenses, as percentage of revenue. This helped adjusted net income per diluted share grow to $6.82 in fiscal 2015 from $5.63 in fiscal 2014, an increase of 21.1%.
Substantial growth in net income was one of a number of factors that helped Cracker Barrel nearly triple free cash flow in fiscal 2015, to ~$244 million. The company’s cash-flow generating capacity, coupled with the firm’s manageable financial leverage, is in our view, a healthy combination for future dividend expansion. The company’s current annual payout of $4.40 yields approximately 3%, and the restaurant recently paid a special dividend of $3 in July 2015, showcasing management’s commitment to delivering cash back to shareholders. Though the restaurant does have a net debt position (~$135 million), its free cash flow generation is quite impressive.
The calendar third quarter of 2015 is expected to be the US restaurant industry’s fifth consecutive quarter of positive same-store sales growth. This will mark the first time in three years that such a trend has taken place, as several dynamics benefit the industry. The job market in the US, for one, is close to the healthiest it has been in a long time, with unemployment falling to 5.1% in August. The recent drop in crude oil and gasoline prices has freed up an increasing portion of consumer budgets, helping consumers not only eat out more often, but also spend more while doing so. Incidentally, Cracker Barrel restaurants, which are located just off the exits of major highways, are in a perfect position to capture the need for those drivers to eat while traveling wherever they are going.
A strong balance sheet, solid free cash flow generation, and a lofty 3% yield offer the triumvirate why Cracker Barrel is one of our favorites in the full-service restaurant space, but an evaluation of other dividends of other companies in the full-service restaurant industry may be helpful as well. We make a distinction between full-service, fast-casual companies such as Chipotle (CMG) and Panera (PNRA), and quick-service restaurants such as McDonald’s (MCD) and Yum! Brands (YUM). In the table below, we offer a comparison of key metrics for the evaluation of each company’s dividend health and dividend growth potential, two interrelated concepts. Each company’s Dividend Cushion ratio is also provided below.
The Cheesecake Factory (CAKE)
The Cheesecake Factory has one of the best Dividend Cushion ratios in our coverage (4.3) thanks in part to its healthy balance sheet and solid free cash flow generation. However, its yield is not as enticing as Cracker Barrel’s despite The Cheesecake Factory recently raising its quarterly payout by 21%. The company’s recent pace of expansion is indicative of what investors can expect regarding the future trajectory of the company’s payout, at least in the near term. The Cheesecake Factory has significant capacity to continue to increase its dividend on the basis of both its strong balance sheet and solid free cash flow profile, but Cracker Barrel is no slouch either, having tripled its dividend payout in recent years. The Cheesecake Factory is a close second in terms of our favorite dividend growth ideas in the full-service restaurant space, second to Cracker Barrel.
Texas Roadhouse (TXRH)
From a stock-selection standpoint, we view Texas Roadhouse in a similar analytical light as The Cheesecake Factory, even as both have uniquely-different business concepts. Texas Roadhouse generates positive free cash flow, holds a decent net cash position, and the firm has doubled its payout since 2011. Though we wouldn’t expect a similar trajectory to continue for its dividend, we are expecting solid growth in the payout in coming years, even as the company plans to use a significant portion of cash flow for the opening of new stores. Texas Roadhouse is very shareholder-friendly, but as with The Cheesecake Factory, its yield isn’t as enticing as that of Cracker Barrel. Texas Roadhouse has a Dividend Cushion ratio of 2.3.
Darden Restaurants (DRI)
Darden Restaurants’ solid Dividend Cushion ratio (1.3) is supported by its strong free cash flow. The firm expects material profit growth in fiscal year 2016, which should continue to support strong cash-flow generation. On the basis of our forecasts, Darden has the capability to continue paying its current dividend with marginal growth and boasts a solid yield, the result of aggressive payout growth in the past. Though it is not a cause for concern just yet in light of today’s still-healthy US economy, the company’s debt is worth keeping an eye on. In fact, the company’s debt load is the primary reason why we’re staying away from it as a consideration in the Dividend Growth Newsletter portfolio, despite its lofty yield.
Brinker International’s (EAT)
Brinker International’s Dividend Cushion ratio (1.3) benefits from similar financial dynamics as that of Darden Restaurants. Brinker has a material debt position, but its relatively strong free cash flow helps buoy the company’s Dividend Cushion ratio. We’re fans of management’s ability to deliver on its promises of margin expansion in recent years, and cash flow has been a beneficiary of that dynamic. Though its current payout is on solid ground in today’s healthy US economy, Brinker has only but a mildly-interesting dividend yield at this time, at least relative to Cracker Barrel, which has an equivalent Dividend Cushion ratio.
Bob Evans (BOBE)
Bob Evans had been one of our favorite dividend growth ideas within the full-service restaurant space for some time, but the size of its long-term debt load has recently turned us off. Not only does Bob Evans not have the same free cash flow generation ability as Brinker or Darden to support its debt load, but we would prefer to see Bob Evans use its cash to maintain the health of its business rather than continue to increase its dividend payout. If the company continues to see earnings pressure–reported results have been volatile since fiscal 2012–its payout could come under serious pressure. We think there are better choices in this restaurant industry subsegment. Its Dividend Cushion ratio is -0.2 (negative 0.2).
Dine Equity (DIN)
We have a number of issues with the health of Dine Equity’s dividend. The firm has a history of cash mismanagement. For one, it suspended its dividend in 2008 in order to pay down its outsize debt load. Though we like that nearly all of the company’s restaurants are now franchised, reducing necessary capital outlays and thereby supporting free cash flow, the firm’s debt may prove to be too much for its cash flow to handle. We think its higher dividend yield is more a reflection of the risk of its outsize debt load than anything else. Its Dividend Cushion ratio is -1.5 (negative 1.5).