Image Source: Mike Mozart
Simulated Dividend Growth Newsletter portfolio ideas Oracle and Cracker Barrel both issued less than compelling forward-looking guidance in their most recent fiscal quarter reports. Oracle continues to throw off robust levels of free cash flow that is being used to fund significant levels of share buybacks, but Cracker Barrel may be forced to stop serving up special dividends that have become common in recent years.
By Kris Rosemann
Oracle Throwing off Free Cash Flow, Gobbling Up Shares
Simulated Dividend Growth Newsletter portfolio idea Oracle’s (ORCL) fiscal first quarter report, released September 17, was met with a mixed reaction as management’s guidance for its fiscal second quarter left a bit to be desired. Total revenue grew 2% in constant currency on a year-over-year basis in the quarter, driven by 4% constant currency growth in ‘Cloud Services and License Support,’ which accounts for more than 70% of total revenue. The company grew its leading market share in enterprise resource planning (ERP) in the period, and management points to the ERP market as the largest segment in the application business and an area that will give Oracle the opportunity to become the world’s largest SaaS applications company.
Oracle’s non-GAAP operating income advanced 3% from the year-ago period, and its non-GAAP operating margin held steady at 41%. A materially lower tax rate is helping drive its bottom line higher, however, as non-GAAP earnings per share leapt 19% in constant currency on a year-over-year basis. Higher operating cash flow and lower capital spending in the first quarter of fiscal 2019 led to 4% year-over-year growth in free cash flow to more than $6.3 billion, and the company’s operating cash flow generated in its past four quarters checked in at a company record $15.5 billion. Cash dividends paid in the quarter were just $742 million, and the company holds a net cash position of just under $2 billion as of the end of its first fiscal quarter. Management looks to have significant room to raise the dividend, and it currently registers a 4.4 Dividend Cushion ratio. Shares yield ~1.6% as of this writing.
Mr. Market was not too fond of Oracle’s fiscal second quarter guidance, and management pointed to a tough year-over-year comparison as a reason for the disappointing expectations. Total revenue in the quarter is projected to be flat to up 2% on a constant currency basis, but the company expects a higher growth rate in the second half of the fiscal year. Non-GAAP earnings per share are expected to grow by 12%-16% in constant currency, and management continues to expect a double-digit growth rate for non-GAAP earnings per share in the full year fiscal 2019.
Oracle remains one of our favorite dividend growth ideas on the market due to its robust free cash flow generation and healthy balance sheet, but its yield is not all that compelling at current levels. Management may not be too concerned about the quarterly payout as it aggressively pursues share repurchases as a means of returning cash to shareholders. In the first quarter of fiscal 2019 alone the company bought back nearly $10 billion of its own stock and has reduced its absolute shares outstanding by more than 8.5% in the twelve month period ending August 31. Its board of directors also raised the authorization for share repurchases by $12 billion following the quarter while maintaining the quarterly payout. We would be far more concerned about this development if Oracle was not as strong of a free cash flow generator, and shares are currently trading near the bottom end of our fair value range, suggesting share repurchases are a value creating move at this juncture.
We currently value shares of Oracle at $58 each
Cracker Barrel Facing Traffic Woes, Rising Costs
Shares of simulated Dividend Growth Newsletter portfolio idea Cracker Barrel (CBRL) faced selling pressure following its fiscal 2018 fourth quarter report, released September 18, as comparable store restaurant sales were impacted by materially softer traffic and rising costs weighed on bottom-line performance.
Comparable store restaurant traffic fell 3.5% in the quarter from the year-ago period with particular softness in lighter eaters and in the dinner daypart that management pinned on ineffective marketing and promotional activity, and a 3.1% increase in average check was not enough to fully offset the soft traffic trend. This combination led to a 0.4% decline in comparable store restaurant sales, but comparable store retail sales grew 1.3% on a year-over-year basis. Total revenue advanced 1.3% over the comparable period of fiscal 2017 when adjusting for the extra week of fiscal 2018 (ended August 3 in 2018 compared to July 28 in 2017).
With no adjustment for the extra week, Cracker Barrel’s operating income in its fiscal fourth quarter was roughly flat from the year-ago period at $82.8 million, but its operating margin contracted one percentage point to 10.2% due to higher cost of goods sold and labor and related expenses, which were partially offset by lower general and administrative spending and other operating expenses. When adjusting for the extra week, these figures fall to $71.5 million and 9.5%, and diluted earnings per share fell by $0.04 to $2.19 when adjusting for the extra week.
Free cash flow in the full fiscal year 2018 fell 15% on a year-over-year basis as capital spending rose nearly 38% but operating cash flow advanced roughly 3%. Such a decline has our full attention as free cash flow came in at approximately $179 million in fiscal 2018 and failed to cover cash dividends paid in the year of $207 million, and capital expenditures are expected to grow to a range of $160-$170 million in fiscal 2019 from $152 million in fiscal 2018. We’re not yet concerned about the company’s balance sheet health, but it does hold $400 million in long-term debt compared to ~$115 million in cash and cash equivalents, the latter of which fell from $161 million a year earlier.
Looking to fiscal 2019, Cracker Barrel expects total revenue of ~$3.04 billion compared to $3.03 billion in fiscal 2018 thanks to the opening of eight new stores and expectations for both comparable store restaurant and retail sales growth to be in the range of flat to 1%. Food commodity inflation is expected to be ~2% in the year, which is expected to result in further contraction of the company’s operating margin to 9.3% in fiscal 2019 from 9.7% in fiscal 2018. Adjusted earnings per diluted share are expected to grow to a range of $8.95-$9.10 from $8.87 in fiscal 2018.
Needless to say, we’ll be monitoring traffic levels very closely at Cracker Barrel, and its substantial drop in customer activity in its fiscal fourth quarter was a notable decline from recent quarters. We think management needs to reconsider its special dividend policy as free cash flow coverage of the dividend has become stretched of late and capital spending is expected to continue growing in the near term. The company’s Dividend Cushion ratio currently sits at 1.4, but investors should be aware that this does not take into account potential special dividends in the future.
Our fair value estimate for Cracker Barrel is currently $155 per share, and we’ll be keeping a close eye on the headwinds facing its business. We don’t think this robust income generator is overcooked just yet, but if traffic and cash flow trends continue to deteriorate and special dividends remain a priority, we may be forced to clear our plates of this idea.
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.