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Equity Analysis & Valuation
Analysts
Trent Fell - [email protected]
Sean DePriest - [email protected]
David Barr - [email protected]
Mario Santos - [email protected]
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Table of Contents
Executive Summary for Cracker Barrel Inc.…………………………………………….……..9
Industry Summary……………………………………………………………………………11
Accounting Summary………………………………………………………………………..13
Financial Summary……………………………………………………………………………14
Valuation Summary…………………………………………………………………………..16
Overview of Cracker Barrel…………………………………………………………………………..17
Industry Overview……………………………………………………………………………………….20
Five Forces……….…………………………………………………………………………………….….22
Rivalry Among Existing Firms……………………………………………………………..23
Industry Growth………………………………………………………………………24
Industry Concentration……….……………………………………………………29
Degree of Differentiation………………………………………………………….32
Switching Costs………………………………………………………………….…...32
Economies of Scale………………………………………………………………....33
Fixed-Variable Costs………………………………………………………………...35
Excess Capacity and Exit Barriers…………………………….…………….....36
Conclusion…………………………………………………………………………….…37
Threat of New Entrants………………………………………………………………….…..37
Scale of Economies.............................................................….....38
First Mover Advantage………………………………………..……………………39
Relationships/Distribution Access………………………………………………39
Legal Barriers………………………………………………………………………….40
Conclusion………………………………………………………………………………41
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Threat of Substitute Products..……………………………………………………………41
Relative Price and Performance…………………………………………………42
Buyer‟s Willingness to Switch…………………………………………………….42
Conclusion………………………………………………………………………………44
Bargaining Power of Customers…………………………………………………………..44
Switching Costs………………………………………………………………………..45
Differentiation………………………………………………………………………....46
Importance of Product for Costs and Quality……………………………....47
Number of Customers..………………………………………………………….….48
Volume Per Buyer……………………………………………………………….…...49
Conclusion…………………………………………………………………………….…50
Bargaining Power of Suppliers………………………………………………………….….50
Switching Costs…………………………………………………………………….….51
Differentiation……………………………………………………………………….…51
Importance of Product for Cost and Quality…………………………..…...52
Number of Suppliers………………..………………………………………….……52
Volume Per Supplier…………………………………………………………….…..53
Conclusion…………………………………………………………………………….…54
Five Forces Conclusion ……………………………………………………………………….54
Key Success Factors for Value Creation………………………………………………..55
Cost Leadership………………………………………………………………………..56
Economies of Scale and Low Input Costs……………………….…56
Efficient Production and Simpler Product Designs………………56
Differentiation………………………………………………………………………....57
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Superior Product Quality, Variety, and Customer Service…….57
Investment in Brand Image……………………………………………..58
Firm Competitive Advantage Analysis……………………………………………………59
Efficient Production & Economies of Scale………………………………..…59
Simple Product Designs…………………………………………………………….60
Low Cost Distribution.……………………….……………………………………..60
Superior Product Quality……………………………………………………………61
Investment In Brand Image………………………………………………………61
Superior Product Variety & Flexible Delivery..………………………………62
Superior Customer Service…………………………………………………………63
Conclusion…………………………………………………………………………………………63
Accounting Analysis…………………………………………………………………………….……..63
Type 1 Key Accounting Policies……………………………………………………..…..66
Superior Product Variety……………………………………………….…………66
Investment in Brand Image………………………………………………………67
Efficient Production Methods…………………………………………………….69
Type 2 Key Accounting Policies………………………………………….……………….70
Operating Leases……………………………………………………………………..70
Potential Accounting Flexibility…………………………………………………………………….72
Operating Leases……………………………………………………………………….………72
Actual Accounting Strategy……….………………………………………………………….………73
Operating Leases……………………………………………………………………………….74
Quality of Disclosure…………………………………………………………………………………....75
Introduction……………………………………………………………………………………...75
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Type 1 Accounting Policies…………………………………………..…….………..……....75
Superior Customer Service/Product Quality……………….………..…..……75
Superior Product Variety…………………………………………………..………...76
Low Cost Distribution/Flexible Delivery....................................….....76
Sales Manipulation Diagnostics..……………………………………………………………77
Net Sales/Cash From Sales………………………………………….………………77
Net Sales/Accounts Receivable…………………………………………………….79
Net Sales/Unearned Revenue……………………………….………………………82
Net Sales/Inventory……………………………………………………..……………..83
Conclusion…………………………………………………………..……………………..85
Expense Manipulation Diagnostics…………………………….…………………………....86
Asset Turnover…………………………………………………………………………....86
Cash Flow From Operations/Operating Income………………..………….….90
Cash Flow From Operations/ Net Operating Assets…………………….…...91
Total Accruals/Sales……………………………………………………..…………….…95
Conclusion…………………………………………………………….………………….….96
Potential Red Flags……………………………………………………………….……………………….….97
Operating Leases………………………………………….……………………………………...…97
Cash Flow From Operations………………………………………………….………………....98
Undo Accounting Distortions………………..……………….………………………………….…..……98
Operating Leases………………………………………………………………………………..…..98
Trial Balance………………………………………….…………………………………….…..….…103
Financial Ratio Analysis, Financial Forecasting, and Cost of Capital Estimation………...107
Financial Ratio Analysis…………………………………………………………….………………….…...107
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Liquidity Ratios………………………………………………………………………………..……..108
Current Ratio……………………………………………….……….………………………108
Quick Asset Ratio……………………………………………....…………………………110
Working Capital Turnover………………………….……………………………………112
Accounts Receivable Turnover…………………………………….…….……………113
Days Sales Outstanding…………………………………………………………….……115
Inventory Turnover…………………………………………………..……………………116
Days Supply of Inventory……………………………………………………….………118
Cash to Cash Cycle……………………………………………..…...……………………120
Conclusion……….……………………………………….……………………………….…121
Profitability Ratio Analysis………………………………………………………….………………………122
Gross Profit Margin..……………………………………………………………….………………123
Operating Profit Margin…………………………………………………..………………………124
Net Profit Margin…………………………………….………………………………………………125
Asset Turnover……………………………………………………..…………..…….……………..126
Return on Assets……………….…………………………………………………………….……..128
Return on Equity…………………………………………….………….……………………………129
Conclusion...........................................................................................…...130
Capital Structure Ratios…………………………………………………….…………………..………….131
Debt to Equity………………………………………………………………………………..………131
Times Interest Earned..……………………………..……………………………………………133
Debt Service Margin…………………………………………….…………………….……………134
Altman‟s Z-Score………………………………………………………………….…………………136
Conclusion……………………………………………………………….……….……………………138
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Firm Growth Ratios…………………………………………………………………………………………..139
Internal Growth Rate………………………………………..……………..……………………..140
Sustainable Growth Rate……………………………………………………………….…..……141
Conclusion……………………………………………………………………………………………...142
Financial Statement Forecasting…………….……………………………………………..……………142
Forecasted Income Statement…………………………….……………………………………143
Forecasted Restated Income Statement………………..…………………….…………….149
Forecasted Balance Sheet………………………………………………………………………..153
Forecasted Restated Balance Sheet………………..………………………………………..157
Forecasted Statement of Cash Flows……………………………………………….…….….160
Estimating cost of Capital……………………………………………………….…………..…………….163
Cost of Equity…………………………………………………………………….…………………..163
Size Adjusted Cost of Equity………………………………….……….………………………..167
Alternative Cost of Equity Estimation…………………….………………………….………167
Cost of Debt………………………………………………….………………………………………..168
Weighted Average Cost of Capital………………..……….……….…………………………171
Valuation Analysis……………………………………………………..…………………………..…………174
Method of Comparables…………………………………………………………………………..174
Trailing Price/Earnings (P/E)………………..……………..…….…………………..175
Forecasted P/E…………………………………………….………………………….……176
Price/Book (P/B)…………………………………………………..……………………...177
Dividends/Price (D/P)….……………………………………………..…………………178
Price Earnings Growth…………………………….………………….…………………179
Price/EBITDA………………..…………………….……………………………………….180
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Price/Free Cash Flow…………………………………………………..……………..181
Enterprise Value/EBTIDA………………..………………………..………………..183
Conclusion……………………………………………….…….…….…………………..184
Intrinsic Valuation Models……………………………………….…...………..…………….184
Discounted Dividends Valuation………………………..…….…………………..185
Discounted Free Cash Flows…………………………….…….……….…………..187
Residual Income…………………….…………………………………….…….………189
Abnormal Earnings Growth……………………………………………………………192
Long Run Return on Equity Residual Income………………..……….……….195
Analyst Recommendation……………………………………………………………………….199
Appendices …………………………………………………………………………………………………….202
Liquidity Ratios………………………………………………………………………………………202
Profitability Ratios……………………………………………………………………………………204
Capital Structure Ratios……………………………………………………………………………206
Operating Leases Restated Financial Statements………………………………………..208
Regression Analysis…………………………………………………………………….…………..210
Method of Comparables…………………………………………………………………………..225
Intrinsic Valuation Models………………………………………….…………………………….227
Works Cited……………………………………………………………………..………………………………235
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Executive Summary for Cracker Barrel
Investor Recommendation: Overvalued, SELL (11/2/09)
CBRL-NYSE (11/2/2009) 32.74
52 Wk Range $11.64-$36.60
Revenue 2.37 Billion
Market Cap. 743.9 Million
Shares Outstanding 22.72 Million
As Stated Restated
Book Value Per Share $5.97 $5.53
Return on Equity 71.08% 66.70%
Return on Assets 5.02% 3.42%
Current Market Share Price (11/2/2009) 32.74
Financial Based Valuations
As Stated Restated
Trailing P/E 36.42 31.03
Forward P/E 31.32 26.06
Price to Book 15.9 14.74
P.E.G Ratio 30.9 13.31
Price to EBITDA 33.02 27.25
EV/EBITDA 4.13 -23.8
Price to FCF 32.57 -
Dividends to Price 26.67 26.67
Intrinsic Valuations
As Stated
Restated
Discounted Dividends 18.26 -
Free Cash Flows 76.24 -
Residual Income 19.07 16.59
Abnormal Earnings Growth 22.71 20.11
Long Run Residual Income 7.68 7.47
Cost of Capital
Estimated R-Squared
Beta Ke
3 Month 0.1745 1.522 0.1128
1 Year 0.1747 0.9842 0.1127
2 Year 0.1747 0.9847 0.1128
5 Year 0.1736 0.981 0.1125
10 Year 0.1731 0.9787 0.1123
Published Beta 0.89
Estimated Beta 0.98
Backdoor Cost of Cap: 10.30%
Backdoor Cost of Equity: 11.27%
Cost of Debt 5.42%
WACC (BT): 10.30%
Altman Z-Score
2005 2006 2007 2008 2009
Initial Scores 4.09 2.66 2.74 2.64 2.8
Revised Scores 2.83 1.92 1.95 1.97 1.95
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Industry Summary
Cracker Barrel Old Country Store, Inc. specifies itself in the casual dining sector
of the restaurant industry. The company operates within two separate industries which
helps aid it in surviving in a highly competitive market. Cracker Barrel‟s restaurant
services make up eighty percent of its revenues and the remaining twenty percent is
delegated to sales from the retail store within the restaurants. Cracker Barrel‟s
financials have been negatively affected due to the recent recession, however the firm
has not made any drastic efforts to change the business or its strategy. The company
has maintained consistent with its strategy because it operates within a highly
differentiated niche of the restaurant industry. Cracker Barrel competes with five other
firms which include Brinker International, Bob Evans Farms, Inc., Darden Restaurants,
Inc., Denny‟s Corporation, and DineEquity, Inc.
The casual dining industry is a highly competitive market similar to all other
restaurant business niches. Even though the restaurant industry is so highly saturated,
new businesses are always arising. This is due to such a large demand for restaurant
services and creative strategies developed by new entrants. In addition, large casual
dining companies must also compete with local businesses. Between choosing direct
Competitive Force Degree of Competition
Rivalry Among Existing Firms High
Threat of New Entrants High
Threat of Substitute Products High
Bargaining Power of Customers High
Bargaining Power of Suppliers Low
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competitors, local fare, and eating at home, consumers have a wide variety of options
when it comes to food.
Not only do companies in the industry have to worry about the other firms they
directly compete with, they must also deal with several consumer trends such as the
recent shift towards healthier dining choices. This massive healthy eating trend, which
has been in effect for several years, coupled with the recent recessionary period has
caused many restaurants to add more healthy options to their menus as well as lower
prices. What this implies is that consumers have a high bargaining power and greatly
influence the items on the menu and the price for these items.
One area in which the casual dining industry does have some bargaining power
is with suppliers. There are many suppliers of food and because of this many restaurant
companies engage in hedging activities that allow them to purchase goods at lower
prices. In addition with the large bulk orders these companies must make, suppliers
give discounts for purchasing their goods. Firms become price makers because of the
numerous methods they can employ to save money when purchasing goods.
While operating within the casual dining industry, it is crucial to enlist both a
differentiation approach and a cost leadership approach in company business strategies.
Because of this there are many key success factors in which competitors in the industry
can procure. In the cost leadership bracket firms can make use of economies of scale,
low input costs, simpler product designs, and efficient production. All of these strategies
are designed in order to cut any unnecessary spending. Under the differentiation
approach competitors in this industry can make use of investment in brand image,
superior product quality, variety, and customer service. Where as cost leadership is
designed to cut spending these traditionally promote additional spending to set
companies apart.
As mentioned earlier, casual dining competitors must operate under both a
differentiation approach and a cost leadership approach to create competitive
advantages. Cracker Barrel is no different when it comes to making use of the key
success factors listed above. Some of the methods in which the company achieves their
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success factors may be different, but for the most part the strategies in this industry
are very similar.
Accounting Summary
Companies utilize several methods in which accountants distort their real
performance therefore the purpose of the accounting analysis is to identify any
potential distortions of value. There are several steps that must be taken to properly
assess any distortions. First, the type 1 and type 2 Key Accounting Policies need to be
identified. The type 1 KAPs directly correlate with the identified Key Success Factors
which drive value where as the type 2 KAPs recognize any items in which accountants
are allowed flexibility in reporting. Next, the quality of disclosure in the firm‟s annual
reports needs to be assessed. This is done by means of a qualitative and quantitative
analysis. The qualitative analysis is an opinion based analysis which states our opinion
of the level of disclosure in regards to Key Accounting Policies. The quantitative analysis
on the other hand is based off of reported data. Revenue manipulation and expense
manipulation diagnostic ratios are performed to properly analyze if there are any
potential distortions or “red flags” in financial data. The last step included in the
accounting analysis is to undo any accounting distortions. To do this, a trial balance
sheet needs to be created by taking the annual reported balance sheet data and adding
back operating leases, goodwill, and research and development. The purpose of
creating a trial balance sheet and adding back these items is to view the company with
the additional assets, liabilities, and owner‟s equity initially avoided.
Cracker Barrel is a high disclosure company when it comes to information
regarding its questionable key accounting policies. There was only one key accounting
policy identified that we needed to adjust which was operating leases. We found that
99.9% of all reported leases are operating leases. This rate is exceedingly high for this
industry and restating these operating leases as capital leases was necessary to
properly value Cracker Barrel. In this section, we break down how we capitalized these
operating leases.
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Financial Summary
The purpose of financial analysis is to evaluate the performance of a company by
comparing it to industry averages. Ratio analysis allows analysts to compare ratios of a
company over numerous years and to ratios of similar firms in an industry.1 When a
company‟s ratios are compared to those of industry competitors it allows analysts to
evaluate a firm‟s strengths and weaknesses. The three types of ratios that will be used
in this analysis are liquidity, profitability, and capital structure.
Liquidity ratios measure a company‟s ability to meet its liability obligations in the
short run. Banks and creditors also use these ratios to determine if a firm is risky, or in
other words able to cover their obligations with their assets. In our financial analysis
we used the following liquidity ratios: current ratio, quick asset ratio, working capital
turnover, day‟s supply of inventory, receivables turnover, day‟s sales outstanding,
inventory turnover ratio and cash-to-cash cycle. From our liquidity ratios, we
determined Cracker Barrel‟s liquidity to be slightly below the industry average. This is
caused by the high levels of inventory that Cracker Barrel keeps for the retail business.
Profitability ratios measure how effective a firm is at creating income as well as
minimizing expenses in order to maximize their profits. The profitability ratios that we
used in our financial analysis are: gross profit margin, operating profit margin, net
profit margin, asset turnover, return on equity, and the return on assets. Based on our
findings, Cracker Barrel outperforms a majority of its industry competitors. This means
that Cracker Barrel is underperforming in its ability to create sales from its assets.
Capital structure ratios are used in examining how a firm finances the purchases
of new assets. Companies can finance operations by either debt or equity. Unlike the
previous two types of ratios, capital structure ratios don‟t measure performance, but let
analysts measure a company‟s default risk. The capital structure ratios that we used in
our financial analysis are: debt/equity, times interest earned, debt service margin, and
1 palepu
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Altman‟s Z score. We found that Cracker Barrel has an average credit risk, this means
that they are healthy enough to withstand a recession and grow during normal
economic climates.
We must also look at potential growth rates when performing the financial
analysis. In order to do so we can use sustainable and internal growth rates. The
sustainable growth rate is the maximum rate that a company can grow without
increasing financial leverage. The internal growth rate is the maximum growth rate
that a company can grow without acquiring any additional funds. Cracker Barrel
outperforms a majority of its competitor‟s growth rates, meaning that the company can
continue to grow without the use of additional funds.
Next, to value the current position of the company, we must forecast financial
statements. In order to forecast financial statements we relied on trends, growth rates,
and financial ratios. We first forecasted the income statement, as stated and restated,
by using estimations based on our forecasted sales growth. Then we forecasted the
balance sheet, as stated and restated, using the asset turnover ratio, accounts
receivable turnover, inventory turnover, and current ratio. Finally we forecasted the
statement of cash flows; this is the hardest statement to forecast due to the fact that
there is no link to any of the other statements. We used the CFFO/Sales and
CFFI/Change in Non-current assets to forecast out the statement of cash flows.
Finally, the cost of capital must be estimated in order to properly value a firm.
Since the leverage of a firm affects return to investors we must find the weighted
average cost of capital (WACC). The WACC is derived by taking the weighted average
cost of equity and adding the weighted average cost of. In order to calculate the WACC
you must first find the cost of debt and the cost of equity. We derived the cost of
equity by using the capital asset pricing model (CAPM). The cost of equity is the
minimum return required for an investor to invest in a company. CAPM is the
company‟s beta multiplied by the market risk premium (MRP) plus the risk free rate.
We found Cracker Barrel‟s cost of equity to be 11.27%. The cost of debt gives insight
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into how easy or expensive it is for a company to borrow money. The cost of debt is a
weighted average of Cracker Barrel‟s debt outstanding and its interest rates, which we
found to be 5.42%. We found the WACC before tax to be 10.5% as stated and 10.3%
restated. Then we found the more appropriate before tax WACC using the back door
method, which was 15.6% as stated and 10.3% restated. We chose the restated
before tax WACC using the back door method as the WACC to use in our valuations.
Valuation Summary
We separated the valuation analysis into two sections: the methods of
comparables and intrinsic valuations. The method of comparables utilizes the industry
average to compute a resulting price for each approach. Components of the ratio were
found on Yahoo Finance on November 2, 2009. Most of the results we found using
these methods showed that Cracker Barrel‟s current market price is overvalued.
Although this is a popular method in calculating the share price of a company, it is not
supported by any theories or analyst opinions. This flaw hinders the effectiveness of
the results. For this reason, we did not make any valuation decisions based on the
method of comparables.
Intrinsic valuation models are much more reliable because they are supported by
theory and include analyst opinions. This allows for a more accurate valuation of the
firm. Because of this, we based our final decision according to the intrinsic valuation
model calculations. The models used were: discounted dividend model, discounted free
cash flow model, residual income model, long run ROE residual income, and the
abnormal earnings growth. According to the models, Cracker Barrel is overvalued in all
but the discounted free cash flow model. The discounted free cash flow model only
takes into account dividends and leaves out capital gains. Also, it only has an
explanatory power between 10-20% so it was not considered in the valuation.
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Overview of Cracker Barrel
The Cracker Barrel Old Country Store was founded along a Tennessee highway in
1969 with the lone mission of “pleasing people.” The goal was to give travelers a large-
portioned, country home-style meal at a fair price while making them feel as if they
were part of the family. Cracker Barrel has since expanded into one of the largest
restaurant chains in the United States. In addition to serving country-style food, Cracker
Barrel maintains a retail store in each location. The retail stores are stocked with an
extremely wide variety of items such as toys, country music, gifts, foods, and their
trademark rocking chairs. The retail section is a unique part of the experience and sets
Cracker Barrel apart by providing customers the ability to “treasure hunt” within the
depths of the store‟s odd trinkets. The firm‟s commitment to providing an enjoyable
customer experience has been recognized by numerous awards, including “being
named “Best in Family Dining” by Restaurants and Institutions magazine‟s “Choice in
Chains” consumer survey for the 18th consecutive year.”2 Today, Cracker Barrel remains
an icon in consistency and quality; a place where the customer experience is put above
all else.
Founder Dan Evins began his vision in Lebanon, Tennessee, and 40 years later
the Corporate Headquarters are still located there. Over the years Cracker Barrel has
expanded throughout Southeast America and into 41 states, with stores as far reaching
as Vermont and Idaho. However, most of its 588 restaurants are located in the
southeastern part the United States where their country food is most loved. Roughly
85% of stores are located along highways as a continued strategy to make Cracker
Barrel a roadside stop for families and travelers. In turn, 40% of its customers are
travelers.
Each store seats 215 customers in a 10,000 sq. ft. building. Around 100
employees serve an average of 7,350 customers per week. Cracker Barrel boasts
2 Cracker Barrel Fact Book. May 27, 2009. Corporate Profile.
18
impressive turnover rates for the restaurant industry, as yearly turnover is below 80%
for hourly employees and 20% for management. This keeps expenses from hiring and
training new employees at bay and is a testament to the company‟s reputation for
treating its employees with respect and creating an enjoyable work environment.
The retail store is supplied from a lone distribution center located with the
headquarters in Lebanon, Tennessee. Each Cracker Barrel is designed so that the
customer must walk through the retail store to enter the restaurant, and back through
the store once more to pay the bill. This results in 32% of customers purchasing retail
in addition to their meals. The retail store also features many items used as door
busters to attract customers to the restaurant. Cracker Barrel has recently done
exclusive CD releases for Dolly Parton, Montgomery Gentry, and The Zac Brown Band.
In addition, they offer exclusive releases for child‟s toys aimed at bringing families to
the restaurant.
Recently the Cracker Barrel retail store was the exclusive retailer of a new design
of the popular kids‟ toys, Webkinz. The retail section not only acts as a way to increase
sales to customers coming for the food, but also as a reason for customers to come in
the first place. The Lubbock store‟s general manager, Terry Edwards, compares Cracker
Barrel‟s retail section to the competitions bar. The vastly different retail is very
important to Cracker Barrel‟s profits. Although Cracker Barrel‟s tagline is “Half
Restaurant. Half Store. All Country.”, Cracker Barrel really only derives around 20% of
its total revenue from sales in the retail store.
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The following chart shows the percentage of revenue generated from the retail
component of the business over the past 5 years:
The next graph illustrates Cracker Barrels total assets from 2003 to 2008. For the most
part total assets have remained flat. In 2008, Cracker Barrel had approximately 1.3
billion dollars in total assets.
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20.5
21
21.5
22
22.5
23
23.5
24
2004 2005 2006 2007 2008
Percentage of Total Revenue from Retail
% of Total Revenue from Retail
0
200
400
600
800
1000
1200
1400
1600
1800
2004 2005 2006 2007 2008
Total Assets (in millions)
Cracker Barrel
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As of September 14th, 2009, Cracker Barrel Old Country Store had a market
capitalization of $725.62 million at a stock price of $32.09. The market value is
calculated by multiplying the number of shares outstanding times the current per share
price. Market value can be used as a way to show the relative size of a firm, but is
subject to massive swings as stock prices change. That being said, Cracker Barrel‟s
market cap is well above the restaurant industry average of $175.62 million. The
following graph illustrates the recent decline in Cracker Barrel‟s market value.
Industry Overview
Cracker Barrel conducts business in two distinctly different industries. Based on
the EDGAR Filings, the primary Standard Industrial Classification code for Cracker Barrel
is “5812 Eating Places.” The secondary SIC code is the “5947 Gift, Novelty & Souvenir.”
3 Notably the main industry for which Cracker Barrel operates is the restaurant
industry. The potential profitability of the firm to co-integrate the different lines of
businesses into one strategically positioned competitive business is important. In the
case of Cracker Barrel, the decomposition of revenues indicates that 71% of its revenue
3 http://www.answers.com/topic/cbrl-group-inc
2015663.4
1643508.55
1402733.64
769456.84
461092.46
2004 2005 2006 2007 2008
End of Year Market Value(in thousands)
21
stream is based on the dining (food service) aspect of the business, while the other
29% is derived from the retail (gift shop) component.
A specific list of competitors for Cracker Barrel is provided in Table 1. This list
does not encompass all of the firms that operate within the restaurant industry.
Instead, these firms are more of a direct rival than an indirect rival. For example,
McDonalds, a very well known fast food chain, also operates in the restaurant industry.
However, McDonalds would be considered more of an indirect competitor because
drive-through windows and casual dining provide substantially different eating
experiences than the sit-down style Cracker Barrel provides. The indirect competition is
important, but for the purpose of this analysis it would be more fruitful to examine the
peers that are more closely related. Table 1 illustrates the five specific peers that
compete directly with Cracker Barrel.
Table 1: The Competition
Brinker International
Bob Evans Farms, Inc.
Darden Restaurants, Inc.
Denny‟s Corporation
DineEquity, Inc.
Darden Restaurants, Inc. has a large variety of restaurants underneath its
umbrella. More specifically, they operate: Red Lobster, Olive Garden, LongHorn
Steakhouse, The Capital Grille, Bahama Breeze, Season 52, Hemenway‟s Seafood Grille,
Oyster Bar, and The Old Grist Mill Tavern. The sheer size of Darden Restaurant‟s, Inc.
imposes significant competition upon Cracker Barrel. Darden Restaurants provides
competition because their restaurants also embrace a specific dining environment.
In this analysis, the term “operate” is used loosely because each firm is slightly
different. For example, Cracker Barrel operates its stores, whereas Darden Restaurants,
Inc. operates and franchises their restaurants. Brinker International also operates and
franchises its restaurants. Another major competitor is Brinker International. Brinker
International has three very distinct brand names under its oversight: Chili‟s Grill and
22
Bar, On the Border Mexican Grill and Cantina, and Maggiano‟s Little Italy. Arguably,
Cracker Barrel‟s most related competitor is Bob Evans Farms, Inc. because both
businesses comingle the restaurant with a novelty / gift shop. Bob Evans Farms, Inc.
oversees Bob Evans Restaurants and Mimi‟s Cafes.
The fourth peer on our list is DineEquity, Inc., which operates the International
House of Pancakes (IHOP) and Applebee‟s Neighborhood Grill and Bar. Furthermore,
according to Terry, the general manager at the Lubbock restaurant, Denny‟s and IHOP
are the two most significant competitors for Cracker Barrel. However, he also
emphasized the importance of the local market for direct comparison. The focus of
Denny‟s, IHOP and Cracker Barrel is to attract the “breakfast crowd.” However, all three
restaurants also serve lunch and dinner. According to the Technomic, “DineEquity Inc.‟s
International House of Pancakes, the category leader, has an estimated 7.3% share of
U.S. sales in the segment, followed by Denny‟s Corp. with 6.8%, Cracker Barrel Old
Country Store Inc. with 5.6% and Bob Evans Farms Inc. with 3%.”4 The list of
competitors chosen does not encompass all of Cracker Barrel‟s potential competitors,
but the comparisons will provide insight into the many intricacies of the highly
competitive restaurant industry.
Five Forces
The industry structure and firm profitability are analyzed from the two
dimensions of the five factor model outlined by Palepu & Healy. The first dimension
evaluates the magnitude of competition and examines the level of competitiveness by
decomposing the intensity of competition into three different subcategories. The first
subcategory examines the current market share and the competitiveness of the
restaurant industry. The second subcategory examines the barriers to entry for the
industry and the ability for firms to enter and exit the market. The last subcategory
evaluates the sensitivity of consumers demand for the product. The second dimension
4 Gibson, Richard. “A New Recipe” The Wall Street Journal. July 13, 2009.
23
explicitly evaluates the competitive nature of the business in both the input market and
the output market. In summary, the analysis scrutinizes the restaurant industry
structure for which Cracker Barrel Old Country Store operates and their potential
profitability in the context described above.
The following graph represents the overall competition and power of the
impending forces upon the company.
Competitive Force Degree of Competition
Rivalry Among Existing Firms High
Threat of New Entrants High
Threat of Substitute Products High
Bargaining Power of Customers High
Bargaining Power of Suppliers Low
Subcategory 1 - Rivalry Among Existing Firms
The rivalry among existing firms is evaluated by looking at the industry growth,
concentration, differentiation, switching costs, scale of economies, learning economies,
fixed cost, variable costs, excess capacity, and exit barriers of the industry. Depending
upon the level of competition that exists within the industry, firms will either compete
along the pricing dimension or on the non-pricing dimension. In order to set prices,
and be competitive, a firm needs to operate in an industry where the number of rivals is
relatively small. The higher the level of concentration, the higher the prices the
restaurants will be able to charge. The lower the level of concentration, the more
competitive the price strategy will have to be. In conclusion, the restaurant industry is
highly competitive and moderately concentrated. The large number of rivals drives
competition to cut cost, innovate, and establish branding image. In summary, the
24
investigation of the rivalry among existing firms enables us to shed light on the actual
and potential competition that exists within the restaurant industry.
Industry Growth
Industry growth reflects how fast an industry can expand and contract. The
restaurant industry growth can be evaluated from two very different expansion paths.
One expansion path enables a firm to acquire market share from a new pool of
potential consumers, while the other expansion path requires the firm to compete
among its rivals for market share among existing customers. Logically, most firms that
compete within the restaurant industry want to attract new customers, while stealing
away customers from the other firms. The most challenging aspect for Cracker Barrel is
that their competitors in the industry are running specials and posting coupons on their
website. Other firms in the industry have also not followed their competitors in hopes
that name brand and the unique atmosphere will carry them through these tough
times.
Julie Jargon wrote in the Wall Street Journal that the restaurant industry is
struggling during these difficult economic times. She also indicated that parents are
now deciding to leave their children at home when they go out to eat, which inevitably
reduces the average restaurant sales ticket. Julie said, “The industry is scrambling to
counter a tendency by recession-pinched parents to leave their children at home when
they go out to eat. Restaurant visits among groups with kids fell 5% in the 52 weeks
ended June 30 compared with a year earlier, according to researcher NPD Group.”5
The current economic downturn has inevitably increased the competitiveness of firms
within the restaurant industry, because the number of consumers who are going out to
eat is on the decline. The following analysis examines the restaurant industry growth
rate from two different angles: annual sales growth, and number of new restaurants.
5 Jargon, Julie. “Restaurants Look Beyond Chicken Fingers.” Wall Street Journal. September 1, 2009.
25
The industry‟s annual sales growth seems to outpace the annual growth rate in
the U.S. Gross Domestic Product. The annual sales growth rate for the restaurant
industry has averaged approximately 6% per year over the five year sample period
(2003 to 2008). Over the course of the sample period, the annual sales growth rate was
lowest in 2005 (at 4.44%) and highest in 2008 (at 12%). The growth rate for 2008 is
misleading because in 2008, DineEquity, Inc. completed its merger with Applebee‟s
Neighborhood Grill and Bar. The annual revenue growth rate for the industry was
5.74% ignoring DineEquity, Inc.‟s growth rate for 2008. This result is not reported in
the table below.
Table 2: Peer comparison of total $ sales in thousands.
2003 2004 2005 2006 2007 2008
Cracker Barrel 1,923,545 2,060,463 2,190,866 2,219,475 2,351,276 2,384,521
Darden Restaurants, Inc. 4,655,000 5,003,400 4,977,600 5,353,600 5,567,100 6,626,500
Brinker International 3,285,390 3,541,005 3,749,539 4,141,291 4,376,900 4,235,223
Bob Evans Farms, Inc. 1,091,337 1,197,997 1,460,195 1,584,819 1,654,460 1,737,026
DineEquity, Inc. 404,805 359,002 348,023 349,560 484,559 1,613,628
Denny's Corporation 950,945 960,006 978,725 994,044 939,368 760,271
Total Sales 12,311,022 13,121,873 13,704,948 14,642,789 15,373,663 17,357,169
Table 2 suggests that over the last 5 years restaurant sales have been on the
rise. The result of DineEquity, Inc.‟s merger with Applebee‟s is apparent in the above
table. In 2007, DineEquity, Inc. had total sales of $484,559,000 and was the smallest
contributor to industry sales. After the completion of the merger with Applebee‟s,
DineEquity, Inc.‟s sales jumped to $1,613,628,000, which is significantly higher than the
previous year. DineEquity, Inc. is no longer the smallest contributor to industry sales.
They have jumped up one spot and have almost caught up with Bob Evan‟s Farm.
26
This increase in sales growth is easier to interpret by looking at Table 3. In addition,
Table 3 reports the annual sales growth rates for each firm within our defined industry.
Table 3: Peer comparison of Annual Sales Growth
2004 2005 2006 2007 2008
Cracker Barrel 7.12% 6.33% 1.31% 5.94% 1.41%
Darden Restaurants, Inc. 7.48% -0.52% 7.55% 3.99% 19.03%
Brinker International 7.78% 5.89% 10.45% 5.69% -3.24%
Bob Evans Farms, Inc. 9.77% 21.89% 8.53% 4.39% 4.99%
DineEquity, Inc. -11.31% -3.06% 0.44% 38.62% 233.01%*
Denny's Corporation 0.95% 1.95% 1.57% -5.50% -19.07%
Industry 6.59% 4.44% 6.84% 4.99% 12.90%*
Annual sales growth rates for each firm i, in year t, is calculated using the following
equation:
𝐴𝑛𝑛𝑢𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 𝐺𝑟𝑜𝑤𝑡 𝑅𝑎𝑡𝑒𝑖 ,𝑡 = (𝑆𝑎𝑙𝑒𝑠 𝑖 ,𝑡
𝑆𝑎𝑙𝑒𝑠 𝑖 ,𝑡−1− 1) ∗ 100.
The following graph illustrates the industry growth rate. The industry growth rate
has been relatively flat over the last few years. The last value is misleading because the
large increase in the industry growth rate stems from the fact that DineEquity, Inc.
0
2,000,000
4,000,000
6,000,000
8,000,000
10,000,000
12,000,000
14,000,000
16,000,000
18,000,000
20,000,000
2003 2004 2005 2006 2007 2008
Annual Industry Sales
27
merged with Applebee‟s. Excluding DineEquity from 2008 decreases the industry growth
rate to 5.74% for 2008.
Table 4 shows the total number of stores that each firm in the industry operates.
Table 4: Total number of restaurants.
2004 2005 2006 2007 2008
Cracker Barrel 504 529 543 562 577
Darden Restaurants, Inc 1,311 1,398 1,443 1,665 1,683
Brinker International 1476 1588 1622 1801 1888
Denny's Corporation 1638 1603 1578 1546 1541
Bob Evans Farms, Inc 558 683 689 694 703
DineEquity, Inc 1165 1186 1242 1302 3320
Total Restaurants 6652 6987 7117 7570 9712
There are three noteworthy findings from this table. First, all of the firms in the
industry have opened up new stores every year since 2004 except for the Denny‟s
Corporation. The number of Denny‟s restaurants has been on the decline since 2004.
Second, the combination of IHOP and Applebee‟s has led to a larger number of stores
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
2004 2005 2006 2007 2008
Industry Revenue Growth Rate
Industry
28
for DineEquity, Inc. Third, the industry on the aggregate has seen a steady increase in
the number of stores that are operated.
The following figure compares the growth rate in the number of stores for the
industry. This time series graph is slightly misleading because the large increase in the
number of restaurants operated and franchised in 2008 is mainly due to DineEquity,
Inc.‟s merger with Applebee‟s.
In summary, the provided evidence suggests that industry annual growth rate in
sales has been relatively flat over the last several years and the annual increase in the
number of new restaurants has been on the rise. These findings are interesting because
the increase in stores, in theory, should also increase the amount of revenues that are
generated. This preliminary evidence suggests that the slow increase in revenues is
mainly attributable to an increase in the number of stores. More importantly, the flat
growth rate in sales has the potential to increase the rivalry among existing firms in the
restaurant industry.
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
2005 2006 2007 2008
Percentage Change in New Stores
29
Industry Concentration
Industries that are highly concentrated are more likely to refrain from engaging
in destructive competitive pricing. Instead, these firms will implicitly coordinate their
prices in such a way that enables each to earn a profit. Industries that exhibit low
levels of concentration are more likely to engage in competitive pricing behavior
because these firms will have a much harder time coordinating and signaling pricing
information to their competition. The restaurant industry is moderately concentrated.
The four-firm concentration ratio for the restaurant industry exceeds 80% for the
period 2003 - 2008, assuming that the industry is defined by the selected firms.
Obviously, the sample of firms does not encompass the entire restaurant industry;
however, these firms are representative of the significant players. Moreover, the
concentration of an industry can have significant implications for the potential
profitability of the firm.
Table 5 illustrates the annual industry concentration results. There are two
significant conclusions that can be drawn from this table. For starters, Cracker Barrel
and Denny‟s are the two most noticeable firms that have been losing market share over
the last five years. Next, DineEquity, Inc. is the only firm that has seen a significant
increase in market share. Undoubtedly, this large increase in market share is derived
from their merger with Applebee‟s. The other three firms (Darden, Brinker and Bob
Evans) have maintained their market share throughout this period of time.
Table 5: Annual Industry Concentration
2004 2005 2006 2007 2008
Cracker Barrel 15.70% 15.99% 15.16% 15.29% 13.74%
Darden Restaurants, Inc. 38.13% 36.32% 36.56% 36.21% 38.18%
Brinker International 26.99% 27.36% 28.28% 28.47% 24.40%
Bob Evans Farms, Inc. 9.13% 10.65% 10.82% 10.76% 10.01%
DineEquity, Inc. 2.74% 2.54% 2.39% 3.15% 9.30%
Denny's Corporation 7.32% 7.14% 6.79% 6.11% 4.38%
Industry 100.00% 100.00% 100.00% 100.00% 100.00%
30
The following figure provides a graphical representation of Table 5.
The following exploding pie chart represents the industry concentration for the
fiscal year 2008. Industry concentration is the total percentage of sales of each
individual firm within the industry. The percentages are based on the total sales of the
firm within a particular year divided by the total number of sales for the industry during
the same year.
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
35.00%
40.00%
45.00%
2004 2005 2006 2007 2008
Annual Industry Concentration
Cracker Barrel Darden Restaurants, Inc. Brinker International
Bob Evans Farms, Inc. DineEquity, Inc. Denny's Corporation
31
The above pie chart illustrates that Darden Restaurants, Inc. and Brinker
International represent more than 50% of the total industry. Cracker Barrel‟s market
share is small, 14%. However, Cracker Barrel ranks third out of all of the firms within
the industry.
In summary, the evidence suggests that the market share is heavily
concentrated among the top four firms. This result implies that the industry is
dominated by two firms, Darden Restaurants, Inc. and Brinker International. Moreover,
the four-firm concentration ratio in 2008 was 86%. The evidence suggests that the
restaurant industry is moderately concentrated. This implies that the firms will not
engage too heavily in destructive price wars and the firms will try to signal to the other
participants the prices that they are setting for a particular meal. The firms in the
industry implicitly price signal other firms in the market by posting some version of their
menu online. These menus all contain prices for the meal. Although the price signaling
is prevalent among these firms, they are also engaging in a recognizable price war.
Some of the restaurants are running specials, while others are posting coupons on their
websites to attract customers in a down economy. Interestingly, Cracker Barrel is not
participating in this price war. There are no coupons or food specials on their website.
14%
38%25%
10%
9% 4%
Industry Concentration - 2008
Cracker Barrel Darden Restaurants, Inc. Brinker International
Bob Evans Farms, Inc. DineEquity, Inc. Denny's Corporation
32
Degree of Differentiation
Product differentiation enables a firm to distinguish itself from the competition.
The degree of product differentiation in the restaurant industry comes from three
sources. The main difference between restaurants is the type of food they are serving
whether it be: Mexican, Italian, Steakhouse and Japanese. This would explain why
many of the firms within the industry choose to have multiple chains under their
supervision. This enables them to cover a large range of potential customers. The type
of restaurant will play a role in where customers choose to eat. However, this method
of differentiation will be minimal because most of the firms in the industry have more
than one style of restaurant.
The restaurant environment and dining experience is another source of
differentiation. This element is important because the array of restaurants in the
industry all have a particular environment they are trying to achieve. For example, On
the Border Mexican Grill aims to provide a fun, Mexican style atmosphere, while Cracker
Barrel attempts to create the home-away-from-home feel. The final two sources are
quality of the food and customer service. Clearly, poor food quality and customer
service can cause customers to seek out alternative eating destinations. Alternatively,
great customer service and high food quality can create a loyal customer base. All of
the restaurants consider customer service as one of the most important aspects of their
business. In conclusion, the restaurant industry exhibits a moderate level of product
differentiation.
Switching Costs
Switching costs refer to the cost associated with allocating the company‟s assets
to a different business venture. The switching costs for a restaurant can be relatively
low. For example, the restaurant can be easily transformed into a different style of
restaurant. The reason for the low amount of switching costs is because very little
switching is required of the capital already in place. A basic remodel of the restaurant
33
will more than likely suffice. The switching costs significantly increase if the restaurant
transforms into anything other than another restaurant. For example, the restaurant
facility could be transformed into an office building or another retail store. The reason
why switching costs will be significantly higher for those firms that choose to change
industries is because much of the capital used in the restaurant industry is industry
specific. New capital would have to be obtained and the existing capital would have to
be sold. In conclusion, the restaurant industry exhibits a high level of switching costs,
assuming the restaurant is not transformed into a different restaurant, which increases
the degree of rivalry among existing firms.
Economies of Scale
Economies of scale contribute to the degree of competitiveness of the firms
within the industry. Economies of scale imply that as the firms grow larger and larger
their average unit costs decline. Firms that do business in an industry where economies
of scale are possible will find it beneficial to increase the size of their firm. “In such
situations, there are incentives to engage in aggressive competition for market share”
(Palepu & Healy). The restaurant industry is not identified as an industry that exhibits
significant economies to scale. The following table and graph illustrate the total assets
of the key firms in the restaurant industry.
Table 6: Peer comparison of total assets in millions.
2004 2005 2006 2007 2008
Cracker Barrel 1435.7 1533.2 1681.2 1265 1313.7
Darden Restaurants, Inc. 2780.3 2937.8 3010.2 2880.8 4730.6
Brinker International 2211.7 2156.1 2221.7 2318 2193.1
Bob Evans Farms, Inc. 853.3 1150.9 1185 1196.9 1207
DineEquity, Inc. 821.6 771 768.8 3831.1 3361.2
Denny's Corporation 499.3 511.7 444.4 377.4 347.2
Industry 8,602 9,061 9,311 11,869 13,153
34
Table 6 shows that the total assets for the industry are on the rise. More
importantly, the total assets of the restaurant industry have almost doubled in 4 years‟
time. Although the industry has been growing, the increase in growth has done little to
reduce the average unit cost of the meal that is produced. The unit cost of the goods
that is produced by the restaurant industry is heavily dependent upon food prices and
energy prices.
The following graph shows the total assets of the industry in millions of dollars.
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
2004 2005 2006 2007 2008
Total Assets of the Industry (in millions)
Industry
35
The following graph shows the total assets of each firm in the industry by year.
As seen in the above graphs, the total asset value for the restaurant industry is
on the rise. This would suggest that the firms are attempting to increase their balance
sheets. However, a closer examination of Table 6 suggests that most of the firms in the
restaurant industry have experienced little to no growth in their total assets. The main
contributor to the increase in total assets is DineEquity, Inc. The results suggest that
the restaurant industry is moderately concentrated. This implies that a few key
companies dominate the market, which makes it difficult for a small firm to compete on
a national or global scale.
Fixed - Variable Costs
Firms that have high a fixed-to-variable cost ratio are more inclined to engage in
aggressive pricing strategies. Alternatively, firms that exhibit a low fixed-to-variable
cost ratio are more concerned with the monitoring of their variable costs. The
restaurant industry has a relatively low amount of fixed costs. The fixed costs include
0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
2004 2005 2006 2007 2008
Total Assets (in millions)
Cracker Barrel Darden Restaurants, Inc. Brinker International
Bob Evans Farms, Inc. DineEquity, Inc. Denny's Corporation
36
industrial grade ovens and refrigerators. In contrast, the restaurant industry has high
variable costs. The variable costs include labor costs, supplies, energy costs, food costs,
and rent costs.
2004 2005 2006 2007 2008 2009
Cracker Barrel
-0.19 -1.16 0.87 -1.73 0.59 -0.92
Bob Evans -0.25 -0.12 -0.40 -0.51 -0.42 -0.30
Dennys -1.17 3.14 -0.51 0.07 2.25
Darden 1.39 1.18 -5.27 -1.92 1.58 1.63
Brinker International
-0.31 0.81 -0.38 -0.21 -0.64 -0.26
The restaurant industry has a fixed to variable cost ratio that is less than one.
We computed this by taking all the positive fixed to variable cost ratios of Cracker
Barrel‟s competitors, not including companies with negative variable costs, and
computed an average of .39. A low fixed to variable cost ratio means that the store is
not highly leveraged, and they can cut stores and cut capacity easily. This also means
that firms cannot reduce this ratio by increasing the demand for their product.
Excess Capacity and Exit Barriers
When the demand for the product exceeds the supply, firms are encouraged to
raise prices to eliminate shortages. On the other hand, firms have incentive to reduce
the prices of the products when the demand for the product is less than supply. Excess
capacity motivates restaurants to offer specials, discounts and coupons. Interestingly,
excess capacity only comes in one dimension in the restaurant industry – empty seats.
The current economic climate has increased the probability of excess capacity in the
restaurant industry. The threat of excess capacity has undoubtedly increased the rivalry
among existing firms.
Palepu and Healy state: “Exit barriers are high when the assets are specialized or
if there are regulations which make exit costly.” The restaurant industry has specialized
assets – the industrial ovens, grills, deep-fryers, and refrigerators. However, there is no
37
discernable regulation which makes exiting the industry costly. Thus, exit barriers in
the restaurant industry are low.
Conclusion
The evidence above suggests that the rivalry among existing in the restaurant
industry is high. The relatively flat industry growth rate indicates that firms are
competing for existing customers. They are able to compete through different pricing
strategies and the degree of product differentiation. The firms exhibit a moderate level
of product differentiations. Furthermore, most of the differentiation is derived from the
restaurant environment, quality and customer service. The firms also exhibit a
significantly high level of switching costs, assuming they are not transforming their
existing assets into different restaurant. These higher switching costs increase the
rivalry among existing firms. The restaurant industry exhibits a low level of economies
of scale, which enables them to reduce some per unit costs as they grow larger. The
restaurant industry has a low fixed-to-variable cost ratio, which implies that the fixed
costs are lower than the variable costs. Most of the restaurant expenses are derived
from the variable costs. Lastly, the current economic climate has reduced demand for
eating out, which also has increased the rivalry among existing firms. With relatively
low exit barriers, it is possible that some of the firms may go out of business.
Subcategory 2 - Threat of New Entrants
Firms all over the world have many threats they must anticipate in order to be
successful and remain profitable. These threats range from other existing firms to
unpredictable events. Such events would be new firms and new products that are not
currently in production. When the industry has positive economic profits to be had, the
industry is in constant threat of new entrants until each firm makes zero economic
profits. Each new entrant takes a share of the market away from the existing firms;
therefore, the threat of new entrants is a problem for all existing firms in that market.
In certain industries firms do not have to worry as much about new entrants because of
38
significant entry barriers such as: scale of economies, first mover advantage,
distribution access, relationships, and legal barriers. All of these barriers help to
determine the degree of a threat from new entrants.
Even though firms may have a specific set of other firms they see as direct
competition, in the restaurant industry every restaurant can be considered a possible
threat. For example, an American food restaurant may not see an Asian food
restaurant as a direct threat, but it could be considered a threat to their dinner crowd if
it opened up shop next door. These threats make the industry very competitive by
nature, because there are so many restaurants in each city.
Scale of Economies
Scale of economies is the idea that the larger a firm gets and the more it
produces, the cheaper the next item is to produce. This creates a cost advantage for
the pre-existing firms because they will have a lower cost than a new start up firm.
This idea also considers that the larger firms become the more bargaining power the
firms get over suppliers. If a firm has many suppliers willing to sell them goods they
are not bound to one supplier. This means if a supplier thinks that a firm is one of their
largest customers, they are willing to negotiate prices to keep the firm‟s business. The
larger the firm is the more bargaining power it receives. This is attributed to the
economies of scale.
Although most restaurants do receive some benefits from the scale of
economies, it is not a huge threat to new entrants. The new firms will not get to enjoy
the cost saving advantages in the first few years, but as long as they break-even they
can increase their customer base and eventually their bargaining power. For this
reason the scale of economies is not significant enough to prevent other companies
from taking market share.
39
First Mover Advantage
The first firm in an industry always has a competitive advantage over firms that
enter later. They learn more about the industry and what their consumers want. If the
firm knows what their customer wants, then fulfills those wants, they will bring the
customers back into their shops. Firms use this advantage to build brand image and
consumer loyalty. The first firm in a market also sets certain standards. In the
restaurant industry, these are prices, serving sizes, customer service, and whether or
not there are free refills on sodas or free chips.
The problem in the restaurant industry is that when a new restaurant opens
most people are willing to try it out. This can cause problems for the existing
restaurants because all of the sudden their tables are empty during the grand opening
of a new restaurant. If the new restaurant doesn‟t fulfill its customer‟s wants, then
they will go back to what they know. However, if they do satisfy their customers, it
means a new firm has just entered the market. For this reason the first mover does not
have a huge advantage over other firms in this industry. Therefore, the first mover
advantage proves to be a relatively small barrier of entry.
Relationships/Distribution Access
Relationships and distribution access tend to be a large barrier to entry in most
industries. These two categories go hand in hand because most distributors want to
build a relationship with their customers in order to keep their business. These
relationships help both sides because the supplier learns what exactly the customer is
looking for, and vice versa. Through these relationships they can make deals with the
distributors to get lower prices. This is an advantage for the earliest firms in the
market because they can form relationships with suppliers. This poses as a potential
problem to new firms that have all the machinery to produce a product, but no inputs
because suppliers are not willing to work with them.
40
In the restaurant industry this problem does not pose a huge threat because of
the vast number of suppliers. These include grocery stores, Sysco, Wal-Mart, SAMs,
and other distributors. These suppliers are located in most major cities that have
restaurants. Another key factor about these suppliers is that they do not require a
company to form a relationship to get reasonable prices. Although a large company will
get slightly better prices, it is not enough to keep competition from entering the market.
Therefore, relationships and distribution access do not present a large barrier to new
firms wanting to enter the market.
Legal Barriers
There are many legal barriers that can restrain new entrants from entering the
market. In every industry there are laws and restrictions that must be followed. In
certain industries firms may have to obtain special licenses in order to operate their
business. These legal barriers vary from state to state if it is a local industry and by
country if it is international. Most of these permits and licenses take months or even
years to acquire.
The restaurant industry is no different. Regulations vary in each state, but most
states require firms to have certain permits and licenses just to open. According to
Lorri Mealey, a writer for About.com, most states require an “entertainment permit, sign
permit, seafood permit, seller‟s license, liquor license, insurance, and a number of other
permits and license” just to open a business.6 In the Texas area restaurants are
required to have a health inspector permit, alcohol license (if the firm serves liquor),
smoking permit (if smoking is allowed in the facility), building inspection, occupancy
permit, fire inspection permit, zoning license, and a sales tax id. The legal barriers are
the toughest barriers a new firm faces when trying to open a new business. If a firm
fails to get any one of these permits it could jeopardize their chances of opening or
being successful.
6 Mealey, Lorri “Restauranting FAQs” About.com
http://restaurants.about.com/od/openingarestaurant/a/Restaurant_FAQs.htm
41
Conclusion
Overall the threat of new entrants into the restaurant industry is very high. This
is because the barriers that keep firms out are comparatively low in the restaurant
industry. The hardest barrier new firms must overcome are the legal issues involved in
acquiring permits and licenses. The first mover advantage does give the first entrants
an edge, but it is not nearly enough to keep competitors out of the market. In today‟s
economy, suppliers are constantly looking for new customers; this allows new firms to
enter the market relatively easily. The scale of economies can help certain firms in the
restaurant industry, but it does not necessarily hurt the smaller firms and keep them
out. In summary, entry barriers are very low in the restaurant industry.
Subcategory 3 - Threat of Substitute Products
Substitute products have an indirect threat to businesses in all industries, as it is
indicated by Porter‟s Five Forces Model. Although a substitute product may not have as
big a threat as relevant products, it is still important to consider the risk a substitute
product poses to a firm‟s primary product line. A substitute product does not have to be
of the same form of an existing product, but simply an alternative product that
performs the same function and gives consumers the same benefit.
Full-service restaurants are highly competitive within their own industry. Food, in
general, is not a unique commodity; it can virtually be found anywhere. Therefore, the
full-service restaurant industry faces the threat of substitutes from other food industry
segments, as well as consumers‟ choice to dine at home. Due to the competition
between restaurants in the industries, they must compete based on menu prices and
performance to attract and retain customers. Because there is such a wide variety of
choices consumers have in the food industry, consumers essentially have a low
switching cost.
42
Relative Price and Performance
Full-service restaurants face steep competition in the segmented food industry.
In the full-service restaurant segment of the industry many restaurants compete for
market share, while also indirectly compete with the fast-service restaurants, limited-
service restaurants, and cafeterias. “In the current year through June, according to the
U.S. Department of Agriculture, sales of food away from home fell by just 2.5 percent
from the previous year.”7 With restaurant industry sales still slumping, it is important for
industry competitors to compete on relative price and performance to increase profits
and gain market share.
In such a highly competitive industry, the restaurant industry has to find ways to
stay competitive while still remaining profitable. Many restaurants are currently offering
discounts and promotions to attract customers as they try to increase revenue. For
example, DineEquity‟s International House of Pancakes and Denny‟s restaurants are
now offering menu items starting at $5.99 to try to increase clientele, due to negative
quarterly revenues of 17.6% and 18.1% respectively.8 Input prices for the industry
have an effect on relative overall pricing. Restaurants try to balance increasing
ingredients cost with menu and price adjustment, while trying to maintain consumers
that have diminished purchasing power. “Up to August, wholesale food prices went up
8.7 percent on top of a 7.6 percent rise in food items the previous year. In contrast,
menu prices went up this year on the average by only 4.2 percent.”9 With an overall
price increase in restaurant menu prices, customers have to decide whether to pay a
premium for a higher quality of food, or switching to a lower cost substitute.
Buyers’ willingness to switch
The food industry has a low switching cost, meaning that consumers in this
industry don‟t have to remain brand loyal. Other segments in the food industry offer an
7 Brett Arends. “Will the Recovery Boost Restaurant Stocks?” Wall Street Journal, August 13, 2009
8 http://finance.yahoo.com/q/co?s=CBRL
9 http://www.allheadlinenews.com/articles/7012830379#ixzz0RHTmJRL8
43
array of low cost substitutes, but the full-service restaurant industry offsets the threat
with the use of strong branding. This includes marketing techniques such as higher
quality menu items, differentiated atmospheres, and outstanding quality of service. In
both the full-service restaurant industry and food industry, switching costs are low
because consumers can compare prices with relative ease; information about menu
prices can be obtained easily through the internet or advertisements. In the fast-service
industry, many competitors offer “value menus” which are a threat to full-service
restaurants because consumers can obtain a similar benefit at a lower cost. The threat
of consumers substituting going out to eat with eating at home is directly correlated
with the success of the economy. In an economic recession, consumer spending on
restaurant dining is one of the first areas to take a hit. The following chart shows the
answers of over 1300 consumers when asked if they will be spending more or less
money on restaurants over the next 90 days.
This chart uses information from ChangeWave Research Company.10
10
http://seekingalpha.com/article/114572-consumers-show-little-appetite-for-restaurants
0
10
20
30
40
50
60
Sep
'06
Nov
'06
Jan
'07
Mar
'07
May
'07
Jun
'07
Aug
'07
Sep
'07
Nov
'07
Jan
'08
Feb
'08
Apr
'08
May
'08
Jul
'08
Aug
'08
Sep
'08
Nov
'08
Dec
'08
Percentage of Restaurant Spending
Spending Less Spending More
44
The consumers‟ answers are split almost 50/50 for the first year (2006), while
the economy was rising. When the stock markets began to crash in late 2007, spending
less shot up into the 30‟s, 40‟s, and even 50‟s while consumers‟ plans to eat out over
the next 90 days plummeted to single digits. When faced with a need to cut spending
costs, consumers will immediately look towards alternative ways of eating rather than
dining at restaurants.
Conclusion
The threat of substitute products in the full-service restaurant industry is
relatively high. With a high degree of competition within the food industry, consumers
demand for food is elastic. Consumers can easily switch to substitute products, like
eating at home, because of the low cost to switch between substitutes in the industry.
In times of economic recession consumers can trade down to lower cost substitutes
such as fast-service restaurants, limited-service restaurants, or choose to just dine at
home. This fact is demonstrated by recent Wall Street Journal Article, by Katy
McLaughlin. She wrote, “Casual dining sales overall are down 6% to 7% this year as
more customers eat at home or turn to fast food to economize, said Technomic, a
Chicago restaurant consultant.”11
Subcategory 4 - Bargaining Power of Customers
The bargaining power of customers determines the price setting ability of
restaurants in the industry. If customers are exuding a relatively strong level of
bargaining power, then the industry will be forced to be more of a price taker. On the
other hand, if customers lack bargaining power, then the industry will have the luxury
of being more of a price setter from the output side of production. The purchasing
decisions and the elasticity of consumer demand is dictated by the amount of
bargaining power the consumer has in the output market. Firms will earn lower profits
in a market where the consumer does have power. Furthermore, customers will be
11
Katy McLaughlin. “Macaroni Grill’s Order: Cut Calories, Keep Customers.” Wall Street Journal. Wednesday, September 16, 2009.
45
more willing to go to different restaurants when the firm increases their price. In
essence, the consumers will be able to substitute other products rather easily and thus
their demand curve will be relatively more elastic. This means they are more sensitive
to a change in prices.
The large number of close substitutes in the restaurant industry provides a
plethora of choices for the consumer. Firms in the industry are inherently aware of this
market complexity. This reduces their ability to set prices. In general, firms are price
takers from the output side of this market. Therefore, restaurants that tend to make
profits strive to keep their prices competitive. To further explain the bargaining power
of customers‟ analysts need to know the switching costs, differentiation, importance of
product for costs and quality, number of buyers, and the volume per buyer.
Switching Cost
Switching costs are the costs associated with customers switching from one
restaurant to another. For example, if it is expensive for a customer to switch
restaurants, then they have high switching costs. By contrast, if it is cheap for a
customer to switch between restaurants, then they have a low switching cost. With so
many restaurants to choose from, customers are never obligated to stay loyal to just
one restaurant. The inherent problem with the restaurant industry is location, location,
location. Most restaurants tend to set up shop relatively close to other restaurants. This
increases the number of restaurant choices without increasing the cost of switching
from one restaurant to another. The amount of fuel consumption for switching
between restaurants is negligible.
The only non-monetary cost would be a consumer‟s taste and preference. For
example, Joe really likes eating at restaurant “X” because he enjoys the live music and
quality of the food. Joe may not like having to switch to another restaurant because the
opportunity costs of switching are high. The “average Joe” is not the same as the Joe
in this example, which means that the opportunity cost of switching between goods is
minimal at best. According to the example, the consumer‟s switching costs are low to
46
non-existent. This increases the customer‟s bargaining power because they can
implicitly dictate what price they are willing to pay. If a restaurant increases their
prices, or competitors lower their prices, the customers will go elsewhere at relatively
no expense to them.
Differentiation
Every firm wants their product or service to standout from other firms in their
industry. This is accomplished through product and service differentiation. The degree
of differentiation is crucial to repeat customers. The customers that go to Denny‟s
definitely do not expect to be able to browse intricate trinkets and CDs. The service and
the food quality of the two restaurants are vastly different. Michael Woodhouse reports
in the annual report that Cracker Barrel has scored reasonably well in market surveys
and has won several awards for quality. “PeopleMetrics, a research firm that tracks
consumer markets, surveyed 1,250 customers about their experiences at nine major
restaurant chains. Cracker Barrel Old Country Store scored high in customer
engagement, which means: 1) the customer feels valued; 2) there‟s an engaged
employee who‟s creating the experience; and 3) there is a clean environment and hot
food.”12 In the restaurant industry the main differentiation between eateries comes in
the form of quality and environment.
If the restaurant is noticeably different, in a positive manner, then the customers
will be more likely to return. At a certain level of product differentiation, the
restaurants will be able to mitigate customer bargaining power because consumers will
be looking for a particular experience. One of the closest substitutes is Bob Evans. Bob
Evans also has a gift shop in its restaurants. The heterogeneous products enable firms
within the industry to attract a particular demographic of customers. Firms in the
industry that offer unique services have a slight advantage over customers‟ bargaining
power when compared to other restaurants like Denny‟s and Applebee‟s.
12
2008 Annual Report. Cracker Barrel Old Country Store.
47
Importance of Product for Costs and Quality
Customers see costs and quality as some of their top priorities when choosing
where to dine out. In the current economic conditions consumers are looking for the
lowest possible prices while maintaining high quality. Firms are choosing to compete
for existing customers to maintain an ample revenue stream. The main source of
competition is through pricing tactics, which encompasses discounts and specials.
Notably, restaurants who neglect to compete or follow the industry have potential for a
significant loss of customers. Although the reduced prices have a tendency to decrease
potential profits, the pricing promotions have the ability to sustain customers in a down
economy. Firms who choose to compete in this manner need to be aware of the
potential downside risk.
Reducing profits to sustain revenues has the potential to reduce a profitable firm
to an unprofitable firm. Furthermore, these promotional activities have the potential to
upset customers. In a recent Wall Street Journal article, Diana Ransom wrote “A recent
KFC promotion actually sparked protests among customers.”13 Interestingly, Cracker
Barrel restaurants do not offer price discounts on their menu items. The only discount
that the restaurant offers is a tourist special. “Our country Coach Service offers several
benefits to tour groups.” In contrast, many of the major competitors are offering
substantial discounts on their food. For example, Applebee‟s is offering the “Pick „N
Pair” lunch special starting at $5.99 and Denny‟s is running a “Build Your Own
Grandslam” for $5.99. Furthermore, Denny‟s also provides a senior citizen discount.
In order to keep customer‟s coming back to their restaurants, restaurants
attempt to keep their prices competitive and their food quality high. While most stores
are offering specials and discounts, Cracker Barrel keeps their prices as static as
possible, and they find other ways to cut cost. For example, instead of serving bread to
everyone before their meal, they ask customers what type of bread they want with their
meal. This reduces the potential waste of bread that companies like Olive Garden have,
13
Ransom, Diana. “Can They Really Make Money Off the Dollar Menu?” Wall Street Journal. May 21, 2009.
48
when they bring a basket full of bread before the meal. Some restaurant managers
have even started “using less costly cuts of meat…offering less free bread and cutting
back on condiments,” according to Carla Norfleet Taylor, a Fitch Ratings analyst.14
Every time one restaurant lowers their prices and cuts quality, it creates a ripple effect
through the industry which in turn changes consumer‟s options. In the end, these
options are allowing customers to have more bargaining power.
Number of Customers
The restaurant industry generated $17,357,169,000 in sales in 2008. The
amount of customers that is served on a daily basis is significant. The size of the
customer basis is inversely related to the level of customer bargaining power. This
means that as the number of potential customers increases the amount of bargaining
power decreases because the restaurants are less concerned with customers switching
to other restaurants. The main variable that may influence this hypothesis is the
decomposition of the customer base. Each restaurant may have a particular
demographic of customers for which they are trying to curtail their restaurant around.
This is especially true for Cracker Barrel, whose customer base is mostly citizens over
the age 50. Over 64% of their clients are over 50 years of age and only 11% are
between the ages of 18 and 34.
14
Arends, Brett. “Will the Recovery Boost Restaurant Stocks?” Wall Street Journal. August 13, 2009.
49
The pie graph illustrates that only 35% of Cracker Barrel‟s customers are under
the age of 50, whereas Denny‟s is targeting 18-24 year olds. When Denny‟s releases
new items on the menu they announce this through Twitter and MySpace.15 From the
industry‟s perspective this could pose as a threat to restaurants because in order to get
new, younger customers they might have to surrender even more bargaining power to
their customers. Old, retired customers tend to have a more elastic demand than
younger customers. This means that older people are more sensitive to a change in the
price of the food they are serving. The restaurant industry needs to consider the price
sensitivity and recognize that this gives their average customer more bargaining power.
Volume Per Buyer
In general the volume per buyer plays a large role when determining a
customer‟s bargaining power. The more that a single customer buys, the more
bargaining power he wields. So, if in a specific industry there is a relatively small
amount of customers, firms are flexible for those individuals. Therefore, the customers
have more bargaining power. On the other hand, if an industry has a vast amount of
customers then firms are not as flexible towards a single customer‟s preferences. This
means that the industry has more bargaining power over customers.
15
Jargon, Julie. “Denny's Tries Night-Owl Vibe.” Wall Street Journal. June 30,2009.
11%
24%
33%
32%
Customer Sales Percentage by Age
18-34 35-49 50-64 65+
50
Thousands of customers visit a single restaurant on a weekly basis. The average
check per person in the United States is $6.51.16 When comparing Cracker Barrel, who
averages a check of $8.93 per person, and Olive Garden, who averages a check per
person of $1517, analysts can see a significant variation from the U.S. average. This
variation allows analysts to assume that each firm has a different amount of bargaining
power over their customers.
Conclusion
In conclusion, restaurants are generally price takers on the consumer side of the
market. Although they do gain some bargaining power through product differentiation
it is not enough to overtake the consumers‟ low switching cost. The restaurant industry
gives up even more bargaining power when they start competing on the cost and
quality of their menu items. The number of customers and volume per buyer should
give the restaurant industry more bargaining power because the number of customers
is high, and the check per person is low. Although this is the case, the restaurant
industry cannot capitalize on this power because the market is extremely competitive.
If they do not cater to each customer then they start losing shares of the market to
their competitors who do cater to each customer. Inevitably, the low switching cost
forces restaurants in the industry to be extremely competitive and give most of the
power to its customers. Although each individual firm has a different amount of
bargaining power, it is not enough for the industry to become a price giver.
Subcategory 5 - Bargaining Power of Suppliers
The bargaining power of suppliers is dependent on the overall concentration of
the industry. The less concentrated an industry is the more influence a supplier has
over the negotiation of the terms of a deal. The higher concentrated an industry
becomes more options become available, shifting the negotiating power over to the
buyers.
16
Dougherty, Connor “Restaurant Traffic Declines Worldwide” Wall Street Journal. August 25, 2009 17
“The Darden Menu” Fast Company. July 1, 2009
51
In the restaurant industry there are many companies for food suppliers to do
business with. Food can be produced locally by farmers, or it can be imported if it is a
specialty food. In this industry there is low price sensitivity when it comes to suppliers
due to the nature of competitiveness. Furthermore, the low barriers of entry in this
industry lead to strong price competition among food suppliers. Due to the high
competition of this industry most of the suppliers will be price takers, which forces them
to price their goods at a competitive market price.
Switching Cost
The switching cost is determined by two key factors; the concentration of an
industry and the uniqueness of a product. The switching cost for suppliers the
restaurant industry with a low concentration is low because there are many buyers
demanding the product. The only exception is for suppliers that provide a specialty
good. The less unique a commodity is the lower the switching cost is for a supplier
because of a larger market and higher demand for that product.
Food suppliers are made up of thousands of domestic and international farmers.
Food is a common commodity, giving a low switching cost to suppliers because they
don‟t have to sell to just restaurants. Suppliers find a high concentration of food
demand locally and abroad from restaurants, grocery stores, hospitals, and other
businesses. If a supplier or a farmer has a type of food that is widely demanded such as
beef, chicken, or pork, the switching cost is relatively low because the market for these
products is much larger and demanded by a larger number of consumers.
Differentiation
Suppliers can increase their bargaining power over customers by setting
themselves apart from the competition. Differentiation can be achieved through quality,
perception, reliability, and uniqueness. Suppliers that deal with a common commodity
have to differentiate in order to be successful because customers will naturally search
for cheaper substitutes.
52
Food that is produced domestically is virtually the same as the food that is
produced internationally. All chicken and beef tastes the same. Food suppliers in the
food industry must differentiate their product in a different ways than the product itself.
One way of doing so is to provide a higher quality commodity. Suppliers can provide
bigger chickens or thicker steaks, but it is up to the customer to conclude if this value
added by the supplier is worth paying a higher price for. Food suppliers also
differentiate themselves by having a strong, reliable relationship with the customer.
Great operational management is key for suppliers to surviving in this industry. Since
supplier products are undifferentiated in the industry their bargaining power is low.
Importance of Product for Cost and Quality
In order for a supplier to have more bargaining power they must deliver a
product that is of high quality for a low cost. If the product is undifferentiated, such as
produce, then buyers are more price sensitive. When firms demand a lower cost,
suppliers have to compete on price. Let us take a look at this relationship in the
restaurant industry.
Restaurants search for suppliers that can deliver low prices so that the profit
margin of its own products does not shrink. Distributors of restaurants have low
bargaining power because they are forced to be price takers in this industry. In order
for the distributers to be profitable it must either increase sale amounts to restaurants,
or tighten up on cost control. In order for restaurants to maintain great quality of their
products at a reasonable price for consumers, it is essential to have suppliers that
consistently deliver great quality products at a low price.
Number of Suppliers
The concentration of the industry is a determinant of how much bargaining
power suppliers have. If there is a low concentration of suppliers then buyers are left
with fewer choices, which increase supplier bargaining power. Alternatively, an industry
53
with a high concentration of suppliers makes buyers more price sensitive and shifts
bargaining power over to the buyer.
There is so much competition in the restaurant industry that suppliers have lower
bargaining power. When dealing with a restaurant that has a strong market share,
suppliers are price takers. Local suppliers are obliged to the contractual terms that firms
set for its suppliers. The high level of competition for suppliers gives the bargaining
power in this market to large restaurants because it sets the standards for its suppliers
using contracts. According to Cracker Barrel‟s 10k,“Approximately 75% of [their] food
commodities are under contract for the remainder of fiscal year 2009 as of November
24.” 18 This type of contract setting is an example of how most firms in the industry
manage supply chains.
Volume Per Supplier
In any industry, the volume of products that suppliers produce can equate to
bargaining power. If a supplier produces a high volume of a certain company‟s
inventory, suppliers have more bargaining power because a company is dependent on
them. Rather, when the supplier‟s volume of a product is relatively low then the power
shifts to the buyer because dependability and switching cost of suppliers are lower.
In the restaurant industry, buyers are not dependant on any single source of
supplies or raw materials because of the low concentration of suppliers. In order for
restaurants to maintain a consistent quality of their food nationwide they must acquire
food products and other items from reliable suppliers. When prices of products are
uncertain in the future restaurants may enter into purchasing contracts or buy supply
in bulk to ensure that their expenses do not increase, and also that quality is assured.
Since firms are usually not dependant on a single source of raw material, suppliers
ultimately have low bargaining power.
18
http://investor.crackerbarrel.com/faq.cfm?expand=true
54
Conclusion
Ultimately, suppliers of firms in the restaurant industry are price takers in the
market. Suppliers have low switching costs because of the low concentration of firms in
the restaurant industry. Because suppliers in this industry have undifferentiated
products their bargaining power is relatively low. In order for restaurants to keep cost
low they are price sensitive when it comes to choosing suppliers. The low concentration
of suppliers gives the bargaining power to the firms in the industry. Finally, the volume
each supplier contributes to firms in the industry determines the bargaining power. High
volume suppliers have higher bargaining power. Alternatively, lower volume suppliers
have a lower bargaining power. As a result of these factors suppliers in the industry
have relatively low bargaining power.
Five Forces Conclusion
Analysis of the five forces within the industry portrays a substantially high level
of competition and consumer power over prices. The restaurant industry is a very
aggressive market because the only real barriers faced by new entrants are permits and
licenses. The other entry barriers faced by new firms in this industry are relatively non-
existent, due in part to the vast amount of suppliers who are willing to offer their
products at a minimal rate. Rivalry amongst the industry‟s suppliers creates high
Competitive Force Degree of Competition
Rivalry Among Existing Firms High
Threat of New Entrants High
Threat of Substitute Products High
Bargaining Power of Customers High
Bargaining Power of Suppliers Low
55
bargaining power for the casual dining industry‟s firms. This is caused in part by the
large amount of suppliers in the restaurant industry. Numerous firms within the
restaurant industry create a very competitive market.
In order to remain a strong competitor, firms must have adequately low prices,
high quality, and an established brand image. If these strategies are not used, home
cooked meals and fast food are readily accessible to the industry‟s consumers. This
entails that the customers play a large role in dictating prices within the industry. In
times of economic pitfalls this can be seen through forced discounts and incentives
given to consumers. This in turn, provides customers the option of going out to dine
over staying home. From the five forces model it is safe to derive that the degree of
competition in this particular industry is significant.
Key Success Factors for Value Creation
When analyzing a firm, there are two strategies involved in creating a
competitive advantage within an industry. Companies can obtain competitive
advantages through a cost leadership approach, a differentiation approach, or a mix
between the two. A cost leadership approach is used when there are other companies
who are producing the same or similar products. This form of strategy is highly
dependent on the competitive prices of items produced as well as the cost of purchased
goods. Efficient production and distribution are also essential when considering a cost
leadership strategy. The differentiation approach is desirable when firms are offering
unique products or services. Some of the operating methods that classify this approach
consist of investment in brand image and research and development, more flexible
delivery, and superior customer service (Palepu & Healy). Both the cost leadership and
differentiation approaches are designed in order to maximize profits within a company.
In the casual dining industry, businesses must be highly competitive and are typically
forced into a cost leadership method of running their operations. Even though
competition may be fierce, some businesses within the industry have still been able to
segment themselves out into acquiring both strategies.
56
Cost Leadership
In an industry where cost leadership is widely used, it is important to be
especially frugal in times of economic downturn. There are many uncontrollable factors
that can negatively impact the industry and the best defense for surviving in such a
market is to have high economies of scale and scope, efficient production, simpler
product designs, lower input costs, low-cost distribution, and small research and
development expenses.
Economies of Scale & Low Input Costs
Economies of scale are highly desirable in lowering costs because the demand in
the casual dining industry is highly elastic or sensitive to a change in prices. Economies
of scale occur when productivity and proficiency increase. As a result of this productivity
increase, the average cost per unit decreases. Companies can achieve economies of
scale in many ways. Purchasing products in bulk can have a great effect on lowering
the average cost per unit because typically incentives or discounts are given to
companies purchasing in this manner. In addition, businesses have the option to have
their purchased products fully specified to their needs in order to lower waste expenses.
When approaching operations using this method, not only will the company lower waste
expenses, but they will increase their economies of scale.
Efficient Production & Simpler Product Designs
It is essential within the restaurant industry that meals be prepared in a timely
manner. This can be achieved in many ways. As mentioned earlier, companies can have
their suppliers carry some of the burden by having them cover more of the manual
preparation. Not only does this cut costs, but it simplifies the preparation as well as
saves precious time between the time ordered and served. Cracker Barrel Old Country
Store, Inc. has “found that when [they] deliver [the customer‟s] food in 14 minutes or
57
less, guests are more likely to return and recommend [their] restaurant over others.”19
Given this example, it is essential to have efficient and timely production in order to
remain in the dining industry. Another common method of speeding up production is by
automating certain jobs through mechanical devices. This method is gaining ground
with some companies because it allows for quicker service and streamlining the man
power required.
Differentiation
The casual dining industry is immensely competitive, so any form of
differentiation can help alleviate some of the financial strain put upon the business.
Differentiation when defined to the industry is simply creating something of value that
is unique or “different” from all other products or services in that market segment. In
regards to the restaurant sector, there are a few methods in which a company can
distinguish itself including superior product quality, variety, and customer service.
Investment in the brand image can also be highly desirable in such a highly competitive
market.
Superior Product Quality, Variety, and Customer Service
A restaurant‟s product quality, variety of items available, and customer service
play a vital role in adding value to its operations. These points of differentiation have
the ability to make or break a firm in the casual dining industry. Superior product
quality is essential when competing in this industry. The consumer almost always
expects a high quality product when dining out, unless they are expecting to be
excessively stingy with their budget. The variety of items available also has the ability to
create value. When there are more products available to be purchased, the customer is
given a greater chance for being satisfied. In a highly competitive market, having a
larger variety of products can allow a business to more readily adapt to changes such
as recent healthy choice trends. According to the Wall Street Journal, “A study last
19
Annual Report 2008. Cracker Barrel Old Country Store.
58
month by market research firm Mintel International Group Ltd. found that parents are
looking for healthier alternatives to the standard kids' fare of chicken fingers, grilled
cheese sandwiches and macaroni and cheese”(Julie Jargon). Without being able to
adapt to market demands, a firm can severely limit its survivability. Quality customer
service within the industry, although it isn‟t necessary, can play a large role in consumer
satisfaction as well. The design of customer service is to tend to any needs and wants
of the customer. This concept adds value by allowing an employee to ensure
contentment in the customer‟s experience.
Investment in Brand Image
The Brand Image can be invested in through several different methods.
Purchasing advertising to be displayed on billboards and T.V. or presented through
radio are some very common methods of investment. Investing in the brand image is
beneficial because it allows consumers to both be better informed as well as create
awareness of the business. In addition, promotions in brand image can create customer
preferences within the market which stimulates a consistent customer base.
The chart above gives insight into how much advertising as a percentage of sales
is spent for each firm in the industry. This information is helpful to analysts because it
allows them to see how much each firm spends on advertising in relation to their
0
0.005
0.01
0.015
0.02
0.025
0.03
0.035
0.04
0.045
0.05
2005 2006 2007 2008 2009
Advertising to Sales Ratio
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
59
competitors. The firms in the casual dining industry range from 1.8% to 4.4% with the
exception of Dine Equity which has been dramatically increasing its spending on
advertising in recent years.
Firm Competitive Advantage Analysis
Since Cracker Barrel Old Country Store, Inc. is in such a highly competitive
market, the company must operate to some extent within the cost leadership strategy.
What sets Cracker Barrel apart from most firms in the casual dining industry has been
the ability to adopt a strong differentiation approach through its retail store as well. The
company prides itself in being one of the most differentiated firms in the casual dining
industry and has managed to be a massive competitor because of it. Both of these
strategies allow the company to create a stronger competitive advantage within the
market. This in turn increases the business‟s survivability and willingness to stay in the
market.
Efficient Production & Economies of Scale
Cracker Barrel uses both the economies of scale and efficient production
strategies in their operations. Economies of scale, as defined in the previous section,
occur when lowering the average cost per unit through minimizing the time it takes to
produce more goods. Cracker Barrel elicits this strategy by forcing their suppliers to
tailor the products to Cracker Barrel‟s specifications. This not only saves money on
waste expenses, but increases efficiency and reduces production time in the kitchen.
Currently, Cracker Barrel is working at applying their “Best of the Barrel” strategy to
their menus nationwide. The new menu is designed to “highlight higher-margin, easy-
to-prepare selections and to eliminate slow-moving, low-volume items.”20 What this
strategy promotes is a more streamlined variety of products that they must supply
which ultimately lowers food preparation time.
20
2008 Annual Report. Cracker Barrel Old Country Store.
60
Another tactic in which Cracker Barrel has taken to speed up production is their
“Seat to Eat” concept. This concept includes both passing off some of the preparation
time to the suppliers, as mentioned earlier, and researching in more efficient kitchen
layouts and equipment. During Cracker Barrel‟s 2007 Thanksgiving Day Special, they
“saved over $500,000 through reduced overtime just related to preparing for that one
day.”20 This concept creates a large competitive advantage by lowering both time and
monetary costs.
Simple Product Designs
When competing in the food industry, consumers expect efficient and timely
service. Cracker Barrel achieves this through simpler product designs. Most of Cracker
Barrel‟s offered products require minimal preparation time. This includes both the items
in the retail store which require no preparation and the food items which are on the
light end of time spent on creation. The “Seat to Eat” strategy mentioned earlier is
designed to find new ways to make preparation both simpler and more time efficient by
passing off some of the work. This plays as a large advantage to Cracker Barrel, and
value is added through speedy preparation.
Low-cost Distribution
In order to lower additional costs, Cracker Barrel has placed distribution centers
in six different regions across the nation. Having these centers spread into separate
regions allows for efficient and well-organized distribution to all of their stores. In
addition to these distribution centers allowing for quicker delivery of goods, they allow
their suppliers to be significantly closer to the Cracker Barrel stores within the region.
This strategy decreases the opportunity for products to spoil during transport, i.e., the
less time it takes food products to get from the supplier to the stores to be sold, the
better minimization of wasted goods.
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Superior Product Quality
Maintaining high standards in product quality is crucial in the casual dining
industry. Cracker Barrel is able to uphold this core competency through shorter
transportation time of goods and having significant power over their suppliers. The
business does not compete by reducing product quality in order to cut prices or
increase profits. They feel that it is their responsibility to sustain their standards and
continue to offer a product in which customers will be satisfied. According to Terry
Edwards, a Cracker Barrel manager, the quality of their inputs from suppliers is what
keeps customers returning. The reason Cracker Barrel‟s product quality remains high is
due to their belief that there is considerable value in product differentiation.
Investment in Brand Image
Another method in which Cracker Barrel differentiates itself is through investing
in their brand‟s image. Cracker Barrel relies heavily on advertising by means of
billboards. Because eighty-five percent of Cracker Barrel restaurants are located along
interstate highways and forty percent of their business derives from travelers, this is a
highly effective method of investment.21 Due to Cracker Barrel‟s recent interest in
building more off-interstate locations, the company is looking at investing in more
conventional methods of advertising such as TV, radio, and newspaper. All of Cracker
Barrel‟s advertising is directed towards promoting their “down-home,” “genuine,” and
“authentic country cooking” image. In advertising their special country flair, they are
creating a valuable competitive advantage by differentiating themselves into a stylized
niche.
21
Cracker Barrel Fact Book. May 27, 2009.
62
The advertising to sales ratio is calculated by dividing advertising by sales. On
average Cracker Barrel‟s advertising to sales ratio remains stable around 1.8%.
Although the company has one of the lowest advertising to sales ratios, investment in
brand image is a necessary component for competitors in the casual dining industry.
With forty percent of Cracker Barrel‟s customer base consisting of travelers it is safe to
assume that their advertising methods are highly effective and efficient in bringing in
new customers.
Superior Product Variety & Flexible Delivery
In the retail portion of Cracker Barrel, a wide variety of products are offered for
the customers to purchase. These products are designated to give the optimum value in
the customer‟s full country experience. Cracker Barrel offers such items as exclusive
popular country artist CDs all the way to rocking chairs, jelly, and apparel. All of Cracker
Barrel‟s retail items are sent to their warehouse located in Lebanon, TN and distributed
to the stores from there. Because their retail system operates on a differentiation
standard, it is a much more time flexible system of delivery compared to their food
delivery process.
0
0.005
0.01
0.015
0.02
0.025
0.03
0.035
0.04
0.045
0.05
2005 2006 2007 2008 2009
Advertising to Sales Ratio
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
63
Superior Customer Service
One of the main traits associated with the country image is southern hospitality.
In an authentic country cooking strategy, it is no surprise that Cracker Barrel tries to
instill this trait within its employees. Through their innovative “Rising Stars” program,
“Cracker Barrel is now below 100% turnover among [their] hourly restaurant
employees, hiring 1/3 fewer people in fiscal 2008”(CBRL Group, INC. 2008 Annual
Report 27). This program entails finding the more dedicated employees and training
them to a higher degree. Employees are able to feel more reward and value in their
work which ultimately creates happier employees. In turn, moods of customer service
employees can play a large role in customer satisfaction.
Conclusion
When faced with the highly competitive environment of the casual dining
industry, businesses must incorporate elements of cost leadership and differentiation
that stiffly control cost of supplies, minimize product preparation time, respond to the
changing demands of the market, produce superior quality of goods, promote a clearly
focused image in advertisement, and offer a wide variety of marketable goods.
Businesses must streamline conditions for obtaining supplies while providing a widely
desirable product in a positive environment. Cracker Barrel Old Country Store, Inc. has
optimized their opportunities for success by enlisting all of these strategies. This
company doesn‟t leave anything to chance in its plan to create value and a strong
competitive advantage within this industry.
Accounting Analysis
There are many ways firms can legally manipulate information to portray
accounting figures in a favorable light. Managers and board members may have
personal incentives, such as management compensation bonuses, to manipulate
64
accounting figures. Therefore, the extensive evaluation of a firm‟s financial statements
and accounting policies is an important step in the firm valuation process. A thorough
accounting analysis will provide an in-depth look at the underlying business components
that hide behind the reported numbers. This analysis consists of 6 important steps.
The first step is to identify the Key Accounting Polices (KAPs). Key Accounting
Policies are the accounting measures that most directly relate to the underlying value of
the company. KAPs are split into two categories: Type 1 and Type 2. Type 1 Key
Accounting Policies are linked to the Key Success Factors presented in the
Business/Industry analysis section. Type 2 KAPs are associated with certain items on
the financial statements that managers have the ability to distort.
The second step is to assess the amount of flexibility that managers in the firm
have when choosing accounting policies and estimates. These choices can range from
depreciation and inventory policies to whether or not a firm will expense marketing
investments. The level of flexibility relates to how informative the accounting numbers
are to analysts. This step focuses more on Type 2 Key Accounting Policies.
After assessing the amount of flexibility in the firm, the next step involves
evaluating the firm‟s accounting strategy. This involves identifying how conservative or
how aggressive a company is in reporting Type 2 Key Accounting Policies. Looking into
the firm‟s choices can reveal the actual strength of the company and whether or not
managers are hiding results. This includes comparing the firm‟s accounting policies to
other firms within the industry. Moreover, this step involves checking if the firm has
made any policy or estimate changes, as well as, whether or not the firm‟s policies and
estimates have been accurate in the past.
The fourth step in the accounting analysis calls for an evaluation of the quality of
disclosure within the firm‟s annual reports (financial statements). The evaluation will
include looking at adequacy of footnotes in financial statements and the amount of
specific information in the letter to shareholders. If a business is segmented, then the
analysis needs to examine how the firm breaks up reporting of the multiple lines of
business or if the firm simply combines them all into one segment. The amount of
65
disclosures from management that are above and beyond minimum requirements and
the way bad news is presented are also examined.
Following the examination of the degree of information transparence, the next
step in the accounting analysis methodology requires that the financial statements are
scoured for red flags that could potentially mask questionable accounting. These red
flags are typically seen when companies are struggling or when firms make
unsubstantiated transactions that increase profits. Red flags may also be found in write-
offs, fourth quarter adjustments, decreasing cash flow while net income remains the
same, and accounting changes that are unexplained. When a red flag is discovered,
“the analyst should examine certain items more closely or gather more information on
them.” (Palepu & Healy).
The final step is to undo the accounting distortions that may have been found in
the previous five steps. Next, the analyst must restate the financial statements to the
best of their ability when accounting policies and practices are discovered that may
have resulted in misleading figures. An examination of the statement of cash flows and
financial statement footnotes will aid in determining the closest possible estimate of the
firm‟s accounting figures.
Key Accounting Policies
As mentioned above, Key Accounting Policies (KAPs) are the policies and
estimates a firm uses that are most directly related to Key Success Factors and have
the most effect on the underlying value of the firm. Identifying the KAPs of a firm is the
first step in the Accounting Analysis. Managers‟ choices in reporting practices
concerning Key Accounting Policies will have the most effect on the perception of the
firm‟s value. Noise and distortion in accounting figures can result from firm managers
dressing up the financial numbers. Therefore it is important to analyze all aspects of the
firms‟ financial statements. However, specifically examining the Key Accounting Policies
will have the greatest effect on an analysts‟ valuation of the firm because these policies
are most closely related to what drives the firm‟s value. Key Accounting Policies will be
separated into two categories: Type 1 KAPs and Type 2 KAPs. Type 1 policies are those
that relate directly to the Key Success Factors identified for the firm in the Business
66
Analysis and relate to activities that drive value. They will show how the company
reports information concerning its core competencies and the aspects that drive firm
value in the industry. This might include how the firm utilizes Economies of Scale or
how the company is a leader in controlling input costs. Type 2 policies relate to asset or
liability items that managers have flexibility in reporting and may significantly influence
the market value of the firm. For example, a firm may intentionally report Goodwill,
Defined Benefit Plan liabilities and operating and capital leases in a way that is opaque
to the average reader. However, a comprehensive analysis of these items can help us
shed light on the parlor tricks that managers may employ.
Type 1 Key Accounting Policies
As mentioned above, Type 1 Key Accounting Policies relate to the Key Success
Factors that drive firm value. For Cracker Barrel, these core policies are their superior
product variety, investment in brand image, and the use of efficient production
methods.
Superior Product Variety
Cracker Barrel maintains its position in the restaurant industry by providing
superior product variety in its stores. The retail store attached to all Cracker Barrel
restaurants is a significant part of the customer experience and contributes
approximately 20% of the total annual revenues for the firm. Notably, Cracker Barrel
does not segment the reporting of results from the two operating activities. Because of
their close proximity, “the operating expenses of the restaurant and retail product lines
of a Cracker Barrel unit are shared and are indistinguishable in many respects.” 22
Cracker Barrel reports operating results from two different industries in one report, as
opposed to most competitors, which are only involved in the restaurant industry. Bob
Evans Farms, Inc. operates similar retail type stores within some of its restaurants and
22
Cracker Barrel 10 – K. 2004-2009.
67
segments the reporting of revenues and expenses for the restaurant and retail portions
of their business.
Investment in Brand Image
Another way Cracker Barrel generates value is through their investment in the
Brand Image. This is done primarily through the use of highway billboard signs. The
signs are uniform and highly recognizable and remind travelers that Cracker Barrel‟s
“home-away-from-home” feeling is close by. This is critical to the success of the
restaurants as over 40% of customers are travelers. Payments for these signs are
recognized as advertising expenses separate of operating leases maintained for store
locations. The notes to the consolidated financial statements specifically outline the
difference between advertising costs and operating leases for restaurant locations. The
following chart shows the total amount of advertising expense over the past 3 years
and the amount of that expense composed of billboard leases. The bar graph of the
dollars spent on advertising expenses and billboard rent expenses indicate that these
expenses have been steady with little growth over the last three years.
4113338274
40522 42160 42371
23374 24938 25204 25177 25950
2005 2006 2007 2008 2009
Investment in Brand Image
Advertising Expense Billboard Rent Expense
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Cracker Barrel has traditionally stayed away from more mainstream advertising
methods such as radio and television advertising. The firm has little information as to
whether the additional advertising would be beneficial and believes the additional costs
might negatively affect results from operations. Other firms in the industry spend a
relatively higher amount of their net sales on advertising expense. The following chart
show a time series plot of the percentage of net sales recorded as advertising expense
for each firms‟ last 5 reported years. It is clear that Cracker Barrel does not employ as
aggressive advertising strategies as its competitors. The firm has traditionally had a
conservative approach to advertising and will continue as long as it experiences
success. DineEquity‟s acquisition of Applebee‟s resulted in a significant increase in
advertising expenses. Applebees‟ employs a heavy dose of television advertising.
Darden operates a multitude of restaurant chains, each of which may require a different
advertising budget.
Note that DineEquity and Denny‟s Corp have not reported 2009 numbers yet.
Cracker Barrel finds itself among the firms in the industry that spend a small
percentage of their net sales on advertising. This is partly a result of the fact that
0
0.005
0.01
0.015
0.02
0.025
0.03
0.035
0.04
0.045
0.05
2005 2006 2007 2008 2009
Advertising Expense / Sales
Cracker Barrel Darden BobEvans DineEquity Denny's Brinker
69
Cracker Barrel does not employ an aggressive television and radio advertising strategy.
However, accounting policy has an effect on this number as well. Cracker Barrel records
all rent expense for operating leases for billboards under advertising expenses. These
billboards are the primary way that Cracker Barrel advertises. Because no tangible
operating revenues come from the billboards, they are not classified under operating
leases. However, the payments are not like normal advertising costs that would be one
time, sunk costs. The leases account for recurring advertising costs for the length of the
billboard contracts.
Efficient Production Methods
Cracker Barrel also utilizes efficient production methods to provide quality food at
a relatively low price. This includes tactics such as having suppliers do portions of the
meal preparation before shipping foods to the restaurant locations. Additionally,
reducing input costs ensures Cracker Barrel can provide food as cheaply as possible.
Notably, Cracker Barrel has a relatively low amount of disclosure when it comes to input
information. The 10-K merely states that Cracker Barrel uses a “contract with an
unaffiliated distributor with custom distribution centers.”23 Cracker Barrel makes use of
standardized kitchen and store setups to ensure that each new location carries the
same amount of efficiency as existing stores. Menus are standardized across the nation
as well. Raw food materials are bought mostly locally, with few if any products relying
on a single source.24 However, Cracker Barrel affords little disclosure when it comes to
the purchase of materials for production. Examining the Gross Profit Margin ((Net Sales
– Cost of Goods Sold)/Net Sales) can serve as a useful tool in identifying firms that are
operating efficiently. The following graph shows the Gross Profit Margin for Cracker
Barrel and its competitors in the restaurant industry over the past 5 years.
23
Cracker Barrel 10 – K. 2004-2009. 24
Cracker Barrel 10 – K. 2004-2009.
70
It is clear that Cracker Barrel is one of the leading firms in the industry when it
comes to maximizing the profits from each sale. Cracker Barrel, Brinker, and Bob Evan‟s
have relatively large market capitalizations for the industry and can utilize economies of
scale.
Type 2 Key Accounting Policies
Firm managers have the most impact on adjusting numbers within type 2
accounting policies. Distortions in reporting can result in misleading figures represented
on the balance sheet and income statement.
Operating Leases
As of September 22, 2009, Cracker Barrel operated 591 restaurant locations. Of
these, 192 are leased under either capital or operating leases. A firm‟s choice to classify
leases as operating or capital can have a significant effect on the financial statements.
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
2005 2006 2007 2008 2009
Gross Profit Margin
Cracker Barrel Bob Evans Denny's
Darden DineEquity Brinker
71
Operating leases allow the firm to record rent payments under operating expenses on
the income statement. Firms are essentially renting the property with no benefits or
risks of ownership, although they may intend to renew the lease over and over again.
Capital leases incorporate an interest payment into the rent payment so that the firm
slowly paying for the asset. As a result, the firm maintains the benefits and risks of
ownership of the asset. This includes recording depreciation expenses for the asset over
its useful life. In addition, the liabilities from future principal and interest payments are
represented in the balance sheet. As of September 22, 2009, Cracker Barrel operated
591 restaurant locations. Of these, 192 stores were leased under either capital or
operating leases.
Firms will generally lean towards operating leases as opposed to capital leases
because it allows them to keep a large chunk of liabilities off of the balance sheet. In
addition, depreciation and interest expense are not recorded, which can understate the
firm‟s expenses. This leads to balance sheets that may not be an accurate
representation of the firm‟s position. Using primarily operating leases will understate
liabilities and assets, in turn overstating equity. This will lead to an overstatement of net
income as well, which affects many key financial ratios.
Cracker Barrel follows the industry trend in that almost all of its leases are
classified as operating leases. The disclosure on the details of such leases is relatively
low. Cracker Barrel lists a very low amount of $60,000 as its capital lease obligations in
the fiscal year 2009. Minimum capital lease payments through 2011 are as low as
$22,000 a year. The results from using operating leases mentioned above will be
demonstrated in Cracker Barrel‟s financial statements and will continue as they plan to
renew operating leases when available. This is the accounting policy that most distorts
Cracker Barrel‟s accounting figures.
Cracker Barrel reports no amount of Goodwill in its financial statements. This is
primarily due to the fact that they have had no major acquisitions in recent years.
When purchasing Logan‟s Roadhouse in 1998, Cracker Barrel did not pay a significant
premium to the market value of the firm, so no Goodwill was accounted for.
72
Foreign currency exchange rates do not affect Cracker Barrel because they only
deal internationally with China. The Chinese yuan has been a peg to the U.S. dollar,
meaning that its value is set in proportion to the dollar. Thus, changes in the strengths
of the dollar are mirrored by the yuan, causing little effect to Cracker Barrel.
Potential Accounting Flexibility
All U.S. based firms deal with various degrees of flexibility in their accounting
policies. This is due to the abundant methods in which firms are capable of creating
value and GAAP‟s (Generally Accepted Accounting Policies) allowance for firms to use
their own judgment in recording a few specific items. These items include goodwill,
operating leases, defined benefit plans, medical benefit plans for retirees, research and
development, and foreign currency risk. When in a competitive market, it is important
for companies to report positive earnings. Because of this, managers often create
distortions in the company‟s value through their firm‟s allotted accounting flexibility. The
ultimate goal of reporting positively to investors can then be accomplished by reporting
the firm‟s effectiveness in creating value through their key success factors. Cracker
Barrel Old Country Store, Inc. has one distinct area in which it is allotted some flexibility
in its accounting policies, the use of operating leases instead of capital leases.
Operating Leases
Accounting for operating leases instead of capital leases has great potential to
distort the actual value of a company. GAAP allows for flexibility in whether a firm can
report its leases as capital or operating, which further aids companies in hiding losses
with greater ease. Under capital leasing, a company will report its leases as assets and
will incur liabilities from rent expenses. This form of leasing allows firms to stay true to
their actual company value. Firms find the use of operating leases desirable because
they allow any liabilities or obligations in regard to their leased assets to be hidden from
the balance sheet. For instance, because the leases are not regarded as assets, firms
73
can avoid the interest expenses that would accumulate if these assets were reported.
The table below breaks down how the balance sheet and income statement could be
affected through using operating leases in comparison to capital leases. Assets would
be understated because the leases are withheld from the books, and liabilities and
equity would be overstated in proportion to assets. Because the additional interest
expense is avoided and there is no effect to revenue, Net Income will have potential to
be overstated. With 99.9% of Cracker Barrel‟s leases being operating leases, this could
have a drastic effect on the firm‟s actual value.
Assets Liabilities Equity Revenue Expenses Net Income
U O O N Avoided O
Actual Accounting Strategy
When evaluating the actual accounting strategy of a firm, it is important to first
compare the firm‟s accounting policies and their quality in disclosing them to those of
its competitors. A firm‟s quality of disclosure reflects greatly on the overall image of the
firm. If managers are given incentives in reporting positive earnings, it is much more
likely that they will choose accounting policies which distort the firm‟s actual earnings
when the company is suffering. For instance when managers own a large amount of
stock in the firm, they will be inclined to overstate earnings because they will be
rewarded monetarily for the increased share price. When the quality of disclosure is
lacking, there is a greater likelihood that managers are distorting the actual value of the
company through accounting policies.
The overall goal of an analyst is to make sure that the company being evaluated
is providing a proper outlook to how the company is doing. What this entails is
deciphering from the company‟s information whether they exercise aggressive,
conservative, or typical accounting policies for the industry. Aggressive accounting
74
policies are characterized by reporting the company‟s income higher than it should be
stated, whereas conservative accounting indirectly leads companies to report lower
incomes. When comparing a firm‟s accounting approaches to other firms in the
industry, the firm‟s overall approach to accounting can then be revealed.
Operating Leases
Cracker Barrel, as mentioned earlier, has a mixture of capital and operating
leases with the majority being operating leases. By reporting a majority of operating
leases, the company is taking advantage of GAAP‟s flexibility in regards to leases.
Cracker Barrel‟s 10-K states that the total present value of the future capital lease
expenses are $562,000 where as the total present value of the future operating lease
expenses are valued at $765,144,000. This means that 99.9% of all of Cracker Barrel‟s
leases are operating leases and are not stated as assets. In 2009, Cracker Barrel
incurred $34,464,000 of rent expenses tied to operating leases. This is a significant
amount of assets to be hidden from the balance sheet and could be a large factor in
determining the actual success and value of the firm.
Even though the use of operating leases is considered to be an aggressive
accounting policy, in comparison to the rest of the casual dining industry Cracker Barrel
is right in line with its competitors. Every one of Cracker Barrels competitors have a
large portion of its leases recorded as operating leases. This is significant because it
gives some perspective to the common accounting policies of the industry. This also
indicates that Cracker Barrel is not manipulating its accounting policies any differently
than anyone else in the industry. Even though its policies are similar, Cracker Barrel is
still regarded to be even more aggressive than its competitors from operating leases.
Not only do they have an excessively large percentage of its leases reported as
operating leases, but the firm also is active in sale-lease backs. This is considered to be
a very aggressive strategy because it sells and leases the properties they build and is
blatant that they are avoiding having these stores hidden from their assets.
75
Quality of Disclosure
Introduction
To evaluate a firm effectively it is important to analyze the managers accounting
discretion in order to decide whether a company‟s financial statements truly reflects all
inside information. GAAP requires that a firm discloses a certain amount of information
as regards to its accounting policy and accounting strategy. Since managers have
intimate knowledge about the firms‟ business, they are expected to reflect that
knowledge in the financial statements in order to give investors and creditors a
transparent view of the company‟s business.
If a manager discloses information beyond what is required by GAAP then the
quality of the company‟s disclosure gives outside users a more accurate view of the
company, which increases the businesses value by making its financial statements more
reliable. On the other hand, managers have an incentive to manipulate the quality of
disclosure by making biased assumptions. If a company‟s chooses not to disclose
certain information then the reliability of its accounting quality decreases because it
does not capture the reality of the business.25 Throughout this section an analysis of
Cracker Barrel‟s quality of disclosure compared to its top competitors will be reported.
Type 1 Accounting Policies
Superior Customer Service/Product Quality
We begin analyzing Cracker Barrel‟s disclosure of type 1 key accounting policies
by taking a look at how they address their superior customer service and product
quality. These are two of their main core competencies, and it is supported by their
mission statement which is “Pleasing People.” Cracker Barrel discusses in their 10-K the
25
Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.
76
process that they follow in order to deliver outstanding service, consisting mainly of
attentive service and consistent food quality. Looking under their “Guest Satisfaction”
section of the 10-K, they thoroughly explain that they are committed to staffing
experienced managers and employees, and training them on the importance of their
mission statement and culture. The company also explains how they manage customer
complaints by engaging in surveys, restaurant visits, and providing internet services for
customers to make comments and suggestions.26 Overall, Cracker Barrel has good
disclosure of their process of maintaining excellent customer service.
Superior Product Variety
Cracker Barrel differentiates itself from competitors by offering a variety of
products. Unlike most restaurants, Cracker Barrel has a wide selection of retail items
that contribute to approximately 21% of the company‟s business. They fully disclose the
types of menu items offered, and also discuss the type of products that are offered in
the retail section by breaking them down into five categories: Apparel, food, seasonal,
home, and toys. However, the company does not segment their reporting of results
from the two types of operating activities, meaning that the expenses from the two
operating activities are “shared and indistinguishable in many respects.”27 Because they
don‟t segment their reporting, Cracker Barrel has a moderate rate of disclosure for its
superior product variety.
Low Cost Distribution/ Flexible Delivery
The ability to have low cost distribution and flexible delivery of products is a key
core competency for the value of a firm. Cracker Barrel does not fully disclose their
distribution method, perhaps to keep information hidden from its competitors. They
only mention their contracts with “unaffiliated distributors” and the locations of their
26
Cracker Barrel 10 – K. 2004-2009. 27
Cracker Barrel 10 – K. 2004-2009.
77
distribution centers. According to their 10-K, these unaffiliated distributers are also
responsible for placing the food orders, warehousing, and delivery of products. Cracker
Barrel also mentions that approximately 42% of their retail purchases for 2009 came
from the republic of China, but fails to disclose specific vendors it contracts or the
specific retail items purchased from China.28 Due to this Cracker Barrel has a low quality
of disclosure of its low cost distribution.
Sales Manipulation Diagnostics
Sales manipulation ratios help analysts compare competing firm‟s financial
statements. By comparing inventory, cash from sales, and accounts receivables to net
sales it allows analyst to find credibility of the sales that are reported. With the
knowledge of these ratios, analyst can find distortions in a company‟s financial
statements. These distortions are seen though drastic changes in the ratios, from one
year to another. The distortions seen in the ratios help to point out “red flags” which
will increase or decrease the value of the information presented by the firms. We will
compare Cracker Barrel‟s ratios with their competition in order to verify if ratios are
related to the industry. With this knowledge you can easily identify problems and
concerns within the financial statements.
Net Sales/Cash From Sales
In order to find cash from sales you must subtract the change in accounts
receivable from net sales. Then to find this ratio you simple divide net sales by cash
from sales. The purpose of this ratio is to measure the correlatation of net sales to
their cash from sales. The ratio should be 1 for a pure cash business because net sales
will equal the total cash from sales. When a company has Accounts Receivable they do
not recognize the cash from the sale and it raises their ratio in one year and lowers it
28
Cracker Barrel 10 – K. 2004-2009.
78
when they receive the cash the next year. When there are increases in sales and
Accounts Receivables stays the same the ratio increases.
Following is a graph that represents the relations.
As you can see the ratio stays very close to 1. This means that it is mostly a
cash industry. There is a large spike in Dine Equity‟s ratio. This is due to their
acquisition of Applebee‟s in 2007. On the other hand Cracker Barrel is consistently
close to 1, which shows their revenues are very closely related to their cash.
0.9
0.95
1
1.05
1.1
1.15
1.2
2004 2005 2006 2007 2008
Net Sales/ Cash From Sales (RAW)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
79
This measures the correlation between sales and cash from sales. When the
correlation is negative it means the sales are not related to the cash from sales. In
summary most of the company‟s ratios remain relatively close to 1, except for Dine
Equity. This means there is a positive correlation between the sales and cash from
sales. Dine Equity had a sales increase in 2006 but a cash decrease; this causes the
spike in 2006 and in 2007 they purchased Applebee‟s. The industry average also
remains close to 1, except for the years in which Dine Equity‟s correlation spikes. Since
there are no distortions in Cracker Barrel‟s ratios, there are no signs of any “red flags.”
Net Sales/Accounts Receivable
This ratio is found by dividing net sales by accounts receivable. It shows the
relationship that accounts receivable have with net sales. If a company‟s sales show a
minor increase and their accounts receivable go down it will increase the ratio. This
ratio should remain relatively static throughout the years. If there are any distortions,
or major spikes, it could be a “red flag.” If the ratio jumps it means the firm recognized
too many revenues from its accounts receivable that year.
Following is a graph of Cracker Barrel and its competitors in the industry.
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
2004 2005 2006 2007 2008
Net Sales/Cash From Sales (CHANGE)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
80
This graph indicates that there is a possible “red flag” for Cracker Barrel between
2004 and 2005. It could be that they changed how much of their receivables they were
recording as revenues each year, based on their bad debt expense percentage.
Although, since the industry average dipped that year it should not be a major concern,
or a “red flag.” Most of the other firms remained fairly constant through-out the 6 year
period.
0
50
100
150
200
250
300
2003 2004 2005 2006 2007 2008
Net Sales/Accounts Receivable
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
81
The following graph shows the change in net sales over accounts receivable.
This graph allows analyst to see the change in net sales relative to the change in
accounts receivable. As you can see the change stays within 1 point of its original ratio,
this means that there is a correlation between sales and accounts receivable. This is
achieved by maintaining good account collections and maintaining a steady accounts
receivable increase relative to sales. This is true for everyone but Darden, which shows
that there is a “red flag” for Darden. Most firms in the industry have a negative ratio
which could mean they are taking on aggressive accounting techniques. This is true for
Cracker Barrel as well except, they were not negative for consecutive years. Therefore,
it should not pose as a major “red flag.”
0
0.5
1
1.5
2
2.5
3
3.5
2004 2005 2006 2007 2008
Net Sales/Accounts Receivable (Change)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
82
Net Sales/ Unearned Revenue
The ratio of net sales/unearned revenue describes how much of a company‟s net
sales are contributed by its unearned revenue. This is an important measure in the
restaurant industry, where companies are faced with the liability of unused gift cards.
There is no specific number in measuring this ratio, just keep in mind the industry
norm.
As the chart above displays, companies in the restaurant industry operate their
net sales/unearned revenue at different levels. Note, Dine Equity fails to disclose
information on unearned revenue before 2007, and Bob Evans fails to disclose
information previous to 2006. The charts shows that most companies in the in the
industry have a downward sloping ratio, meaning that unearned revenue is increasing
more than net sales. While normally this would raise a “red flag” of sales manipulation,
the industry norm suggest that it is a trend between most of the companies.
The change in net sales/unearned revenue is a measure of the correlation
between a firms‟ net sales and unearned revenue. If the change in ratio is positive, it
implies that the company‟s unearned revenue is increasing as sales increase, which is a
common trend. However, if the change ratio is negative, it implies that net sales and
0
20
40
60
80
100
120
140
160
2003 2004 2005 2006 2007 2008
Net Sales/Unearned Revenue (RAW)
Cracker Barrel
Bob Evans
Darden
Dine Equity
Brinker International
Industy
83
unearned revenue are moving in opposite direction. Keep in mind that only positive and
negative values are important in analyzing the change ratio.
As the chart above explains, most of the companies are relatively close to one another;
with the exception of Cracker Barrel during 2005 and 2007. For those two years Cracker
Barrel‟s sales and unearned revenue had negative correlation with one another. This is
not necessarily a bad sign because it means that the company received more cash up
front, as opposed to writing down a liability. It could, however, be a cause of concern
that sales may have been manipulated. Looking closer at Cracker Barrels financial
statements, their sales decreased from 2004 to 2005 by 7.98% and increased by 5.95%
during 2006-2007, with unearned revenue staying relatively constant. Given this
information, the negative correlation between the two accounts is explained by
fluctuating payment styles by consumers.
Net Sales/Inventory
This ratio is found by dividing net sales by inventory. It shows the relationship
between net sales and inventory. Since, inventory is directly related to sales it should
correlate, meaning if sales raise so should the amount of inventory. Any spikes in this
-600
-500
-400
-300
-200
-100
0
100
200
2004 2005 2006 2007 2008
Net Sales/Unearned Revenue (CHANGE)
Cracker Barrel
Bob Evans
Darden
Dine Equity
Brinker International
Industy
84
ratio show that inventory was not properly accounted for in that period. Following is a
graph of the industries net sales over inventory ratio.
As you can see most companies stay fairly static over the 6 year period. The
exception is Dine Equity who kept low inventory until they acquired Applebee‟s in 2006.
In the future analyst should expect to see Dine Equity show the same consistency as
the other firms in the industry. The industry average is also offset by Dine Equity‟s
ratio.
0
50
100
150
200
250
300
350
400
450
500
2003 2004 2005 2006 2007 2008
Net Sales/Inventory
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
85
Following is the graph of change in net sales over inventory.
This graph better illustrates the changes in the net sales over inventory ratio.
According to this graph Cracker Barrel had a major distortion in 2005 which could point
to a “red flag.” This shows that they did not have a direct correlation between net sales
and inventory. Although, the industry average decreased so it could be considered an
industry trend and not considered a “red flag.” The same cannot be said for Denny‟s
because they have a huge distortion in 2006. This has huge implications on the
accounting policies that Denny‟s used.
Conclusion
In conclusion, Cracker Barrel‟s ratios stayed fairly consistent throughout the time
period, with respect to industry averages. The only major exception was in 2005 with
their net sales over inventory ratio. This could mean they changed their inventory
methods, or just had a really good year on retail sales at the end of the period. Either
is possible because the next year the inventory ratio went back to normal. This leads
me to assume that there is only one “red flag” for Cracker Barrel and that was in 2005
with relation to their inventory.
-500
-400
-300
-200
-100
0
100
200
300
2004 2005 2006 2007 2008
Net Sales/Inventory (CHANGE)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
86
Expense Manipulation Diagnostics
Expense diagnostics use line items from the financial statements to check for any
manipulations. They are helpful in determining if companies are overstating expenses
for the purpose of understating net income. These ratios take the line items from the
financial statements and measure the connection between them. The three financial
statements that will be used for the expense ratios are the income statement, the
balance sheet, and the statement of cash flows. The ratios will be compared to
competitors in the restaurant industry in order to uncover any irregularities from the
industry norm.
Asset Turnover
The turnover ratio is calculated by dividing the firm‟s net sales over their total
assets. This ratio is a lag ratio, meaning that net sales are divided by the total assets of
the previous year. It measures how efficiently a firm is utilizing its resources.29 In the
restaurant industry there are companies of all sizes, and the asset turnover ratio allows
for the comparison of the amount of sales produced for each dollar amount of assets
for different size companies. For example, if the ratio is high it means that a company is
making more sales with the assets on hand.
29
investopedia
87
The following is a graph showing the firms asset turnover ratio.
As you can see most firms in the industry remain relatively consistent, and the
industrial average also remains consistent. Dine Equity‟s ratio is smaller than its
competitors, signaling that the company operates with a higher amount of assets.
According to this graph Cracker Barrel jumped from 2006 to 2007. This spike is caused
from the discontinuance of Logan‟s Steak House in 2006. For this reason, there is no
“red flag” for Cracker Barrel.
0
0.5
1
1.5
2
2.5
3
2003 2004 2005 2006 2007 2008
Asset Turnover (RAW)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
88
The following graph shows the change in asset turnover for the industry.
The graph above shows the change in total assets and sales over a five year
period. Most of the companies in the industry have a positive asset change ratio, which
means that total assets and sales are positively correlated. The asset turnover change
ratio shows that for the year 2005 Cracker Barrel‟s change in sales were negatively
correlated with the change in total assets. In fact, Cracker Barrel had an increased
amount of total assets which produced a lower amount of sales compared to the year
before. Cracker Barrel for the most part has a positive asset turnover change ratio
which would not raise any concerns of manipulation. Denny‟s and Dine Equity begin
with negative change ratios in 2004, but then rise to a positive ratio which raises no
“red flags.”
-3
-2
-1
0
1
2
3
4
2004 2005 2006 2007 2008
Asset Turnover (CHANGE)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
89
The following graph shows Cracker Barrel‟s Asset Turnover in relation to the trial
balance worksheet.
The result from this graph allows the user to see that the restated financials
reduced the total assets of Cracker Barrel. This caused the ratio to be lowered and
shows that Cracker Barrel is under the industrial average. This is not a huge concern
because all of the other companies in the industry have operating leases which would
lower their assets as well. This would cause Cracker Barrel to stay close to the industry
average. Note, the last year of the industrial average was unattainable due to the fact
that not all companies have posted their 2009 10-Ks.
As Stated Restated Industry Average
2004 1.66 1.42 1.47
2005 1.43 1.11 1.43
2006 1.32 1.02 1.48
2007 1.86 1.45 1.54
2008 1.82 1.45 1.54
2009 1.90 1.42
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
2004 2005 2006 2007 2008 2009
Asset Turnover (RESTATED)
As Stated
Restated
Industry Average
90
Cash Flow from Operations/Operating Income
The ratio is calculated by taking the cash flow from operations and dividing it by
the operating income for a given period. The ratio links the income statement with the
statement of cash flows and gives a measure of the correlation between operating
income and cash flow from operations. It is a useful ratio in determining if a company is
deferring expenses. When interpreting this ratio the correlation between operating
income and cash flow from operations must be analyzed with the industry norm to
check for any irregularities.
Over the past five years, most of the firms in the industry have experienced
some stability in their CFFO/OI ratio, with the exception of Dine Equity. The trend of the
industry CFFO/OI ratio seems to be declining over the years, meaning that operating
income is increasing faster than cash flow from operations. Dine Equity had a major
drop off in 2007, which was caused by a negative operating income for the years 2007
and 2008. Cracker Barrel‟s ratio was relatively constant from 2003-2006, but then
dropped after the sale of Logan‟s Steakhouse in 2006. After examining their financial
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2003 2004 2005 2006 2007 2008
CFFO/OI (RAW)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
91
statements, Cracker Barrel had a bigger decrease in cash flow from operations than in
operating income, which explains the decrease in their CFFO/OI ratio.
The change ratio for CFFO/OI should be positive because operating income and
cash flow from operations should be positively correlated. On the other hand, if the
change CFFO/OI ratio is negative, it should raise a red flag of accounting manipulation
because it is implying that cash flows are not being attributed from operating income.
The chart above explains the change in CFFO/OI ratios over the past five years.
It shows that Cracker Barrel had a negative CFFO/OI in all years except for 2006. This
raises a red flag for Cracker Barrel because the change ratio is explaining that operating
income is negatively correlated with cash flow from operations. This should cause
concern if Cracker Barrel is misrepresenting expense numbers to try and manipulate net
income. In 2007 Cracker Barrel‟s CFFO/OI ratio decreased dramatically due to the sale
of Logan‟s Steakhouse during 2006.
Cash Flow from Operations/ Net Operating Assets
This ratio links the statement of cash flows with the balance sheet. Net operating
assets are a company‟s property plant and equipment minus any depreciation. This
ratio is helpful in measuring the correlation between a company‟s cash flow from
-30
-25
-20
-15
-10
-5
0
5
10
2004 2005 2006 2007 2008
CFFO/OI (CHANGE)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
92
operations and its net operating assets. It is useful in determining if a company is
correctly depreciating its assets or writing off expenses, and it allows for analyst to
check for any irregularities due to these accounting manipulations.
As the chart above shows, most of the companies in the restaurant industry are
fairly close to one another. Cracker Barrel‟s CFFO/NOA ratio stays relatively constant
with the industry norm, except for a sudden drop in 2006. The decrease in Cracker
Barrel‟s CFFO/NOA ratio is not a “red flag” because the sale of Logan‟s Steak House
increased current assets for the year. Due to the sale of Logan‟s Steak House, Cracker
Barrel had negative net operating assets for the year. The negative net operating
assets are the reason for the big drop during 2006.
The CFFO/NOA ratio change should be positive, implying that an increase in
assets should generate more cash flow. If a firm has a negative change ratio it is
implying that they may be distorting expenses. It raises a “red flag” that the company
may not be appropriately expensing their operating assets. The only thing important in
the graph is the value sign of the ratio.
-9
-7
-5
-3
-1
1
3
5
2003 2004 2005 2006 2007 2008
CFFO/NOA (RAW)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
93
As you can tell by the graph Cracker Barrel has a relatively constant CFFO/NOA
ratio change compared to the industry norm. Bob Evans and Darden have negative
change in 2006, raising a “red flag” that the two companies may not be depreciating
their assets appropriately, or that expenses were not written off correctly. The same
can be said about Denny‟s in the year 2005.
-8
-6
-4
-2
0
2
4
6
8
10
2004 2005 2006 2007 2008
CFFO/NOA (CHANGE)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
94
The following graph shows Cracker Barrel‟s CFFO/NOA ratio with respect to the
trial balance sheet.
This graph allows the user to see that capitalizing the operating leases does not
significantly impact the CFFO/NOA ratio in 2004 or2005. It does however balance out
the sale of Logan‟s Steak House in 2006. Without the sale of Logan‟s Steak House in
2006, the industry average would be much closer to the restated ratio. The 2007-2009
ratio is impacted and lowered, this would happen to all companies that capitalized their
operating leases. Note, the last year of the industrial average was unattainable due to
the fact that not all companies have posted their 2009 10-Ks.
As
Stated
Restated Industry
Average
2004 0.22 0.17 0.22
2005 0.24 0.18 0.16
2006 -8.31 0.60 -1.24
2007 0.54 0.22 0.10
2008 0.91 0.32 1.03
2009 0.81 0.36
-10
-8
-6
-4
-2
0
2
2004 2005 2006 2007 2008 2009
CFFO/NOA (RESTATED)
As Stated
Restated
Industry Average
95
Accruals/ Sales
In order to calculate total accruals you must subtract operating income from
cash flow from operations, and then divide that by sales. This ratio measures the
relationship between the company‟s accruals and sales. There is no ideal ratio number,
it is only a measure that should be compared to the industry in order to test for any
irregularities from the norm. This is another useful ratio in checking for any expenses
manipulations. For example, If the ratio is dropping over time it means that a company
is reporting more accruals, in which they may be deferring expenses.
The chart above shows the total accruals/sales ratio for Cracker Barrel and its
competitors over the past five years. Most these restaurants in this industry have a
stable accruals/sales ratio over the years. However, in 2006 Dine Equity has a spike,
which is of cause of concern. The increase in Dine Equity‟s ratio may have been
attributed to the acquisition of Applebee‟s that year, or it could be a “red flag” that the
company overstated its expenses during the year and decreasing accruals. Cracker
Barrel has a ratio close to zero, which is not uncommon in the restaurant industry
because companies operate mostly with cash transactions instead of having accounts
receivables.
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
2003 2004 2005 2006 2007 2008
Total Accruals/Sales (RAW)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
96
Now we will observe the total accruals/sales ratio change in order to test the
relationship between the two accounts. Basic theory suggests that if sales increase then
so should the number of accruals. If the change in ratio is of negative value, then it is
implying that sales and accruals are not positively correlated. When looking for “red
flags” it is only significant to consider if the ratio value is positive or negative.
As the chart above displays, there are three companies that have negative
change in ratios: Cracker Barrel, Denny‟s, and Brinker International. Looking more
closely, we see that Cracker Barrel and Denny‟s had negative change ratios for two
consecutive years. The negative change ratios point out that accruals and sales had no
correlation for the two years, which should raise a “red flag.” Examining Cracker Barrel‟s
statements of cash flow more closely, there is a decrease of cash flow from operations
of -24% from 2005 to 2006 and -44.5% for the following year. It raises a “red flag”
that the company may have been overstating expenses during the two years.
Conclusion
Expense manipulation diagnostics are important in analyzing a company‟s
financial statements. They are useful tools in aiding analyst decipher any expenses
manipulations that effect could affect net income. Comparing these ratios among
-6
-4
-2
0
2
4
6
2004 2005 2006 2007 2008
Total Accruals/Sales (CHANGE)
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
97
competitors in a given industry helps to point out potential “red flags.” Cracker Barrel‟s
asset turnover, CFFO/IO, and CFFO/NOA ratios were consistent with the norm of the
industry, except for differences in 2006 from the discontinuation of Logan‟s Steak
House. Finally, Cracker Barrel‟s accruals/sales change ratio had “red flags” in two
consecutive years. The negative correlation of the change ratio was caused by a
decrease in cash flow from operations, which may have been an affect from an
overstatement of expenses during the two years.
Potential Red Flags
Part of an analyst‟s job when valuing a firm is to identify potential red flags in
the company‟s financial statements. Red Flags are defined as misrepresentations of
financial data which can distort the real value of the company‟s performance. When a
red flag is presumed it is important to decipher why there is a significant change in the
company‟s reports. From there, the analyst needs to decide whether or not the
numbers related to the red flag should be corrected.
Operating Leases
Cracker Barrel‟s key concern for a red flag is held in reporting operating leases.
The present value of future operating lease payments for 2009 is $453,544 and long-
term debt is $638,040. This would cause the present value of its operating lease
payments in proportion to their long-term debt to equal 71%, meaning present value of
the company‟s operating lease payments has been found to exceed ten percent of its
long-term debt. This is the main indicator of distortions in the company‟s actual value.
When the firm reports their leases as operating leases, a significant portion of their
assets and liabilities incurred from these assets are removed from their books and in
addition net income and equity could potentially be inflated. From these effects it is
reasonable to assume Cracker Barrel is signaling a red flag and their books must then
be restated.
98
CFFO
Decreases in CFFO(cash flow from operations) may be a bad sign for the overall
health of a firm. Companies may begin complete more credit sales and have less cash
to show for total revenues. Cracker Barrel‟s CFFO decreased slightly in the fiscal year
2006 and even more sharply in the year 2007. However, this is due to the firm‟s
divestiture of Logan‟s Roadhouse. The company recorded a loss from discontinuing
operations under CFFO in both years due to this divestiture. Therefore it is not a
significant sign of danger that the change ratio of Total Accruals to Sales was negative
in years 2006 and 2007.
Undo Accounting Distortions
The purpose of finding “red flags” is to ultimately undo any accounting
distortions in the financial statements. This allows analyst to properly value firms
without the biased accounting techniques used by managers. When undoing
distortions, the balance sheet is properly reflected, giving viewers a transparent view of
the statements. This allows investors and creditors to create what is called a trial
balance sheet. The trial balance sheet restates assets and liabilities by adding back in
operating leases, goodwill, and research and development. These restated sheets help
to properly value the firms. Their operating leases created a “red flag” which ultimately
affected their financial statements. To give users a better view the operating leases will
be capitalized and restated in the financial statements.
Operating Leases
Cracker Barrel‟s Operating leases amounted to a present value of over 10% of its
long term debt. This means that the operating leases must be capitalized and added
into their financial statements. By doing so, it properly valuates their assets and
99
liabilities onto the financial statements. To find the present value we first had to come
up with the interest rate to discount their future payment obligations. This was
achieved by finding the internal rate of return of their future cash flow payments from
their capital leases. Then, we assumed that Cracker Barrel will exercise all future
renewal on operating leases and that all leases are 20 year leases. The first five
payments were given in Cracker Barrels 10-K and we found the last 15 payments by
dividing the sum of their later years by 15. Below is the table created to properly
amortize operating leases for years 2004-2009.
100
0.0729 Ol Payment
Year t PV Factor PV Payment BB Interest Payment EB Change In Loan Depreciation Total CL Exp CL-OL
2005 1 30156 0.930233 28052 2005 1 241168 17833 30156 232304 -12323 12231 30065 -91
2006 2 29856 0.865333 25835 2006 2 232304 16935 29856 219383 -12921 12231 29166 -690
2007 3 29754 0.804961 23951 2007 3 219383 15993 29754 205622 -13761 12231 28224 -1530
2008 4 29798 0.748801 22313 2008 4 205622 14990 29798 190814 -14808 12231 27221 -2577
2009 5 29688 0.696559 20679 2009 5 190814 13910 29688 175037 -15778 12231 26142 -3546
2010 6 19571 0.647962 12682 2010 6 175037 12760 19571 168225 -6811 12231 24992 5420
2011 7 19571 0.602755 11797 2011 7 168225 12264 19571 160917 -7308 12231 24495 4924
2012 8 19571 0.560702 10974 2012 8 160917 11731 19571 153077 -7841 12231 23962 4391
2013 9 19571 0.521583 10208 2013 9 153077 11159 19571 144665 -8412 12231 23391 3819
2014 10 19571 0.485194 9496 2014 10 144665 10546 19571 135639 -9025 12231 22777 3206
2015 11 19571 0.451343 8833 2015 11 135639 9888 19571 125956 -9683 12231 22119 2548
2016 12 19571 0.419854 8217 2016 12 125956 9182 19571 115567 -10389 12231 21414 1842
2017 13 19571 0.390562 7644 2017 13 115567 8425 19571 104420 -11147 12231 20656 1085
2018 14 19571 0.363313 7111 2018 14 104420 7612 19571 92461 -11959 12231 19844 272
2019 15 19571 0.337966 6614 2019 15 92461 6740 19571 79630 -12831 12231 18972 -600
2020 16 19571 0.314387 6153 2020 16 79630 5805 19571 65863 -13766 12231 18036 -1535
2021 17 19571 0.292453 5724 2021 17 65863 4801 19571 51093 -14770 12231 17033 -2539
2022 18 19571 0.272049 5324 2022 18 51093 3725 19571 35246 -15847 12231 15956 -3615
2023 19 19571 0.253069 4953 2023 19 35246 2569 19571 18244 -17002 12231 14801 -4771
2024 20 19571 0.235413 4607 2024 20 18244 1330 19571 3 -18241 12231 13561 -6010
0.062 Ol Payment 241168
Year t PV Factor PV Payment BB Interest Payment EB Change In Loan Depreciation Total CL Exp CL-OL
2006 1 30174 0.943396 28466 2006 1 432682 26826 30174 429334 -3348 21634 48460 18286
2007 2 29947 0.889996 26653 2007 2 429334 26619 29947 426006 -3328 21634 48253 18306
2008 3 29934 0.839619 25133 2008 3 426006 26412 29934 422484 -3522 21634 48046 18112
2009 4 30190 0.792094 23913 2009 4 422484 26194 30190 418488 -3996 21634 47828 17638
2010 5 30376 0.747258 22699 2010 5 418488 25946 30376 414059 -4430 21634 47580 17204
2011 6 38195 0.704961 26926 2011 6 414059 25672 38195 401536 -12523 21634 47306 9111
2012 7 38195 0.665057 25402 2012 7 401536 24895 38195 388236 -13299 21634 46529 8335
2013 8 38195 0.627412 23964 2013 8 388236 24071 38195 374113 -14124 21634 45705 7510
2014 9 38195 0.591898 22607 2014 9 374113 23195 38195 359113 -15000 21634 44829 6635
2015 10 38195 0.558395 21328 2015 10 359113 22265 38195 343184 -15930 21634 43899 5705
2016 11 38195 0.526788 20120 2016 11 343184 21277 38195 326266 -16917 21634 42911 4717
2017 12 38195 0.496969 18981 2017 12 326266 20229 38195 308300 -17966 21634 41863 3668
2018 13 38195 0.468839 17907 2018 13 308300 19115 38195 289220 -19080 21634 40749 2554
2019 14 38195 0.442301 16893 2019 14 289220 17932 38195 268958 -20263 21634 39566 1371
2020 15 38195 0.417265 15937 2020 15 268958 16675 38195 247438 -21519 21634 38309 115
2021 16 38195 0.393646 15035 2021 16 247438 15341 38195 224585 -22853 21634 36975 -1219
2022 17 38195 0.371364 14184 2022 17 224585 13924 38195 200315 -24270 21634 35558 -2636
2023 18 38195 0.350344 13381 2023 18 200315 12420 38195 174540 -25775 21634 34054 -4141
2024 19 38195 0.330513 12624 2024 19 174540 10821 38195 147167 -27373 21634 32456 -5739
2025 20 38195 0.311805 11909 2025 20 147167 9124 38195 118097 -29070 21634 30758 -7436
Loan Amortization Table
Loan Amortization Table
101
0.046 Ol Payment 404063
Year t PV Factor PV Payment BB Interest Payment EB Change In Loan Depreciation Total CL Exp CL-OL
2007 1 35634 0.956938 34100 2007 1 532573 24498 35634 521437 -11136 26629 51127 15493
2008 2 36021 0.91573 32986 2008 2 521437 23986 36021 509402 -12035 26629 50615 14594
2009 3 36130 0.876297 31661 2009 3 509402 23433 36130 496705 -12697 26629 50061 13931
2010 4 35076 0.838561 29413 2010 4 496705 22848 35076 484477 -12228 26629 49477 14401
2011 5 35014 0.802451 28097 2011 5 484477 22286 35014 471749 -12728 26629 48915 13901
2012 6 43723 0.767896 33574 2012 6 471749 21700 43723 449727 -22022 26629 48329 4607
2013 7 43723 0.734828 32129 2013 7 449727 20687 43723 426692 -23035 26629 47316 3594
2014 8 43723 0.703185 30745 2014 8 426692 19628 43723 402597 -24095 26629 46256 2534
2015 9 43723 0.672904 29421 2015 9 402597 18519 43723 377394 -25203 26629 45148 1426
2016 10 43723 0.643928 28154 2016 10 377394 17360 43723 351032 -26362 26629 43989 266
2017 11 43723 0.616199 26942 2017 11 351032 16147 43723 323457 -27575 26629 42776 -946
2018 12 43723 0.589664 25782 2018 12 323457 14879 43723 294613 -28844 26629 41508 -2215
2019 13 43723 0.564272 24671 2019 13 294613 13552 43723 264443 -30170 26629 40181 -3542
2020 14 43723 0.539973 23609 2020 14 264443 12164 43723 232884 -31558 26629 38793 -4930
2021 15 43723 0.51672 22592 2021 15 232884 10713 43723 199874 -33010 26629 37341 -6381
2022 16 43723 0.494469 21619 2022 16 199874 9194 43723 165346 -34528 26629 35823 -7900
2023 17 43723 0.473176 20688 2023 17 165346 7606 43723 129229 -36117 26629 34235 -9488
2024 18 43723 0.4528 19798 2024 18 129229 5945 43723 91451 -37778 26629 32573 -11149
2025 19 43723 0.433302 18945 2025 19 91451 4207 43723 51936 -39516 26629 30835 -12887
2026 20 43723 0.414643 18129 2026 20 51936 2389 43723 10602 -41334 26629 29018 -14705
0.046 Ol Payment 533056
Year t PV Factor PV Payment BB Interest Payment EB Change In Loan Depreciation Total CL Exp CL-OL
2008 1 29044 0.938967 27271 2008 1 393892 18119 29044 382967 -10925 19695 37814 8770
2009 2 29178 0.881659 25725 2009 2 382967 17616 29178 371406 -11562 19695 37311 8133
2010 3 27917 0.827849 23111 2010 3 371406 17085 27917 360573 -10832 19695 36779 8862
2011 4 27697 0.777323 21530 2011 4 360573 16586 27697 349463 -11111 19695 36281 8584
2012 5 27666 0.729881 20193 2012 5 349463 16075 27666 337872 -11591 19695 35770 8104
2013 6 31311 0.685334 21459 2013 6 337872 15542 31311 322103 -15769 19695 35237 3926
2014 7 31311 0.734828 23008 2014 7 322103 14817 31311 305608 -16494 19695 34511 3200
2015 8 31311 0.703185 22018 2015 8 305608 14058 31311 288355 -17253 19695 33753 2441
2016 9 31311 0.672904 21069 2016 9 288355 13264 31311 270308 -18047 19695 32959 1648
2017 10 31311 0.643928 20162 2017 10 270308 12434 31311 251431 -18877 19695 32129 818
2018 11 31311 0.616199 19294 2018 11 251431 11566 31311 231686 -19745 19695 31260 -51
2019 12 31311 0.589664 18463 2019 12 231686 10658 31311 211032 -20654 19695 30352 -959
2020 13 31311 0.564272 17668 2020 13 211032 9707 31311 189428 -21604 19695 29402 -1909
2021 14 31311 0.539973 16907 2021 14 189428 8714 31311 166831 -22597 19695 28408 -2903
2022 15 31311 0.51672 16179 2022 15 166831 7674 31311 143194 -23637 19695 27369 -3942
2023 16 31311 0.494469 15482 2023 16 143194 6587 31311 118470 -24724 19695 26282 -5030
2024 17 31311 0.473176 14816 2024 17 118470 5450 31311 92608 -25862 19695 25144 -6167
2025 18 31311 0.4528 14178 2025 18 92608 4260 31311 65557 -27051 19695 23955 -7357
2026 19 31311 0.433302 13567 2026 19 65557 3016 31311 37261 -28296 19695 22710 -8601
2027 20 31311 0.414643 12983 2027 20 37261 1714 31311 7664 -29597 19695 21409 -9903
Loan Amortization Table
Loan Amortization Table
102
0.059 Ol Payment 385083
Year t PV Factor PV Payment BB Interest Payment EB Change In Loan Depreciation Total CL Exp CL-OL
2009 1 30294 0.943396 28579 2009 1 368862 21763 30294 360331 -8531 18443 40206 9912
2010 2 30504 0.889996 27148 2010 2 360331 21260 30504 351086 -9244 18443 39703 9199
2011 3 29083 0.839619 24419 2011 3 351086 20714 29083 342717 -8369 18443 39157 10074
2012 4 29073 0.792094 23029 2012 4 342717 20220 29073 333865 -8853 18443 38663 9590
2013 5 29307 0.747258 21900 2013 5 333865 19698 29307 324256 -9609 18443 38141 8834
2014 6 33038 0.704961 23290 2014 6 324256 19131 33038 310349 -13907 18443 37574 4536
2015 7 33038 0.665057 21972 2015 7 310349 18311 33038 295622 -14727 18443 36754 3716
2016 8 33038 0.627412 20728 2016 8 295622 17442 33038 280026 -15596 18443 35885 2847
2017 9 33038 0.591898 19555 2017 9 280026 16522 33038 263510 -16516 18443 34965 1927
2018 10 33038 0.558395 18448 2018 10 263510 15547 33038 246019 -17491 18443 33990 952
2019 11 33038 0.526788 17404 2019 11 246019 14515 33038 227497 -18523 18443 32958 -80
2020 12 33038 0.496969 16419 2020 12 227497 13422 33038 207881 -19615 18443 31865 -1172
2021 13 33038 0.468839 15489 2021 13 207881 12265 33038 187108 -20773 18443 30708 -2330
2022 14 33038 0.442301 14613 2022 14 187108 11039 33038 165110 -21998 18443 29482 -3555
2023 15 33038 0.417265 13785 2023 15 165110 9741 33038 141814 -23296 18443 28185 -4853
2024 16 33038 0.393646 13005 2024 16 141814 8367 33038 117143 -24671 18443 26810 -6228
2025 17 33038 0.371364 12269 2025 17 117143 6911 33038 91017 -26126 18443 25355 -7683
2026 18 33038 0.350344 11575 2026 18 91017 5370 33038 63349 -27668 18443 23813 -9225
2027 19 33038 0.330513 10919 2027 19 63349 3738 33038 34049 -29300 18443 22181 -10857
2028 20 33038 0.311805 10301 2028 20 34049 2009 33038 3020 -31029 18443 20452 -12586
0.055 Ol Payment 364848
Year t PV Factor PV Payment BB Interest Payment EB Change In Loan Depreciation Total CL Exp CL-OL
2010 1 36890 0.947867 34966.81363 2010 1 455080 25029 36890 443219 -11861 22754 47783 10893
2011 2 35601 0.898452 31985.78965 2011 2 443219 24377 35601 431995 -11224 22754 47131 11530
2012 3 35668 0.851614 30375.36815 2012 3 431995 23760 35668 420087 -11908 22754 46514 10846
2013 4 35980 0.807217 29043.66766 2013 4 420087 23105 35980 407212 -12875 22754 45859 9879
2014 5 36401 0.765134 27851.64273 2014 5 407212 22397 36401 393208 -14004 22754 45151 8750
2015 6 38974 0.725246 28265.44751 2015 6 393208 21626 38974 375860 -17347 22754 44380 5407
2016 7 38974 0.687437 26791.89466 2016 7 375860 20672 38974 357559 -18301 22754 43426 4453
2017 8 38974 0.651599 25395.15879 2017 8 357559 19666 38974 338251 -19308 22754 42420 3446
2018 9 38974 0.617629 24071.22559 2018 9 338251 18604 38974 317882 -20370 22754 41358 2384
2019 10 38974 0.585431 22816.35362 2019 10 317882 17483 38974 296391 -21490 22754 40237 1264
2020 11 38974 0.554911 21626.87935 2020 11 296391 16302 38974 273719 -22672 22754 39056 82
2021 12 38974 0.525982 20499.41208 2021 12 273719 15055 38974 249800 -23919 22754 37809 -1165
2022 13 38974 0.498561 19430.71699 2022 13 249800 13739 38974 224566 -25235 22754 36493 -2481
2023 14 38974 0.472569 18417.71518 2023 14 224566 12351 38974 197943 -26622 22754 35105 -3868
2024 15 38974 0.447933 17457.56157 2024 15 197943 10887 38974 169857 -28087 22754 33641 -5333
2025 16 38974 0.424581 16547.45006 2025 16 169857 9342 38974 140225 -29631 22754 32096 -6877
2026 17 38974 0.402447 15684.8084 2026 17 140225 7712 38974 108964 -31261 22754 30466 -8507
2027 18 38974 0.381466 14867.1033 2027 18 108964 5993 38974 75983 -32981 22754 28747 -10227
2028 19 38974 0.361579 14092.03531 2028 19 75983 4179 38974 41189 -34795 22754 26933 -12041
2029 20 38974 0.342729 13357.38295 2029 20 41189 2265 38974 4481 -36708 22754 25019 -13954
Loan Amortization Table
Loan Amortization Table
103
Trial Balance
When restating financial statements it is important to construct a trial balance of
each year‟s financial statements. The trial balance will make sure that debits and credits
match up after proper yearly adjustments. First we created an amortization schedule for
the operating leases Cracker Barrel currently has. From this table we were able to come
up with the adjustment numbers to show accrued depreciation and interest on the
capitalized leases. This allowed us to formulate restated balance sheets and income
statements for years 2004-2009. Restating the financial statements shows a more
realistic view of Cracker Barrel‟s position. The following pages show the adjusted trial
balance sheet.
104
CBRL GROUP, INC.
TRIAL BALANCE SHEET
(In thousands except share data)
ASSETS
2004 2004 2005 2005
As Stated Debits Credits Adjusted As Stated Debits Credits Adjusted
Current Assets:
Total current assets 203040 203040 190483 190483
Property and Equipment:
Land 298233 298233 328362 328362
Buildings and improvements 662682 662682 709730 709730
Buildings under capital leases 3289 3289 3289 3289
Restaurant and other equipment 315512 315512 359533 359533
Leasehold improvements 193859 193859 228859 228859
Construction in progress 28739 28739 34275 34275
Assets Under Capitalized Lease Rights (Net) 241168 241168 445005 12231 432774
Total 1502314 1743482 1664048 2096822
Less: Accumulated depreciation and amortization of capital leases383741 383741 445750 445750
Property and equipment - net 1118573 1359741 1218298 1651072
Goodwill 93724 93724 93724 93724
Other Assets 20367 20367 30767 30767
Total 1435704 1676872 1533272 1966046
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Total current liabilities 242235 242235 295345 295345
Long-term Debt 185138 185138 212218 212218
Capital lease obligations (net) 0 241168 241168 12323 445005 432682
Interest rate swap liability 0 0 0 0
Other Long-term Obligations 36225 36225 48411 48411
Deferred Income Taxes 98770 98770 107310 107310
Total Long Term Liabilities 320133 561301 367939 800621
803535.732 1095966
Total shareholders' equity 873336 873336 869988 870080
Total 1435704 1676872 1533272 1966046
2004 2004 2005 2005
As Stated Debits Credits Adjusted As Stated Debits Credits Adjusted
Total revenue 2380947 2380947 2567548 2567548
Cost of goods sold 785703 785703 847045 847045
Gross profit 1595244 1595244 1720503 1720503
Labor & other related expenses 880617 880617 939849 939849
Impairment and store closing charges 0 0 0 0
Other store operating expenses 405139 405139 447506 447506
Op. Lease Expense 30156 -30156
Depreciation Expense, Operating Leases 12231 12231
Store operating income 309488 309488 333148 351073
General and administrative 126501 126501 130986 130986
Operating income 182987 182987 202162 220087
Interest expense 8444 8444 8693 17833 26526
Interest income 5 5 96 96
Income before income taxes 174548 174548 193565 193657
Provision for income taxes 62663 62663 66925 66925
Income from continuing operations 111885 111885 126640 126732
Income from discontinued operations net of tax 0 0 0 0
Net income 111885 111885 126640 126732
Trial Balance Test 241167.7 241167.7 487392 487392
105
ASSETS
2006 2006 2007 2007
As Stated Debits Credits Adjusted As Stated Debits Credits Adjusted
Current Assets:
Total current assets 653830 653830 200281 200281
Property and Equipment:
Land 277605 277605 287873 287873
Buildings and improvements 651643 651643 687041 687041
Buildings under capital leases 3289 3289 3289 3289
Restaurant and other equipment 315867 315867 336881 336881
Leasehold improvements 149061 149061 165472 165472
Construction in progress 17909 17909 19673 19673
Assets Under Capitalized Lease Rights (Net) 511422 21634 489788 380088 26629 353459
Total 1415374 1905162 1500229 1853688
Less: Accumulated depreciation and amortization of capital leases432870 432870 481247 481247
Property and equipment - net 982504 1472292 1018982 1372441
Goodwill 0 0 0 0
Other Assets 44963 44963 45767 45767
Total 1681297 2171085 1265030 1618489
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Total current liabilities 330533 330533 274669 274669
Long-term Debt 911464 911464 756306 756306
Capital lease obligations (net) 0 3348 511422 508074 0 11136 380088 368952
Interest rate swap liability 0 0 0 0
Other Long-term Obligations 55128 55128 67499 67499
Deferred Income Taxes 81890 81890 62433 62433
Total Long Term Liabilities 1048482 1556556 886238 1255190
1887089 1529859
Total shareholders' equity 302282 283996 104123 88630
Total 1681297 2171085 1265030 1618489
2006 2006 2007 2007
As Stated Debits Credits Adjusted As Stated Debits Credits Adjusted
Total revenue 2219475 2219475 2351576 2351576
Cost of goods sold 706095 706095 744275 744275
Gross profit 1513380 1513380 1607301 1607301
Labor & other related expenses 832943 832943 892839 892839
Impairment and store closing charges 5369 5369 0 0
Other store operating expenses 384442 384442 410131 410131
Op. Lease Expense 30174 -30174 35634 -35634
Depreciation Expense, Operating Leases 21634 21634 26629 26629
Store operating income 290626 299166 304331 313336
General and administrative 128830 128830 136186 136186
Operating income 161796 170336 168145 177150
Interest expense 22205 26826 49031 59438 24498 83936
Interest income 764 764 7774 7774
Income before income taxes 140355 122069 116481 100988
Provision for income taxes 44854 44854 40498 40498
Income from continuing operations 95501 77215 75983 60490
Income from discontinued operations net of tax20790 20790 86082 86082
Net income 116291 98005 162065 146572
Trial Balance Test 563230 563230 442351 442351
106
2008 2008 2009 2009
As Stated Debits Credits Adjusted As Stated Debits Credits Adjusted
Current Assets:
Total current assets 220639 220639 198325 198325
Property and Equipment:
Land 299608 299608 286161 286161
Buildings and improvements 711030 711030 686736 686736
Buildings under capital leases 3289 3289 3289 3289
Restaurant and other equipment 359089 359089 379459 379459
Leasehold improvements 183729 183729 200704 200704
Construction in progress 15071 15071 16089 16089
Assets Under Capitalized Lease Rights (Net) 345230 19695 325535 435161 18443 416718
Total 1571816 1897351 1572438 1989156
Less: Accumulated depreciation and amortization of capital leases526576 526576 570662 570662
Property and equipment - net 1045240 1370775 1001776 1418494
Goodwill 0 0 0 0
Other Assets 47824 47824 45080 45080
Total 1313703 1639238 1245181 1661899
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Total current liabilities 264719 264719 264962 264962
Long-term Debt 779061 779061 638040 638040
Capital lease obligations (net) 77 10925 345230 334382 60 8531 435161 426690
Interest rate swap liability 39618 39618 61232 61232
Other Long-term Obligations 83147 83147 89610 89610
Deferred Income Taxes 54330 54330 55655 55655
Total Long Term Liabilities 956233 1290538 844597 1271227
1555257 1536189
Total shareholders' equity 92751 83981 135622 125710
Total 1313703 1639238 1245181 1661899
2008 2008 2009 2009
As Stated Debits Credits Adjusted As Stated Debits Credits Adjusted
Total revenue 2384521 2384521 2367285 2367285
Cost of goods sold 773757 773757 764909 764909
Gross profit 1610764 1610764 1602376 1602376
Labor & other related expenses 909546 909546 916256 916256
Impairment and store closing charges 877 877 2088 2088
Other store operating expenses 422293 422293 421594 421594
Op. Lease Expense 29044 -29044 30294 -30294
Depreciation Expense, Operating Leases 19695 19695 18443 18443
Store operating income 278048 287397 262438 274289
General and administrative 127273 127273 120199 120199
Operating income 150775 160124 142239 154090
Interest expense 57445 18119 75564 52177 21763 73940
Interest income 185 185 0 0
Income before income taxes 93515 84745 90062 80150
Provision for income taxes 28212 28212 24105 24105
Income from continuing operations 65303 56533 65957 56045
Income from discontinued operations net of tax 250 250 -31 -31
Net income 65553 56783 65926 56014
Trial Balance Test 393969 393969 483898 483898
107
Financial Ratio Analysis, Financial Forecasting, and Cost of Capital Estimation
In order to give a proper evaluation of the company‟s performance we will
examine the firm by analyzing financial ratios, forecasting financial statements, and
estimating the cost of capital. Each of these tasks involved in the financial analysis are
essential in estimating the value of the firm.
The financial ratio section is designed to give an outlook on a firm‟s liquidity,
profitability, and capital structure. This section also states these qualities in an absolute
and relative manner by comparing the firm‟s ratios to those of its competitors. The
financial forecasting section is used to portray how the company will look up to ten
years in the future. The forecasts use estimated growth rates based off of data trends
from five years previous. In addition, it gives a ten year forecast of financial data after
restating for any significant distortions. The final section of the financial analysis is a
cost of capital estimation. When estimating the cost of capital the weighted average
cost of capital (WACC) formula is used. The WACC formula gives the rate at which the
firm must pay off its financing from both debt and equity.
Financial Ratio Analysis
Examining a company‟s financial ratios offers a simple, uniform way to assess the
performance of a firm. In addition, Palepu and Healy state that “Ratio
analysis...provides the foundation for making forecasts of future performance.”30
Investors and analysts can use these ratios to compare firms at their current positions
as well as into the future. This allows for another angle at assessing the value of the
firm.
30
Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.
108
Liquidity Ratios
Liquidity ratios are representative of the company‟s ability to take care of debts
in the short run. These ratios can also show how efficiently a firm is running. Carrying
mostly assets that are not able to be converted relatively quickly into cash (illiquid
assets) can pose a risk when companies do not generate expected cash flows and
short-term liabilities come due. Illiquid assets generally create more long term cash
flows, but liquidity is key in times of economic downturn or unexpected events when
firms must find alternative ways to generate cash for debt payments.
The following ratios will be used to evaluate Cracker Barrel and compare the firm
to competitors in the industry.
Liquidity Ratios:
- Current Ratio
- Quick-Asset (Acid Test) Ratio
Operating Efficiency Ratios:
- Working Capital Turnover
- Days‟ Supply of Inventory
- Receivables Turnover
- Days‟ Sales Outstanding
- Inventory Turnover Ratio
- Cash-to-Cash Cycle
Current Ratio
The current ratio is a quick and easy way to determine if a company has
sufficient resources to satisfy next years‟ current liabilities. The current ratio is found by
dividing all current assets by all current liabilities. In general, a current ratio lower than
109
one means that a firm would not be able to pay off all its liabilities if they came due and
could be in a bad financial position. In contrast, a ratio above one indicates that the
firm would be able to cover its debts with its current assets. For this reason, banks
typically like to lend to firms with a ratio greater than two. However, it is important to
remember that different industries carry different standards, so an industry wide
comparison is essential. In some cases, firms try to keep their ratio just around one. If
a company has long term stability, it can borrow against future cash flows in order to
cover current liabilities.31
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 0.84 0.64 1.98 0.73 0.83 1.00
Bob Evans 0.33 0.30 0.52 0.51 0.22 0.37
Denny's 0.32 0.42 0.46 0.44 0.50 0.43
Darden 0.51 0.39 0.37 0.51 0.41 0.44
Dine Equity 1.82 1.14 1.22 1.14 1.06 1.28
Brinker International 1.06 0.73 0.49 1.21 0.87 0.87
Industry 0.81 0.60 0.61 0.76 0.61 0.68
31
“Financial Ratio Analysis” http://www.nd.edu/~mgrecon/simulations/micromaticweb/financialratios.html
0
0.5
1
1.5
2
2.5
2004 2005 2006 2007 2008
Current Ratio
Cracker Barrel
Bob Evans
Denny's
Darden
Dine Equity
Brinker International
Industry
110
Cracker Barrel maintains a 5 year current ratio average of almost exactly 1,
about .33 above the industry average. This indicates Cracker Barrel would be able to
cover its short term debts with its short term assets. However, closer examination of
the numbers reveals an aberration in the year 2006, when Cracker Barrel sold its
ownership claims in Logan‟s Roadhouse, Inc. Cracker Barrel received a notable
consideration of cash and other assets in the sale. Around $400,000,000 from the sale
was represented as “assets from discounted operations” on the balance sheet for the
fiscal year 2006. This caused the current ratio to spike to more than double what it was
in any of the four other years. Without the year 2006, Cracker Barrel maintains a
current ratio average of .7614, much nearer to the industry average. The restaurant
industry as a whole is able to generate cash rather quickly (as most sales are cash
sales), so Cracker Barrel‟s low current ratio is not necessarily a sign of danger.
Quick Asset Ratio
The quick asset ratio, also known as the acid test ratio, is a measure of a firm‟s
ability to pay off current liabilities using only assets that can quickly be turned into cash.
The main difference from the current ratio is that the quick asset ratio excludes
inventories. Excluding inventory allows for a glance at the current liability coverage a
firm has should it stop selling its product. It is used in many cases instead of the
current ratio because it provides a more conservative look at a firm‟s liquidity position.
Inventories may build up during economic downturns and represent a large portion of
current assets that might not be able to be quickly sold to cover current liabilities. It can
be used as a disaster measure to see what liabilities the firm could cover in the event
that the business has to shut down.
111
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 0.25 0.16 1.59 0.20 0.24 0.49
Bob Evans 0.19 0.17 0.34 0.37 0.12 0.24
Dennys 0.26 0.36 0.40 0.39 0.45 0.37
Darden 0.22 0.16 0.17 0.31 0.22 0.22
Dine Equity 1.81 1.13 1.22 1.10 1.02 1.26
Brinker International 0.96 0.61 0.41 1.15 0.80 0.79
Industry 0.69 0.49 0.51 0.66 0.52 0.57
With the exception of 2006, Cracker Barrel‟s quick asset ratio consistently ranks
near the bottom of the industry. Upon looking at Cracker Barrel‟s 10-K, it is clear that
this is because such a large portion of their current assets is made up of inventories.
Inventories consistently comprise around two thirds to three quarters of total current
assets (69% in the most recent year). These inventories inflate the current ratio and
indicate that Cracker Barrel may have more trouble covering current liabilities than
previously thought. However, Cracker Barrel acknowledges this fact and claims that the
purchasing and holding of retail inventories are “aided by rapid product turnover of the
restaurant industry.”32 Investors can expect this trend to continue; as long as Cracker
Barrel maintains the retail portion of its stores, their quick asset ratio will continue to
rank near the bottom of the restaurant industry. For these reasons, Cracker Barrel‟s low
quick ratio does not cause us concern.
32
CBRL 10-K, 2009
0
0.5
1
1.5
2
2004 2005 2006 2007 2008
Quick Asset Ratio
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
112
Working Capital Turnover
Working capital turnover is defined as the amount of sales divided by working
capital (WC=CA-CL). Working capital is the amount of current assets left after covering
for current liabilities that can be invested into business growth. It is the net investment
into the companies‟ cash-to-cash cycle. Working capital turnover represents the
productivity of those investments. In general, the higher the WC turnover, the better,
as this indicates a firm is operating more efficiently with the amount of money invested.
A WC turnover nearing zero or one that is negative may be an indication that a firm is
in serious financial trouble and may go bankrupt soon.
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel -60.74 -20.89 6.87 -31.61 -54.10 -27.50
Bob Evans -12.18 -11.11 -20.56 -16.76 -6.80 -14.45
Dennys -10.36 -11.28 -13.62 -12.76 -14.17 -10.78
Darden -14.84 -8.28 -7.72 -10.52 -9.92 -11.23
Dine Equity 7.49 39.93 24.47 9.26 92.66 17.22
Brinker International
170.40 -32.05 -16.28 39.18 -59.82 27.68
Industry 28.10 -4.56 -6.74 1.68 0.39 1.69
-100
-50
0
50
100
150
200
2003 2004 2005 2006 2007 2008
Working Capital Turnover
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industy
113
At first glance, it seems as though almost every company in the industry is
headed for bankruptcy. However, a negative working capital turnover is actually quite
common in the restaurant industry. Recalling from the current ratio section, almost all
firms had a current ratio of less than one. This implies that current assets are less than
current liabilities, which in turn creates negative working capital. This negative working
capital plugged in to the WC turnover equation yields the negative working capital
figures shown above. Because cash is received at the point of sale, the firms can easily
and quickly raise cash should they need to cover liabilities immediately. In many cases,
firms in the restaurant industry sell food inventories to customers before they even pay
their suppliers for the foods. Still, when analyzing Cracker Barrel it is important to
remember that the company also holds retail inventory, which does not enjoy the quick
turnover that restaurant inventory does. This means that Cracker Barrel may be in more
danger operating with a working capital deficit than other restaurants in the industry.
Accounts Receivable Turnover
Accounts receivable turnover is a representation of a firm‟s ability to collect
payments from customers. A low ratio can indicate that a company may be too liberal
with the credit policies they extend to customers. A high ratio implies that a firm is
either efficient with collecting accounts receivable or operates in a mostly cash industry.
Receivables turnover is found by dividing net sales by accounts receivable.
As mentioned previously, the restaurant industry is dominated by cash sales at
the point of transaction. Sales are made at such a high rate and at such a low cost that
there is no need for firms to extend financing to customers. Even in the case of Cracker
Barrel‟s retail sector, sales are still made with cash or third party credit. Because
companies in the restaurant industry maintain such low accounts receivable balances,
the receivables turnover ratio can be expected to be high and is not very relevant in
assessing the health of a firm.
114
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 242.88 159.50 194.11 199.98 176.84 194.66
Bob Evans 89.32 99.29 98.25 80.65 87.06 90.91
Dennys 77.58 58.16 68.25 69.15 50.20 64.67
Darden 165.36 144.57 134.82 122.62 95.35 132.54
Dine Equity 8.09 7.97 7.67 4.20 13.68 8.32
Brinker International
97.74 86.01 79.01 87.80 80.97 86.31
Industry 87.61 79.20 77.60 72.88 65.45 76.55
As expected, ratios are extremely high across the board with the exception of
DineEquity, who maintains receivables for income from franchised locations.33 Cracker
Barrel is consistently the industry leader in receivables turnover. However, as previously
stated, this ratio does not have much relevance in an industry where receivables
numbers are so low.
33
DineEquity 10-K, 2008
0
50
100
150
200
250
300
2004 2005 2006 2007 2008
Receivables Turnover
Cracker Barrel
Bob Evans
Denny's
Darden
Dine Equity
Brinker International
Industry
115
Days’ Sales Outstanding
Days‟ sales outstanding represents how many days it takes a firm to collect
money from a sale. It is calculated by dividing 365 days in a year by the receivables
turnover. Because a component of days‟ sales outstanding is the receivables turnover,
the explanations of the restaurant industries‟ quick cash collection shown in the
receivables turnover section will again be prevalent in the days‟ sales outstanding.
However, now the quickest collecting firms will be represented by the lowest numbers.
Cracker Barrel leads the industry in collection efficiency, with a five year average of
1.91 days to collect cash from sales.
0
10
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2004 2005 2006 2007 2008
Days Sales Outstanding
Cracker Barrel
Bob Evans
Denny's
Darden
Dine Equity
Brinker International
Industry
116
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 1.5 2.3 1.9 1.8 2.1 1.9
Bob Evans 4.1 3.7 3.7 4.5 4.2 4.0
Dennys 4.7 6.3 5.3 5.3 7.3 5.8
Darden 2.2 2.5 2.7 3.0 3.8 2.8
Dine Equity 45.1 45.8 47.6 86.9 26.7 50.4
Brinker International
3.7 4.2 4.6 4.2 4.5 4.3
Industry 12.0 12.5 12.8 20.8 9.3 13.5
Inventory Turnover
Inventory turnover is an indication of a firm‟s ability to efficiently manage its
inventory. It is calculated by dividing the cost of goods sold by inventory. If a firm sells
the same inventory over and over and keeps restocking it, the cost of goods sold will
rise while inventory remains constant, increasing the ratio. A higher ratio means that a
company is restocking its inventory more times. A lower ratio can represent dormant
inventories. This is a sign of trouble and can hurt the company when prices drop while
inventory is held. As with other ratios, it should be compared within the industry as
different industries maintain different size inventories. The restaurant industry holds low
amounts of inventories relative to cost of goods sold because the inventories are turned
over so quickly.
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2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel Without Retail
16.69 13.93 18.52 17.25 19.72 17.22
Cracker Barrel With Retail 5.54 5.02 5.50 5.15 4.96 5.24
Bob Evans 17.52 18.15 16.74 16.81 16.51 17.15
Dennys 91.09 94.97 95.35 120.55 104.51 101.29
Darden 19.63 17.40 22.28 20.32 23.71 20.67
Dine Equity 1541.68 395.88 526.43 22.98 98.88 517.17
Brinker International 26.89 21.79 28.79 41.87 33.94 30.65
Industry 339.36 109.64 137.92 44.51 55.51 137.39
Cracker Barrel‟s inventory turnover ratio is far below the rest of the industry. This
is a result of Cracker Barrel‟s retail sector, which causes the firm to hold much larger
inventories than the rest of the industry. In the most recent year, Cracker Barrel‟s
inventory was $137,424,000, of which $108,412,000 were retail inventories. If in the
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2004 2005 2006 2007 2008
Inventory Turnover
Cracker Barrel Without Retail
Cracker Barrel With Retail
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
118
most recent year the retail inventories are taken out of Cracker Barrel‟s inventory and
inventory turnover is recalculated (reducing COGS by 25% as this is what portion of
sales are retail sales), Cracker Barrel has an inventory turnover of 19.77. This is much
more on par with the industry average, and indicates Cracker Barrel is able to generate
restaurant sales as well as its competitors. DineEquity‟s extremely large ratio is due to
the fact that they franchise almost all their locations and do not include the inventory of
the franchised locations in their inventory numbers. However, they do include the cost
of goods sold from the franchises, and this severely inflates the numbers. The efficiency
represented by a higher ratio translates into a higher level of liquidity for the firm.
Days’ Supply of Inventory
The days‟ supply of inventory represents how long it takes a firm to turnover its
inventory. It is calculated by dividing 365 days in a year by the inventory turnover ratio.
It has a relationship with the inventory turnover rate much the same way that days‟
sales outstanding has a relationship with the receivables turnover rate. The higher the
receivables turnover rate, the lower the days‟ supply of inventory. A low DSI is
generally seen as more desirable as it represents less days that inventories are unsold
and less days that the company could lose money from market prices for inventories
dropping.
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2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel Without Retail
21.87 26.20 19.71 21.16 18.51 21.49
Cracker Barrel With Retail
65.88 72.68 66.32 70.82 73.57 69.86
Bob Evans 20.83 20.11 21.80 21.71 22.11 21.31
Denny’s 4.01 3.84 3.83 3.03 3.49 3.64
Darden 18.59 20.98 16.38 17.96 15.39 17.86
Dine Equity 0.24 0.92 0.69 15.89 3.69 4.29
Brinker International 13.58 16.75 12.68 8.72 10.75 12.50
Industry 11.45 12.52 11.08 13.46 11.09 11.92
Cracker Barrel has the highest days‟ supply of inventory of any of the firms at
69.85 days. This is different from the industry average for the same reasons the
inventory turnover was different. However, applying Cracker Barrel‟s inventory turnover
excluding retail to the days‟ supply of inventory formula yields a five year average of
21.29 days. While still higher than the industry average, it is much nearer than the
roughly 70 days with retail. Retail items hold far greater shelf lives than food
inventories used for the restaurant section of the stores. While there is room for
improvement, Cracker Barrel‟s days supply of inventory does not cause us much
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2004 2005 2006 2007 2008
Days Supply of Inventory
Cracker Barrel Without Retail
Cracker Barrel With Retail
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
120
concern. The retail section of Cracker Barrel stores is a key part of its success and this
must be considered when analyzing the high ratios it can cause.
Cash -to-Cash Cycle
A firm‟s cash-to-cash cycle represents the amount of time it takes for cash
received from customers to be free for use by the firm. Accounts receivable represent
cash from a sale already made that is not collected and therefore unable to be used.
Inventories also tie up cash because the company must back up sitting inventories with
cash. Therefore the ratio is calculated by adding days‟ sales outstanding and days‟
supply of inventory. A lower ratio indicates that the firm is able to use cash received
from sales in investing activities sooner than a firm with a higher ratio. A lower ratio is a
good sign and has been linked to improved earnings per share.34
34
Ward, Peter. Cash-to-Cash is What Counts. Via http://www.vitalentusa.com/learn/cash_to_cash.php
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2004 2005 2006 2007 2008
Cash to Cash Cycle
Cracker Barrel Without Retail
Cracker Barrel With Retail
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
121
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel Without Retail
23.37 28.49 21.59 22.98 20.57 23.40
Cracker Barrel With Retail
67.39 74.97 68.20 72.65 75.63 71.77
Bob Evans 24.92 23.78 25.52 26.23 26.31 25.35
Dennys 8.71 10.12 9.18 8.31 10.76 9.42
Darden 20.80 23.51 19.09 20.94 19.22 20.71
Dine Equity 45.38 46.74 48.28 102.76 30.37 54.71
Brinker International 17.31 21.00 17.30 12.87 15.26 16.75
Industry 23.42 25.03 23.87 34.22 20.38 25.39
Due to Cracker Barrel‟s high DSI, they have the highest average cash-to-cash
cycle. Using the DSI without Cracker Barrel‟s retail section yields a much more average
cash-to-cash cycle. However, the retail portion is more relevant in the cash-to-cash
cycle than in the other ratios, as Cracker Barrel must account for the retail inventories it
holds with cash that could be used for financing. The retail inventories tie up a
significant amount of cash received from Cracker Barrel‟s sales. Cracker Barrel‟s
inventory represents nearly 20% of its cost of goods sold, while no other company even
reaches double digits. As a result, Cracker Barrel has less of its cash from sales to use
toward financing daily activities than its competitors. This may be viewed as a credit
risk by lenders as less cash available for investing also means less cash available to
cover short term debts.
Conclusion
In conclusion, Cracker Barrel‟s liquidity can be measured as slightly below
average relative to the industry. Although Cracker Barrel‟s restaurant operations run
efficiently, the amount of inventory represented by retail puts the firm at a
disadvantage to other firms in the industry in terms of liquidity. The only area that
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Cracker Barrel performs above the industry average is in receivables turnover and days‟
sales outstanding, which in the restaurant industry are volatile numbers because of the
extremely low amount of accounts receivable. Investors can expect these ratios to
remain somewhat the same as the retail sector of Cracker Barrel restaurants is a key
component that drives their value.
Ratio Performance Trend
Current Ratio average increasing
Quick Asset Ratio average stable
Working Capital Turnover below average decreasing
Accounts Receivable
Turnover
above average decreasing
Days’ Sales Outstanding above average increasing
Inventory Turnover below average decreasing
Days’ Supply of Inventory below average increasing
Cash-to-Cash Cycle below average increasing
Profitability Ratio Analysis
A profitability ratio analysis is key in figuring out how effective a firm is at
creating income as well as minimizing expenses in order maximize their profits. The
system in which to go about this analysis is to evaluate the firm‟s operating efficiency,
asset productivity, and rate of return on assets and equity. The main ratios involved in
the process are:
Gross Profit Margin
Operating Profit Margin
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Net Profit Margin
Asset Turnover
Return on Assets
Return on Equity
To properly assess a firm‟s profitability, an analyst must compare the firm‟s ratios
it is inspecting to those of its competitors and an industry average. For each ratio, the
higher a firm‟s percentage the more profitable it is. This form of information is
important to investors so that they can get a full and comparable track record of how
well the firm is operating.
Gross Profit Margin
A firm‟s gross profit margin can hint at two things: either a superior price
premium on its goods and/or the efficiency in its production processes. Gross profit
margin is a measurement of basic product profitability and can be calculated by dividing
a firm‟s gross profit by its sales revenue. In order to find gross profit, the cost of goods
sold needs to be subtracted from the company‟s revenues. Gross profit is considered to
be the income in excess after the cost of sales has been taken out.
0
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2004 2005 2006 2007 2008
Gross Profit Margin
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
124
This table breaks down how Cracker Barrel relates to the rest of the competitors
in its industry as well as the industry average. As seen in the chart, one can notice that
Cracker Barrel maintains a relatively high gross profit margin in comparison to several
of its competitors in the industry. On average, the company‟s GPM lies around 67.7%.
This is indicative of both the price premiums in its retail store as well as its cost
leadership strategy in its restaurant business. Brinker International‟s high GPM can
mostly be attributed to price premiums on its food, but it is no surprise that Bob Evans
has a similar track record in its GPM because of its highly comparable market strategy
of selling both retail and food. The industry average stays rather stable around 44%
and the large gap between Cracker Barrel‟s GPM and the industry average suggests a
stellar performance.
Operating Profit Margin
Operating profit margin is a measurement of a company‟s day to day business
profitability. Some analysts like this measurement because it allows them to see a
company‟s performance before taxes have been taken out. In a sense it is a raw form
of performance before the government affects income. A firm‟s operating profit margin
is derived from dividing operating income by sales. Operating income is found by taking
the gross profit mentioned earlier and subtracting operating expenses, e.g. salaries and
selling and administrative expenses.
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In the last five years, Cracker Barrel‟s operating profit margin has been on a
decline from 7.7% in 2004 to 6% in 2009. This decline is in line with the industry‟s
steady fall from 8.7% in 2004 to 2.1% in 2008. Although the industry average is much
higher in 2006, it is mainly due to a radical year for Brinker International. From the
chart we can see that Cracker Barrel has been performing below the industry average
for a few years, but has managed to outperform the industry in more recent years. This
is mainly due to Cracker Barrel‟s much slower rate of decline than the industry average.
After the restatement of operating leases, Cracker Barrel‟s trend for operating
profit margin in 2005 through 2009 has been on a moderately steady decline. From
2005-2007 the company performs beneath the industry average. Even so, in 2008 the
company manages to outperform the industry average due to a slower rate of decline.
Net Profit Margin
Net Profit Margin is a measurement of the excess money a firm actually receives
per dollar of sales. It is calculated by dividing net income by sales. Net income is
defined as the income received after all expenses and taxes have been taken out. The
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Operating Profit Margin
Cracker Barrel
CBRL Restated
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
126
graph below is a visual aid to show how Cracker Barrel‟s net profit margin relates to its
competitors.
From 2004 to 2006 Cracker Barrel has remained relatively stable with a net profit
margin of around 5%. In 2008 and 2009 their NPM was steady around 2.7%. The
recent years NPM of 2.7% give insight into Cracker Barrel‟s performance under
recessionary time periods. Overall, Cracker Barrel‟s net profit margin has managed to
remain above the industry average in all years except 2006.
When restated after capitalizing their operating leases, Cracker Barrel shows to
consistently be only slightly below its as stated net profit margin. The restated company
manages to stay above the industry average as well.
Asset Turnover
Asset Turnover is a measure of how well a company utilizes its assets in the
creation of revenues. Asset turnover is considered to be a lag ratio. What this means is
that when it is calculated by dividing sales by total assets, the total assets in the
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2004 2005 2006 2007 2008
Net Profit Margin
Cracker Barrel
CBRL Restated
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
127
denominator of the ratio need be the previous year‟s total assets rather than the
current year‟s assets.
Taken from a five year average, Cracker Barrel has a 1.61 asset turnover. When
compared to a five year industry average of 1.53, Cracker Barrel represents a strong
competence in outperforming a majority of its competitors. In 2008 and 2009 the
company shows a 1.88 and 1.8 asset turnover. The past two fiscal years represent how
they have remained strong in recessionary time periods.
According to the restated financials, Cracker Barrel consistently sits below the
industry average. In 2008 and 2009 Cracker Barrel has an asset turnover of 1.47 and
1.44 which is moderately close to the industry average. The restated asset turnover
from 2005-2007 is shows a different story about the company however. With the
additional assets on the books from capitalizing operating leases the asset turnover is
lowered below the industry average and runs nearly parallel to the as stated company.
This information is significant because it shows an underperforming company compared
to its competitors.
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Asset Turnover
Cracker Barrel
CBRL Restated
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
128
Return on Assets
The return on assets ratio is very similar to the asset turnover ratio except that it
takes the revenues after all expenses and taxes have been taken out. The equation for
calculating the return on assets is net income divided by total assets. In addition, the
return on assets ratio is a lag ratio. This means that to properly calculate the ratio, the
total assets in the denominator need to be taken from the previous year.
From 2004 to 2007 Cracker Barrel went from an 8.4% to a 9.6% return on
assets. Due to recessionary times their return on assets dropped to around 5.2% in
2008 and 5% in the following year. This means that Cracker Barrel has become less
effective at generating net income from their assets in more recent years. Compared to
the industry average, Cracker Barrel has managed to consistently outperform the
industry average. This is substantial in evaluating a company‟s performance because it
allows analysts to see how effective the company is at turning their assets into profit.
Cracker Barrel‟s return on assets shows similar trends with both as stated and
restated financial statements. In 2008 and 2009 their ROA is observed at 3.5% and
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2004 2005 2006 2007 2008
Return on Assets
Cracker Barrel
CBRL Restated
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
129
3.4% respectively. In comparison to the industry average, Cracker Barrel‟s restated
return on assets are relatively close to this average.
Return on Equity
Similar to return on assets, return on equity measures how well a firm generates
profit. In addition to monitoring how well the firm creates profit from its assets, it is just
as important to monitor how well the firm creates profits from shareholder‟s invested
money. Return on Equity is a lag ratio as well and is calculated by dividing net income
by the previous year‟s owners‟ equity.
From 2004 to 2006, Cracker Barrel‟s return on equity hovered around 14%. In
2007, the company experienced steep growth and has managed to grow substantially in
following years. The 2007, 2008, and 2009 return on equity of Cracker Barrel far
exceed any of the other firms in the industry and showed rising rates of 54%, 63%,
and 71%. The reason for this sudden jump is that the company has been substantially
decreasing the amount of shareholder‟s equity. Although they are being more
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Return on Equity
Cracker Barrel
CBRL Restated
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
130
productive with the equity they have, it has potential to worry an analyst because the
company could be changing the makeup of the company.
With the restatement, in 2007 through 2009 there is an upward spike in return
on equity similar to what was observed with the as stated returns. The ROE increases
nearly right in line with those of the as stated rates showing 51.6%, 64.1%, and 66.7%
in 2007, ‟08, and ‟09, respectively. Both the as stated and restated return on equity
yield high rates which more than surpass any of the rates represented by any other
firm.
Conclusion
From the profitability ratio analysis it can be concluded that Cracker Barrel is
outperforming the majority of its competitors in gross profit margin, net profit margin,
asset turnover, return on assets, and return on equity. In addition, Cracker Barrel has
managed to stabilize at all of these rates except for return on equity in which it is
increasing. To the average investor this would be great news, but when the firm‟s
financials are restated the data tells a slightly different story.
With a financial restatement for operating leases, there is only one significant
difference between the as stated and restated profitability ratios. This occurs with the
asset turnover ratio. The restated asset turnover ratio shows to be below the industry
average in several years. This is significant information to investors because it shows
Cracker Barrel to be underperforming in its ability to create sales from its assets.
131
Ratio Performance Trend
Gross Profit Margin Outperforming Stable
Operating Profit Margin Average Stable
Net Profit Margin Slightly Outperforming Stable
Asset Turnover Outperforming Stabilizing
Return on Assets Outperforming Stabilizing
Return on Equity Outperforming Increasing
Capital Structure Ratios
Capital structure ratios are used in examining how a firm finances the purchase
of new assets. In analyzing these ratios one can assess how leveraged a company is.
When a company is highly leveraged, it is borrowing large sums of money to invest in
capital now in order to increase future cash flows. The more leveraged a company is,
the more it has potential for growth. However, more leveraged companies are also
exposed to higher risk levels as they could face bankruptcy if they are unable to meet
debt payments on the loans. Three ratios are used to analyze a firm‟s capital structure:
the debt to equity ratio, times interest earned ratio, and debt service margin. In
addition, the Altman‟s Z-Score method will be used to further assess the firms‟ health.
Debt to Equity
The debt to equity ratio is a simple way to measure the amount of debt a
company holds versus the amount of equity they have issued. It is an easy way to
identify the preference of a firm in financing the purchase of new assets. The ratio is
calculated by dividing total debt by stockholder‟s equity. A high ratio represents a firm
that can be deemed risky. This can lead to large future gains or serious financial
132
trouble. Typically any ratio over 2.0 can be viewed as very risky and may cause a firm
to have higher interest rates on its debt.35
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 0.64 0.76 4.56 11.15 13.16 6.06
Cracker Barrel Restated 0.92 1.26 6.64 17.26 18.52 8.92
Bob Evans 0.38 0.81 0.68 0.70 0.97 0.71
Denny's -2.89 -2.92 -2.98 -3.07 -2.99 -2.97
Darden 1.37 1.31 1.45 0.87 2.36 1.47
Dine Equity 1.42 1.62 1.66 -4.89 77.59 15.48
Brinker International 1.23 0.96 1.06 1.88 2.69 1.56
Industry 0.30 0.36 0.37 -0.90 16.12 3.25
Cracker Barrel‟s debt to equity ratio is dangerously high. However, when
examining the firm‟s financials it should be noted that Cracker Barrel has aggressively
repurchased stock in the past 5 years. Since 2003, they have repurchased over 25
million shares to go from 47,872,542 shares in ‟03 to 22,722,685 shares in 2009. When
35
Machon, Michael. “Banking on Financial Ratios” http://www.bdo.ca/library/publications/agriculture/articles/Accounting_Financial_Ratios.cfm
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2004 2005 2006 2007 2008
Debt/Equity
Cracker Barrel
Cracker Barrel Restated
Bob Evans
Denny's
Darden
Dine Equity
Brinker International
Industry
133
firms repurchase stock, the stock is subtracted form shareholder‟s equity at the
purchase price. However, the originally issued shares show up at par value on the
balance sheet.36 This can cause a debt to equity ratio to be abnormally high, as is the
case with Cracker Barrel. Adding the share repurchases back into the denominator
significantly reduces the ratio.
Times Interest Earned
When determining a firm‟s capability to meet its debt obligations, it is useful to
use the times interest earned ratio. The times interest earned ratio represents how
many times a firm would be able to pay interest payments on its debt using its income
from operations. It is calculated by dividing operating income by the interest expense
charged on debt. A high ratio, while representing protection against possible
bankruptcy, may be a red flag to some investors as it could indicate that the company
has a low amount of debt and is not planning on growing. A low ratio is a much more
severe red flag that indicates a firm is not making enough income to cover debt
obligations. It is important to compare a firms TIE ratio to competitors and the industry
as a whole when assessing the results of the ratio.
36
Durell, Philip. “Using the Debt to Equity Ratio”. Motley Fool Inside Value. December 2006.
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2004 2005 2006 2007 2008
Times Interest Earned
Cracker Barrel
Cracker Barrel Restated
Bob Evans
Denny's
Darden
Dine Equity
Brinker International
Industry
134
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 0.64 0.76 4.56 11.15 13.16 6.06
Cracker Barrel Restated 0.92 1.26 6.64 17.26 18.52 8.92
Bob Evans 0.38 0.81 0.68 0.70 0.97 0.71
Denny's -2.89 -2.92 -2.98 -3.07 -2.99 -2.97
Darden 1.37 1.31 1.45 0.87 2.36 1.47
Dine Equity 1.42 1.62 1.66 -4.89 77.59 15.48
Brinker International 1.23 0.96 1.06 1.88 2.69 1.56
Industry 0.30 0.36 0.37 -0.90 16.12 3.25
Cracker Barrel‟s times interest earned ratio is well above the industry average.
This is good in an industry that is very susceptible to damage during a recession. In
addition, the ratio is still low enough to indicate that Cracker Barrel is investing in future
growth. However, the ratio is showing an increasing trend over the past few years, and
investors should keep an eye out to make sure it does not become too high.
Debt Service Margin
The debt service margin measures a firm‟s ability to pay off its current debts. It
is a lagged ratio, meaning it is calculated by dividing cash flow from operations by the
current portion of long term debt from the previous year. A higher ratio means that a
company will be able to pay off its current debts and have extra cash flow to invest.
135
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 2003.65 1218.841 831.8762 11.93593 15.2064 816.302
Bob Evans 34.13975 32.51275 37.063 37.876 4.663912 29.25108
Denny’s 0.544965 10.66915 4.959368 4.020062 3.338168 4.706343
Darden 40.22359 12.95 3.627247 18.93361
Dine Equity 11.68749 9.471766 3.315222 24.57174 12.26155
Brinker International 27.67946 23.50191 260.6465 220.7542 205.3038 147.5772
Industry 18.51292 23.27583 76.49603 60.0344 54.23328 42.54595
Cracker Barrel‟s debt service margin is off the charts in the first few years. This is
primarily due to Cracker Barrel having extremely low current portions of long term debt
in those years in addition to a large cash flow from operating activities. After the
divestiture of Logan‟s in 2006, Cracker Barrel‟s CFFO decreased and they took on more
debt, radically lowering their ratio. Investors can expect to see a ratio similar to the
past two years in the future. Cracker Barrel has a healthy debt service margin and
easily makes enough cash flows to cover its current debts.
0
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2004 2005 2006 2007 2008
Debt Service Margin
Cracker Barrel
Bob Evans
Denny's
Darden
Dine Equity
Brinker International
Industry
136
Altman’s Z Score
The Z-Score is a method of combining many different elements into a number
that represents the probability of a firm going bankrupt in the next two years. It can
also be used in assessing the credit risk of a company. The z-score is computed as
follows:
1.2(Net Working Capital / Total Assets)
+1.4(Retained Earnings / Total Assets)
+3.3(EBIT / Total Assets)
+1.0(Sales / Total Assets)
+0.6(Market Value of Equity / Book Value of Liabilities) = Z-Score
A firm with a z-score greater than or equal to 3.0 is considered healthy and not
at risk. A z-score between 1.8 and 3.0 is considered to be in the “gray area”, not
healthy but not in deep trouble yet. A firm with a calculated z-score of less than 1.8 has
a high probability of going bankrupt in the next two years.
CBRL Z Scores 2005 2006 2007 2008 2009
1.2(WC/TA) -0.08 0.23 -0.07 -0.04 -0.06422
1.4(RE/TA) 0.79 0.25 0.12 0.12 0.188039
3.3(EBIT/TA) 0.43 0.31 0.43 0.37 0.376964
1(Sales/TA) 1.42 1.32 1.85 1.81 1.901157
0.6(MVE/BVL) 1.51 0.54 0.39 0.36 0.40229
Z-Score 4.09 2.66 2.74 2.64 2.804232
Cracker Barrel‟s z-score dipped from a healthy level in 2005 to the gray area in
2006 and has stayed there through the present. However, it is on the higher side of the
137
gray area. Cracker Barrel should not be seen as a risk to go bankrupt, but the z-score
should be closely monitored over the next few years as it is not completely healthy. One
factor to keep in mind is that most of the restaurant industry purposefully operates with
a negative working capital. This makes the WC/TA portion of the z-score negative and
significantly brings down the end z-score.
CBRL Restated Z Scores 2005 2006 2007 2008 2008
1.2(WC/TA) -0.06 0.17 -0.05 -0.03 -0.04
1.4(RE/TA) 0.61 0.19 0.09 0.10 0.14
3.3(EBIT/TA) 0.24 0.13 0.16 0.16 0.14
1(Sales/TA) 1.11 1.02 1.45 1.45 1.42
0.6(MVE/BVL) 0.91 0.39 0.29 0.28 0.29
Z-Score 2.83 1.92 1.95 1.97 1.95
Cracker Barrel‟s restated z-score has a more stressful outcome. The z-score is in
the gray area in all 5 years and over this last 4 years has not even made it over two.
This is not a very good sign, but one must still remember that the restaurant industry
wants to operate with negative working capital so the z-score is a little smaller
compared to comparable firms in other industries.
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2005 2006 2007 2008 2009 Five Year Average
Cracker Barrel 4.09 2.66 2.74 2.65 2.80 2.99
Cracker Barrel Restated
2.83 1.93 1.95 1.98 1.96 2.13
Bob Evans 2.92 3.79 3.51 3.00 3.22 3.29
Denny's 0.21 0.90 0.79 0.00 0.48
Darden 3.19 3.06 2.52 2.28 2.35 2.68
Dine Equity 2.23 2.32 0.50 0.60 1.41
Brinker International
4.23 5.05 3.95 3.28 3.50 4.00
Industry 2.56 3.02 2.25 1.83 3.02 2.37
Cracker Barrel is right around the industry average for Altman‟s z-score. Denny‟s
has a very high probability of going bankrupt within the next two years. Cracker Barrel‟s
z-score has been stable for the past 4 years, so it looks to be in no real danger of
heading towards bankruptcy.
Conclusion
These capital structure ratios give the investor a good idea as to how a firm is
financed and how prepared they are to cover their obligations. Cracker Barrel‟s debt to
0.00
1.00
2.00
3.00
4.00
5.00
6.00
2005 2006 2007 2008 2009
Z-Scores
Cracker Barrel
Cracker Barrel Restated
Bob Evans
Denny's
Darden
Dine Equity
Brinker International
Industry
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equity ratio is far above average and will continue to be as long as they continue their
recent trend of consistently repurchasing stock. Their times interest earned ratio is also
above industry average, a contributing factor to their stability through the current
economic recession. Over the past 3 years, the TIE ratio has been steadily increasing,
and investors should watch to make sure it doesn‟t get too high, which can represent
lack of future growth. Their debt service margin has stabilized over the past few years
and the firm has a comfortable margin to cover its debts.
Cracker Barrel‟s z-score is primarily in the gray area, but the strength of their
other ratios and the tendency of the restaurant industry to have lower z-scores makes
this not of much concern. Overall it can be said that Cracker Barrel has an average
credit risk and is healthy enough to withstand a recession and grow during normal
economic climates.
Capital Structure Ratio Performance Trend
Debt to Equity above average Increasing
Times Interest Earned above average Increasing
Debt Service Margin above average Stable
Z-Score average Stable
Firm Growth Ratios
Considering the growth rates of a company aid in evaluating whether the firm
can maintain its growth in the future without having financing from outside sources. A
firm that is able to grow based on internal funds has an advantage over firms that use
external sources for funding. Also, understanding the growth rates of a company allow
analysts to enhance predictions of future expansions by the company. A company with
excess internal funds is more willing to expand than a company that has to be
externally funded. In the following section we will be discussing the internal growth rate
and sustainable growth rate for Cracker Barrel and its competitors.
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Internal Growth Rate
A firm‟s internal growth rate is defined as the largest amount of growth it can get
without using financing from outside sources. The IGR is important to analyze because
it allows for insight into the highest growth a business can get from using only the
firm‟s resources. In times where interest rates are high this plays a vital role in how well
a firm can maintain positive growth. To calculate the internal growth rate, multiply the
return on assets by one minus the dividend payout ratio. The dividend payout ratio can
be found by dividing dividends by net income.
From 2004 to 2006, Cracker Barrel‟s internal growth rate has been stable around
6.2% on average. In 2007, a spike in their growth rate occurs and settles back down
around 3.8% in 2008 and 2009. Again, it is possible 2008-09 are at lower rates due to
the recent recessionary period and may not be fully indicative of Cracker Barrel‟s typical
internal growth rate. Compared to the industry average, Cracker Barrel manages to
outperform several of its competitors.
-0.1
-0.08
-0.06
-0.04
-0.02
0
0.02
0.04
0.06
0.08
0.1
0.12
2004 2005 2006 2007 2008
Internal Growth Rate
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
141
Sustainable Growth Rate
The sustainable growth rate indicates the maximum rate in which a firm can
grow without borrowing any additional funds. In finance lingo, borrowed funds are
commonly referred to as financial leverage. SGR can be calculated by multiplying the
internal growth rate by one plus financial leverage. Financial leverage calculated by
dividing debt by equity.
(Chart excludes Dine Equity‟s SGR for 2008)
In order to get a better view of Cracker Barrel and the industry average‟s SGR,
the SGR for Dine Equity needed to be removed. During 2008 Dine Equity acquired
Applebee‟s which caused the company‟s net income to be highly negative. Because of
this, Dine Equity observed a -500% sustainable growth rate, significantly distorting the
industry average.
In 2007 there is a large spike in Cracker Barrel‟s sustainable growth rate. The
main explanation for this is that in 2006 Cracker Barrel sold off Logan‟s and a
substantial amount of equity was removed from their books. This made the following
year‟s SGR inflate significantly. After 2007, it appears the company has been working to
put more equity onto their books and as a result their sustainable growth rate has been
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
2004 2005 2006 2007 2008
Sustainable Growth Rate
Cracker Barrel
Bob Evans
Dennys
Darden
Dine Equity
Brinker International
Industry
142
falling back to normal levels. In all previous years Cracker Barrel‟s sustainable growth
rates have outperformed its competitors and as a result the company has been able to
continue to grow at a considerable level without the use of further borrowing of funds.
Conclusion
Cracker Barrel is one of the top companies when it comes to internal and
sustainable growth rates over the past five years. Their internal growth rate stays
positive over the five year span, and it is also outperforms the industry average. The
sustainable growth rate for Cracker Barrel was the highest out of the entire industry.
Based on the internal and sustainable growth rate, we believe that Cracker Barrel is
more likely to have future expansion than its competitors. We also expect their firm
growth rates to remain above its competitors in the future.
Internal Growth Rate Outperforming Decreasing
Sustainable Growth Rate Outperforming Decreasing
Financial Statement Forecasting
Forecasting a company‟s financial statements is important in the valuation
process because it attempts to fairly estimate future performance. In order to forecast,
we analyzed historical data over the last five years for trends, growth rates, and
financial ratios that will help in the forecasting process. The three financial statements
that will be forecasted are the income statement, balance sheet, and the statement of
cash flows. The stated and adjusted income statements are the first financial
statements to be forecast because they are the most reliable. The stated and adjusted
balance sheets are the next financial statements that are forecasted. The income
statement provides forecasted numbers that are required to forecast out the balance
sheet. The final financial statement that is forecasted is the cash flow statement. This
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statement is the hardest to forecast, and is the most unreliable statement because you
cannot correctly predict a company‟s future cash flows.
Forecasted Income Statement
When you begin to forecast it is important to start out with the income
statement. This is the first financial statement that we will forecast because it will be
used to forecast the balance sheet and the statement of cash flows by the assumptions
made from the income statement. The overall valuation of the firm‟s future financial
performance relies on the accuracy of the income statement‟s forecasts. Because of the
interdependence of the income statement and the other financial statements, it is
crucial to make these forecasts as accurate as possible. In this section we will discuss
the steps taken in forecasting the income statement.
We began the forecasting of the income statement by forecasting future sales. In
order to forecast sales, we examined Cracker Barrels historical performance and looked
for a relative growth trend to estimate future revenues. Also, when predicting future
sales it is important to take into account the current condition of the economy, which
could impact growth of sales. Looking at historical data we figured out an average of
about .182% sales growth rate over the last five years. The growth average was
affected by the recession in year 2008 and 2009, as well as the disposition of Logan‟s
Steakhouse in 2006. We excluded those three years and recalculated the average and
came up with a growth rate of 5.1% based on sales and assumed a growth rate of 5%.
Since we believe that it could take approximately two to three more years for the
recession to end, we took a conservative approach and grew our sales at a lower rate
than the assumed 5%. We began the sales forecasting by growing sales by 1% in 2010,
3% in 2011, and 4% in 2012 considering a staggered increase in demand as the
recession comes to an end. Then from 2013-2019 we grew our sales by 5% annually,
assuming that Cracker Barrel returns to its normal growth rate from before the
recession.
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The second step taken in forecasting the income statement is to calculate the
gross profit. In order to calculate Cracker Barrel‟s gross profit, we measured their
historical gross profit as a percentage of sales over the past five years. We calculated a
historical gross profit average of 67.68%, but decided to assume a gross profit of
68.2% because we believe that it is more indicative of the gross profit/sales percentage
before the recession. Next, we took our assumed gross profit percentage of 68.2% and
multiplied it by our forecasted sales for the years 2010-2019 in order to forecast gross
profit for each year.
The third step is to forecast the company‟s cost of goods sold. Since we already
have an assumed gross profit percentage, we can use the gross profit method to
calculate cost of goods sold. Gross profit is found by subtracting cost of goods sold from
net sales. The gross profit method is used by accountants to quickly estimate cost of
goods sold. This is accomplished by multiplying sales by the gross profit percentage to
come up with gross profit for a given year, and then subtracting the gross profit from
sales to back into the cost of goods sold calculation. In order to forecast cost of goods
sold, we subtracted our forecasted gross profit from the forecasted sales step for each
year.
The fourth step taken in forecasting the income statement was to forecast labor
and other related expenses. In order to forecast this expense, we calculated labor and
other expenses as a percentage of sales. We found an average of 37.83% over the last
five years. The percentages were relatively stable over the past five years, so we
decided to forecast Cracker Barrel‟s labor and other related expenses at an assumed
rate of 38.5% of sales. This is indicative of the percentage trend over the three most
recent years. We then multiplied our forecasted sales for each year by 38.5% to
calculate the labor and other related expenses for that given year.
The fifth step in forecasting the income statement is to forecast other store
operating expenses. A percentage of the expense was taken by dividing other store
operating expenses by sales. It is important to note that any item that does not follow a
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trend is not able to be forecasted. An average of 17.35% was calculated, which was
reflective of the other store operating expenses/sales percentage over the last few
years. We assumed a percentage of 17.6% based on the average of the percentages,
and also considered the three most recent years to be a more precise measure. The
other store operating expenses were forecasted for the next ten years by multiplying
our assumed percentage of 17.6% by the forecasted sales of each year.
The sixth step in forecasting the income statement is to forecast store operating
income. In order to do so, we calculated the percentage of store operating income
compared to sales. Over the last five years there was an average of 12.45%, but we
choose to assume a conservative percentage of 11% for store operating income. Next,
we multiplied each year‟s forecasted sales by 11% to forecast operating income for the
next ten yeas.
The seventh step taken to forecast the income statement is to forecast general
and administrative expenses. We divided general and administrative expenses by sales
to calculate a percentage over time. There was a relatively stable trend in this
percentage and we assumed a general and administrative expense/sales percentage of
5.2%. General and administrative expenses were forecasted by multiplying each year‟s
forecasted sales by 5.2%
The eighth step taken in forecasting the income statement is to forecast
operating income. Operating income was divided by sales over the last five years, and
an average of 7.03% was derived. We came to a conclusion of 6.5% for operating
income/sales because the most recent years‟ percentages were lower than the average.
Operating income for the next ten years was forecasted by multiplying each future
year‟s forecasted sales by our assumed operating income/sales percentage of 6.5%.
The ninth step in forecasting the income statement is to forecast interest
expense. We divided interest expense by sales for each of the last five years, and
calculated an average of 1.48%. In assuming a percentage to forecast interest
expense, only the three most recent years‟ percentages were considered relevant. An
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assumed percentage rate of 2% was chosen, and interest expense was forecasted for
the next ten years by multiplying each year‟s forecasted sales by the assumed
percentage of 2%.
The final step in forecasting the income statement is to forecast net income. The
net profit margin was used to forecast net income. The net profit margin equals net
income divided by sales. Net profit margin was calculated over the last five years and
an average of 4.6% was derived. Our assumed net profit margin of 3% was calculated
by looking at the trend of the net profit margin over the three most current years. The
reason why only the three most current years were considered is that Cracker Barrel
had a higher net profit margin from 2004-2006, which was before the disposal of
Logan‟s Steakhouse. To forecast net income, we simply multiplied each year‟s
forecasted sales by the assumed net profit margin of 3%.
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Forecasted Restated Income Statement
In order to properly value a company, we must restate its income statement to
include any expenses that may be of significance. Cracker Barrel‟s income statement
must be restated to capitalize operating leases. Capitalizing an asset reports the proper
liabilities previously not included in financial statements by a company‟s use of
operating leases.
The first adjustment made to the income statement is to include the depreciation
expense for the newly capitalized operating leases. Earlier, we calculated the new
depreciation expense in the operating lease schedule. The new depreciation expenses
calculated in the operating lease schedule for 2005-2009 are $12,231, $21,643,
$26,629, $19,695, and $18,443 respectively. We included these expenses on the
income statement for the years 2005-2009 to make the proper adjustment.
The next adjustment made to the income statement was the reduction in rent
expense for operating leases. Because operating leases only show up as an expense on
financial statements, we must reduce Cracker Barrel‟s rent expense on operating leases
for the last five years. Cracker Barrel‟s 10-K includes a schedule of rent expense for
past years, and the rent expense given for each year was the amount of rent expense
reduced.37 In order to forecast the reduction of rent expense, we calculated rent
expense as a percentage of sales over the past five years. The result was an average of
1.47%. We chose to assume a rent expense/sales percentage of 1.5%, which is above
the average. Cracker Barrel‟s rent expenses have increased each year since the
disposition of Logan‟s Roadhouse in 2006, so we felt this figure was appropriate. To
forecast the reduction in rent expense we just multiplied each year‟s forecasted sales by
1.5%, and reduced each year‟s operating expenses by the amount calculated.
The third adjustment made to the income statement was to adjust the interest
expense. Since we capitalized all of Cracker Barrel‟s operating leases, we must make an
adjustment to the amount of new interest realized. Looking back at the operating lease
37
Cracker Barrel 10 – K. 2004-2009.
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schedule, we have calculated new interest expenses for the years 2005-2009 to be
$17,833, $26,826, $24,498, $18,119, and $21,763 respectively. Adjustments for
interest expense were made by taking the interest expenses given by Cracker Barrel in
their 10-Ks for the years 2005-2009, and adding to the stated interest expense the
interest expense calculated in the operating lease schedule.38
After adjustments to depreciation expense, reduction in rent expense, and
interest expenses were made, operating income and net income were affected. Because
of these changes, we recalculated operating profit margin and net profit margin
accordingly. Operating income was higher after adjustments were made, so we
adjusted our assumed operating profit margin from 6% to 6.5%. Net income was lower
after adjustments, so we changed our assumed net profit margin from 3% to 2.5%.
Next, we multiplied the new operating profit margin and the net profit margin by the
forecasted sales over the next ten years to forecast operating profit and net income.
38
Cracker Barrel 10 – K. 2004-2009.
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Forecasted Balance Sheet
After forecasting the income statement the balance sheet needs to be
forecasted. The balance sheet reports a company‟s assets, liabilities, and owners‟
equity. The main equation of the balance sheet is Assets= Liabilities + Owners‟ Equity.
It is very important that this equation is in balance, because if it is not there are errors
in the financial statement. This financial statement allows investors to view and
compare various accounts needed in many important financial ratios. It is important to
note that the balance sheet can be manipulated by managers in a firm. This means
accounts like receivables, goodwill, and inventories all have various reporting methods
and can be impaired. These impairments lead to distorted ratios and poor quality
financial information.
In order to forecast the balance sheet, it is important to start with forecasting
assets. The accounts receivable turnover is used to forecast out the accounts
receivable. This ratio is used because it relates net sales to accounts receivable. This
ratio is calculated by dividing the net sales from the forecasted income statement by
the accounts receivable turnover. We found the receivables turnover to be about 190
over the past 4 years. So we took the forecasted net sales for 2010-2019 and divided it
by 190 to forecast each year‟s accounts receivable.
Next, the inventory is forecasted by using the inventory turnover ratio. This ratio
also relates inventory to the net sales. To forecast the inventory the net sales is taken
from the forecasted income statement and divided by the inventory turnover. We found
our inventory turnover to be 5.2 over the past 6 years. We used this ratio to divide the
forecasted net sales for 2010-2019 to forecast out the inventory.
One of the most important forecasts on the balance sheet is the total assets.
This is forecast out by using the asset turnover ratio. The total assets are forecast by
taking the net sales and dividing them by the asset turnover ratio. We found our asset
turnover to be 1.75 based on the past two years, which seems to be stable after the
sale of Logan‟s Roadhouse. We then used this number to forecast out the total assets
154
the same way we did the inventory and accounts receivable. Once the total assets are
forecast, it allows for the current assets to be forecast. The current assets are not
forecasted out with a turnover ratio. Instead, they are forecast out by using a
percentage, based off of prior years, of current assets to total assets. We found current
assets to be equal to about 15% for the past 5 years, except in 2006 when they had a
large amount of current assets due to the sale of Logan‟s Roadhouse.
After finding the current assets, the current liabilities are easily found by using
the current ratio. The current ratio is current assets over current liabilities. We found
the current ratio to be .75 over the past 3 years since the sale of Logan‟s Roadhouse.
We then took the forecasted current assets and divided it by .75 to find the forecasted
current liabilities.
Next, the retained earnings are forecast out by taking the prior year‟s retained
earnings plus the current year‟s net income minus the dividends paid for the current
year. We found these numbers on the forecasted income statement and forecasted
them out with that calculation. We then found the stockholders‟ equity the same way,
taking the previous year‟s stockholders‟ equity and adding net income minus the
dividends for that year.
Finally, the total liabilities are computed by taking the total assets minus the
stockholders‟ equity minus the current liabilities. This forecast is not very reliable
because it is distorted. Either the stockholders‟ equity is distorted or the total liabilities
are distorted. It is much more important to have the stockholders‟ equity than the total
liabilities, so we chose to distort the total liabilities.
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Forecasted Restated Balance Sheet
Since Cracker Barrel has operating leases we must restate the financials to
include them on their balance sheet. The restated financials change the total assets,
total liabilities, net income, and operating income. These adjustments also change the
ratios used to forecast out the balance sheet. The asset turnover ratio is changed from
1.75 to 1.4. We chose 1.4 to be the new asset turnover because it is consistent with the
past two years for Cracker Barrel. This lower ratio means that the total assets are going
to increase when net sales are divided by the new ratio.
The total asset increase means the total liabilities, long term assets, and long
term liabilities are also going to increase. The total assets increase because the
operating leases are put into the property, plant, and equipment account. The property,
plant, and equipment account is forecasted out by a new percentage of total assets.
The new percentage that we found is 84% instead of 80%. We found it to be around
84% of total assets based on the previous years, excluding 2006 because current assets
were high in that year with the sale of Logan‟s Roadhouse. We then took the new
percentage and multiplied it times the adjusted forecasted total assets. The total
liabilities also increase because we added a capital lease obligation account to the long
term liabilities to balance out the equation.
The retained earnings and stockholders‟ equity are also affected by the adjusted
financial statements. These accounts are decreased because the net income has
decreased in our adjusted income statement. The net income has decreased because
we are including the interest expense and depreciation expense into the financials. We
also added back the rent expense that is incurred by the operating leases. Although this
expense is added back, the other expenses (interest expense and depreciation expense)
were greater than the amount of rent expense so the net income decreases. This
decrease affects retained earnings because the net income minus dividends paid is
added into retained earnings each year.
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159
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Forecasted Statement of Cash Flows
The final financial statement to forecast is the statement of cash flows. It is
forecast last because it is the hardest financial statement to forecast. The reason it is
the hardest to forecast is because of its limited association to the other financial
statements. The three parts of the cash flow statement that we forecast are the cash
flow from operations (CFFO), cash flow from investing (CFFI), and cash flow from
financing (CFFF).
The first step in forecasting the statement of cash flows is forecasting the cash
flow from operations. We tried three methods to forecast CFFO. The methods used
were CFFO/Sales, CFFO/Net Income, and CFFO/Operating Income. The most stable of
these ratios was the CFFO/Sales method. The average of the past five years was 7.2%
and we made the assumption of 7.5% based off of years prior to the recession. To
forecast CFFO we took 7.5% and multiplied it by the forecasted sales for the next ten
years.
The second step in forecasting the statement of cash flows is forecasting the
cash flow from investing activities. We tried two methods to forecast CFFI. These
methods were the CFFI/Change in Non-Current Assets and CFFI/Change in Operating
Equipment. The most reliable ratio was CFFI/Change in Non-Current Assets. The
average of this ratio was 2.27; however, we assumed 2.4 based off of years after the
sale of Logan‟s Roadhouse in 2006. To forecast CFFI we took forecasted sales and
divided it by 2.4.
The final step in forecasting the statement of cash flows is forecasting the cash
flow from financing activities. We used the dividend payout ratio to forecast this
method. We found the average dividend payout ratio to be 19.8%. We assumed a rate
of 19% by removing years that were associated with the recession. In order to forecast
CFFF we multiplied our forecasted net income by 19% for each of the ten years.
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Estimating Cost of Capital
The cost of capital is the opportunity cost of financing because it is the minimum
return that an investor requires. For creditors, this is the interest rate required on loans.
For the company, it is the minimum return that the company should make on its own
investments.39 In this section we will estimate the cost of equity using the Capital Asset
Pricing Model (CAPM), the size-adjusted CAPM, and the back door method.
Cost of Equity
According to Charles Jones, publisher of Investments: Analysis and Management,
the cost of equity is the “minimum expected return necessary to induce an investor to
purchase the stock.”40 The cost of equity is higher than the cost of debt because there
is more risk associated with equity; this is due to the fact that stock holders are lower
on the priority of claims than creditors. In order to calculate cost of equity we used the
Capital Asset Pricing Model (CAPM). The CAPM “provides investors with a method of
calculating a required return for a stock.”41 This equation defines the cost of equity as:
The first part of this equation is the risk free rate. The risk free rate is based off
of treasury bills because the U.S. government is viewed as a riskless investment. We
determined the risk free rates by using the ten year treasury constant maturity rate
from the September 2009 St. Louis Federal Reserve.42 The market risk premium (MRP)
is the “amount that investors demand for bearing beta risk.”43 The market risk premium
equation is defined as:
39
Modigliani, F.; Miller M. (1958). “The Cost of Capital, Corporation Finance and the Theory of Investments. American Economic Review 48 (3) 261-297 40
Jones, Charles. Investments: Analysis and Management. 9th
Ed. 2003 41
Jones, Charles. Investments: Analysis and Management. 9th
Ed. 2003 42
Economic Research Federal Reserve Bank of St. Louis http://research.stlouisfed.org/fred2/series/GS10?cid=115 43
Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.
164
The beta of a firm “reflects the sensitivity of its cash flows and earnings (and
hence the stock price) to economy-wide market movements.”44 It measures the
systematic risk of the company, which is the risk that cannot be diversified away. The
beta is found by using a linear regression analysis. In order to find an appropriate beta
for Cracker Barrel we ran linear regressions for five points on the yield curve. We used
the risk free rates for the three month, one year, two year, seven year, and ten year to
find the five points of the yield curve. We used the monthly return for the S&P500 for
the return on the market. We determined the monthly risk free rates by using the St.
Louis Federal Reserve. With both of these numbers we were able to calculate the
monthly MRP. We then performed linear regression analysis on a 72 month, 60 month,
48 month, 36 month, and 24 month horizons in order to find the most useful beta. The
regression outputs were then broken down by their adjusted R^2. The higher a
regression‟s R^2, the more explanatory power the beta has. The linear regression
analysis tests the stability of beta over time. The regression analyses that we ran are as
follows:
3 Month Treasury Bill
Beta Adjusted R2 B ub B lb Ke Ke low Ke Up
72 0.90092 0.14006 1.40785 0.39399 0.10607 0.06552 0.14663
60 0.98494 0.17458 1.52196 0.44793 0.11280 0.06983 0.15576
48 0.95320 0.15996 1.56147 0.34493 0.11026 0.06159 0.15892
36 0.86592 0.15189 1.51866 0.21317 0.10327 0.05105 0.15549
24 0.86571 0.13517 1.70329 0.02814 0.10326 0.03625 0.17026
1 Year Treasury Bill
Beta Adjusted R2 B ub B lb Ke Ke low Ke Up
72 0.90092 0.14033 1.40731 0.39452 0.10607 0.06556 0.14659
60 0.98422 0.17469 1.52065 0.44779 0.11274 0.06982 0.15565
48 0.95220 0.16001 1.55974 0.34467 0.11018 0.06157 0.15878
36 0.86480 0.15183 1.51682 0.21277 0.10318 0.05102 0.15535
24 0.86536 0.13529 1.70225 0.02846 0.10323 0.03628 0.17018
44
Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.
165
2 Year Treasury Bill
Beta Adjusted R2 B ub B lb Ke Ke low Ke Up
72 0.90227 0.14061 1.40890 0.39564 0.10618 0.06565 0.14671
60 0.98466 0.17474 1.52125 0.44807 0.11277 0.06985 0.15570
48 0.95237 0.16000 1.56003 0.34471 0.11019 0.06158 0.15880
36 0.86480 0.15171 1.51710 0.21251 0.10318 0.05100 0.15537
24 0.86651 0.13538 1.70426 0.02877 0.10332 0.03630 0.17034
7 Year Treasury Bill
Beta Adjusted R2 B ub B lb Ke Ke low Ke Up
72 0.90094 0.14009 1.40782 0.39406 0.10608 0.06553 0.14663
60 0.98101 0.17359 1.51759 0.44443 0.11248 0.06955 0.15541
48 0.94947 0.15919 1.55692 0.34201 0.10996 0.06136 0.15855
36 0.86193 0.15057 1.51454 0.20932 0.10295 0.05075 0.15516
24 0.86677 0.13486 1.70623 0.02731 0.10334 0.03618 0.17050
10 Year Treasury Bill
Beta Adjusted R2 B ub B lb Ke Ke low Ke Up
72 0.89918 0.13974 1.40573 0.39262 0.10593 0.06541 0.14646
60 0.97869 0.17310 1.51486 0.44252 0.11230 0.06940 0.15519
48 0.94734 0.15879 1.55424 0.34043 0.10979 0.06123 0.15834
36 0.85999 0.15012 1.51213 0.20784 0.10280 0.05063 0.15497
24 0.86563 0.13458 1.70478 0.02648 0.10325 0.03612 0.17038
The Capital Asset Pricing Model (CAPM) says that beta is relatively stable
over time. The company has a relatively stable beta, meaning that this is the type of
company that investors would buy and hold. This shows that it covers a wide range of
investor horizons.
166
After running these regressions we determined the beta for our company by
finding the highest adjusted R squared. The adjusted R squared is the percentage
explained by the market; the rest is firm specific risk. The highest adjusted R squared
that we found was on the 2-Year Treasury bill at the 60 month time period, which was
17.474%. Once identified, we were able to determine the beta for our company which
is .98466. Compared to the published beta on Yahoo Finance of .89, the beta we
derived is higher, meaning that it is riskier. The fact that the beta is below 1 means that
the firm‟s cash flows and earnings are less sensitive to economic changes.45 The market
risk premium is 8% and the risk free rate is 3.4%. These numbers came from the St.
Louis Federal Reserve. Now that we have derived the risk free rate, the market risk
premium, and the beta we are able to determine the cost of equity.
After computing the cost of equity we can determine how certain we are that it is
11.3% by using the 95% confidence levels. The confidence levels are found by
calculating the upper and lower bounds of cost of equity. We found that the lower 95%
confidence level was 6.9% and the upper 95% confidence level was 15.6%. This means
that we are 95% sure that the estimated cost of equity is between 6.9% and 15.6%.
We found these percentages by replacing the beta with the Upper Bound (Ub) and
Lower Bound (Lb) from the regression analysis as follows:
Size Adjusted Cost of Equity
45
Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.
167
We used the CAPM model in order to estimate our cost of equity, but there is
evidence that the model is incomplete. There are “factors beyond just systematic risk
that seem to play some role in explaining variation in long-run average returns.”46 For
this reason, we calculated the size adjusted CAPM. In order to calculate the size
adjusted CAPM we used a table comparing average stock returns for U.S. firms varied
across size deciles form 1926 to 2005.47 The size deciles range from 1 to 10, 1 being
companies with the smallest market value and 10 being companies with the largest
market value. The firms with size deciles closer to one have a larger size premium and
the firms with size deciles closer to ten have a smaller size premium. We found that the
market value of Cracker Barrel is 743.9 million. This means that Cracker Barrel falls in
the third decile, which has a size premium of 2.3%. We then recalculated CAPM, which
we found to be 13.6%, with a size premium of 2.3% as follows:
Alternative Cost of Equity Estimation
An alternative method in estimating a firm‟s cost of equity is the back door
method. This method can be calculated as follows:
𝑀𝑎𝑟𝑘𝑒𝑡𝑒𝐵𝑜𝑜𝑘𝑒
= 1 + 𝑅𝑂𝐸 + 𝐾𝑒
𝐾𝑒 − 𝑔
𝑀𝑎𝑟𝑘𝑒𝑡𝑒 = Market Value of Equity or Market Cap
𝐵𝑜𝑜𝑘𝑒 = Book Value of Equity
𝑅𝑂𝐸 = Return on Equity
𝑔 = Historical Sales growth rate
𝐾𝑒 = Cost of Equity
46
Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008. 47
Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.
168
Cracker Barrel‟s market to book ratio as of November 2nd has been found to be
5.485398. This was found by dividing the market value of equity by the book value of
equity. We calculated the market value of equity to be 745,940,700 by multiplying the
number of shares outstanding by the current price as of November 2, 2009. We got the
book value of equity of 135,622,000 from Cracker Barrel‟s 2009 10-K. The Return on
Equity is .710784789, which was calculated earlier in the profitability ratio analysis. The
growth rate used was our assumed growth rate for sales in the forecasting section,
which was 5%. Solving for the as stated Ke we found the backdoor cost of equity to be
17.1%. To find the restated Ke you must use the restated book value of equity, which
is 125,710,000, and the restated Return on Equity, which is .666984. Then you must
solve for the restated Ke, which equals the restated backdoor cost of equity. The
resulting Ke was 11.3%. The back door cost of equity calculated is very close to
the cost of equity derived using the CAPM, which was 11.277 %.
The following is a table comparing as stated and restated backdoor cost of equity.
Back Door Cost of Equity
ROE Growth Rate P/B Cost of Equity
Cracker Barrel 71.1% 5% 5.485 17.1%
Cracker Barrel
Restated 66.7% 5% 5.918 11.3%
Cost of Debt
Figuring the cost of debt, 𝐾𝑑 , is useful for finding out the rate at which a firm
must pay off its liabilities, as well as how risky a firm is. The cost of debt is important
for analysts to investigate because it gives some insight into how easy or expensive it is
for a firm to borrow money. It is calculated by taking a weighted average of all liability
accounts multiplied by the interest rates which apply to them. The process in which this
169
calculation is achieved is to divide the amount in a single liability account by total
liabilities to get the weight of the account. After that, multiply the weight just found by
the rate in which the company pays interest on the account to compute the weighted
rate. This process is done to all liability accounts. When all of the weighted rates have
been calculated, the cost of debt is found by adding together all of the weighted rates
for all accounts.
The table below breaks down the rates, weights, and values used in calculating
Cracker Barrel‟s cost of debt. Interest rates placed on accounts are the most important
in estimating the cost of debt because they are the only potentially variable items
involved in the estimation. Some firms don‟t fully disclose the rates they pay on certain
items. All Cracker Barrel‟s liability accounts were able to be properly identified from
their 10-k except for “Taxes withheld and accrued” and “Deferred Income Taxes.” For
these two accounts an outside source had to be used. Because both of these accounts
dealt with taxes, a riskless rate was used for the interest rate. This riskless rate
originated from the September 2009 St. Louis Federal Reserve 10 year treasury
constant maturity rate of 3.4%48.
After adding the weighted rates for all accounts, we found Cracker Barrel‟s cost
of debt, 𝐾𝑑 , to equal 5.42%.
48
Economic Research Federal Reserve Bank of St. Louis http://research.stlouisfed.org/fred2/series/GS10?cid=115
170
Cost of Debt
Amount Rate Weight
Weighted
Rate Source
Current Liabilities:
Accounts payable 92,168 0.18% 8.31% 0.01% Cracker Barrel 10-k
Current maturities of
long-term debt and other
long-term obligations
7,422
7.07% 0.67%
0.05%
Cracker Barrel 10-k
Taxes withheld and
accrued
32,081 3.40% 2.89% 0.10%
10 year Treasury Constant Maturity Rate
Accrued employee
compensation
49,994
2.88%
4.51%
0.13%
Cracker Barrel 10-k
Accrued employee
benefits
32,633 2.88%
2.94%
0.08%
Cracker Barrel 10-k
Deferred revenues 22,528 2.88% 2.03% 0.06% Cracker Barrel 10-k
Accrued interest expense 10,379 2.88% 0.94% 0.03% Cracker Barrel 10-k
Other accrued expenses 17,757 2.88% 1.60% 0.05% Cracker Barrel 10-k
Long-term Liabilities:
Long-term Debt 638,040 6.80% 57.50% 3.91% Cracker Barrel 10-k
Capital lease obligations 60 6.50% 0.01% 0.00% Cracker Barrel 10-k
Interest rate swap
liability
61,232 5.57%
5.52%
0.31%
Cracker Barrel 10-k
Other Long-term
Obligations
89,610 6.50%
8.08%
0.52%
Cracker Barrel 10-k
Deferred Income Taxes 55,655 3.40% 5.02% 0.17% 10 year Treasury Constant Maturity Rate
Total Liabilities 1,109,559 𝑲𝒅 5.42%
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Weighted Average Cost of Capital (WACC)
The weighted average cost of capital is the average expected return from a
firm‟s investors. A firm‟s assets are financed by debt and equity, so the weighted
average cost of capital is the weighted average cost of debt plus the weighted average
cost of equity. The weighted average cost of debt is calculated by first taking the
market value of a firm‟s debt and dividing it by the market value of a firm‟s asset. The
weight is then multiplied by the cost of debt. The market value of a firm‟s liabilities is
unknown, so the book value of liabilities is used. The weighted average cost of equity
can be found by dividing the market value of equity by the market value of assets, then
multiplying the weight by the cost of equity. In order to find the market value of equity,
you multiply the current price of the company‟s stock by the number of shares
outstanding. Because a firm‟s assets equal its liabilities plus owners‟ equity, the market
value of assets is the market value of its liabilities plus the market value of its equity.
The following is the equation for calculating the weighted average cost of capital before
tax:
𝑊𝐴𝐶𝐶𝐵𝑇 = 𝑀𝑉 𝑜𝑓 𝐷𝑒𝑏𝑡
𝑀𝑉 𝑜𝑓 𝐴𝑠𝑠𝑒𝑡𝑠∗ 𝑟𝑑 +
𝑀𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦
𝑀𝑉 𝑜𝑓 𝐴𝑠𝑠𝑒𝑡𝑠∗ 𝑟𝑒
Using the formula above, we came up with a WACC before tax of 10.5% and a
WACC before tax for the adjusted statements of 10.3%. The WACC before tax for our
adjusted statements is lower because of the capitalization of operating leases. This
caused our MVL/MVA to increase and our MVE/MVA to decrease because the market
value of liabilities increased, while the market value of equity stayed constant. We also
calculated the WACC before tax using our backdoor and the WACC before tax size
adjusted. The WACC before tax using our backdoor came out to be 15.6%, and the
adjusted WACC before taxes using our backdoor came out to be 10.3%. The average
stock returns for U.S. from 1926-2005 for firms with a market value between 586.4 and
872.1 million averaged stocks returns between 16.6 and 17.5 %.We decided to go with
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the WACC before tax using the back door because Cracker Barrel has a market value of
743.9 million, which falls into the third decile of table 8-1 in the text book “Business
Analysis & Valuation Using Financial Statements.”49 The following tables and chart
explain the above.
Weighted Average Cost of Capital
Cost of Debt MVL/MVA Cost of
Equity MVE/MVA WACC
𝑊𝐴𝐶𝐶𝐵𝑇 5.4% 13% 11.3% 87% 10.5%
𝑊𝐴𝐶𝐶𝐵𝑇 𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑 5.4% 17.1% 11.3% 82.9% 10.3%
Weighted Average Cost of Capital (Using Backdoor Ke)
Cost of Debt MVL/MVA Cost of
Equity MVE/MVA WACC
𝑊𝐴𝐶𝐶𝐵𝑇 5.4% 13% 17.1% 87% 15.6%
𝑊𝐴𝐶𝐶𝐵𝑇 𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑 5.4% 17.1% 11.3% 82.9% 10.3%
49
Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.
173
Weighted Average Cost of Capital (Using Size Adjusted Ke)
Cost of Debt MVL/MVA Cost of
Equity MVE/MVA WACC
𝑊𝐴𝐶𝐶𝐵𝑇 5.4% 13% 13.6% 87% 12.5%
𝑊𝐴𝐶𝐶𝐵𝑇 𝐴𝑑𝑗𝑢𝑠𝑡𝑒𝑑 5.4% 17.1% 13.6% 82.9% 12.2%
TABLE 8-1 STOCK RETURNS, VOLATILITY, and FIRM SIZE
Size Decile
Market Value of
largest
company in
decile in 2005
($ millions)
Fraction of total
market value
represented by
decile in 2005
(%)
Average annual
stock return,
1926-2005(%)
Beta,
1926-2005
Size Premium
(return in
excess of
CAPM-%)
1-smallest 265 .8 21.6 1.41 6.4
2 586.4 1 17.5 1.34 2.7
3 872.1 1.3 16.6 1.28 2.3
4 1281 1.7 15.6 1.23 1.7
5 1728.9 2.4 15.3 1.18 1.7
6 2519.3 3.2 14.9 1.16 1.5
7 3961.4 4.7 14.3 1.13 1.1
8 7187.2 7.6 13.8 1.10 .9
9 16016.5 14 13.2 1.04 0.7
10-largest 367495.1 63.3 11.3 .91 -.4
Source: Ibbotson and Associates, Stocks, Bonds, Bills, and Inflation (2006).
174
Valuation Analysis
The purpose of valuation is to estimate the value of a firm‟s assets and equity.50
There are two approaches in valuing a firm: market based valuation and intrinsic
valuation. Market based valuation is a ratio and consensus based valuation that has no
support from theories. On the other hand, intrinsic valuation values a firm using
theory, models, and personal opinion. This adds value in the valuation process. For this
reason, we will put more emphasis on intrinsic based valuations to value Cracker Barrel.
We will be using the method of comparables for market based valuation and popular
valuation methods for intrinsic valuation.
Method of Comparables
The method of comparables is a basic screening tool used by analysts to value a
firm. “The primary reason for the popularity of this method is its simplicity.”51 These
methods don‟t use theory and rely on the market for most of their inputs. The only
reason why these methods are accepted is because they are consensuses based.
These methods allow us to compare firms in the industry despite different operational
levels. These methods are valued because people have faith in them, such as fiat
money like the U.S. dollar.
In this report we will be using a 10% analyst perspective. This is a conservative
approach to valuing a company, and it also has a higher likelihood of being correct if a
firm is misvalued. On November 2, 2009, Cracker Barrel‟s price per share was $32.74.
This means that any valuation above $36.01 is undervalued and any valuation below
$29.47 is overvalued; any computed price in between $36.01 and $29.47 is considered
fairly valued. We will be using eight different methods to value Cracker Barrel. These
methods include Trailing Price/Earnings, Forecasted Price/Earnings, Price/Book,
Dividends/Price, Price Earnings Growth, Price/Earnings Before Interest Depreciation and
Amortization (EBITDA), Price/Free Cash Flows, and Enterprise Value/EBITDA.
50
Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008. 51
Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.
175
Trailing Price/Earnings (P/E)
Trailing price to earnings ratio is calculated by taking the price per share of
common stock and dividing it by the prior year‟s earnings per share. This method is
based on actual earnings because to find the trailing earnings per share you take net
income and divide it by the number of shares outstanding. We gathered the
information for this method from Yahoo Finance on November 2, 2009.
Trailing P/E
PPS EPS P/E Trailing Industry Avg. Computed PPS
CBRL 32.74 2.89 11.32 12.59 36.42
CBRL Restated 32.74 2.47 12.59 31.03
Denny's 2.16 0.21 10.33
DineEquity 20.76 -4.63 -
Darden 30.41 2.75 11.06
Bob Evan's 26.12 -0.09 -
Brinker 12.60 0.77 16.36
Once the information has been gathered it enables you to calculate the industry
average for the trailing price to earnings (P/E) ratio, which does not include Cracker
Barrel. To get this average you add up all of the P/E ratios, after removing any outliers,
and divide it by the number of companies you are averaging. It is also important to
note that any negative P/E ratios are not relevant. In our model, DineEquity and Bob
Evans have negative P/E ratios so are not used, and there are no outliers.
Once you have computed the industry average you are able to compute the price
per share by multiplying the industry average times the trailing earnings per share that
was calculated. We found Cracker Barrel‟s as stated computed price per share to be
$36.42 and the restated price per share to be $31.03. According to this method,
Cracker Barrel is undervalued given their as stated earnings per share, and fairly valued
when their earnings per share are restated.
176
Forecasted P/E
This method is similar to the trailing price to earnings method except the
forecasted price to earnings ratio is calculated by taking the price per share of common
stock and dividing it by the forecasted earnings per share. This method is based on
forecasted earnings because in order to calculate the forecasted earnings per share you
take the forecasted net income for the next year and divide it by the number of shares
outstanding. We gathered the information for this method from Yahoo Finance on
November 2, 2009.
Forecasted P/E
PPS EPS 1yr Out P/E Forecasted Industry Avg. Computed
PPS
CBRL 32.74 3.16 9.91 31.32
CBRL Restated 32.74 2.63 9.91 26.06
Denny's 2.16 8.61
DineEquity 20.76 10.54
Darden 30.41 10.44
Bob Evan's 26.12 10.46
Brinker 12.60 9.50
Once the information has been gathered it enables you to calculate the industry
average for the forecasted price to earnings (P/E) ratio, which does not include Cracker
Barrel. To get this average you add up all of the P/E ratios, after removing any outliers,
and divide it by the number of companies you are averaging. As in the previous
method it is important to note that any negative P/E ratios are not relevant. In our
model there are no outliers.
177
Once you have computed the industry average you are able to compute the price
per share by multiplying the industry average times the forecasted earnings per share
that was calculated. We found Cracker Barrel‟s computed price per share to be $31.32
and the restated price per share to be $26.06. According to this method Cracker Barrel
is fairly valued as stated, but when Cracker Barrel is restated it is overvalued.
Price/Book (P/B)
This method of comparables evaluates a firm‟s market value of equity to its book
value of equity. This is a reliable method in valuating stocks because unlike
price/earnings, the P/B ratio will always be positive.52 The following is the P/B ratio for
Cracker Barrel and its competitors.
Price To Book
PPS BPS P/B Industry Average Computed
PPS
CBRL 32.74 5.97 5.49 2.66 15.90
CBRL Restated 32.74 5.53 5.92 2.66 14.74
Denny's 2.16 -1.52 -
DineEquity 20.76 4.34 4.79
Darden 30.41 12.01 2.53
Bob Evan's 26.12 19.36 1.35
Brinker 12.60 6.34 1.99
The price to book ratio can be found by dividing a firms‟ price per share by its
book value of equity per share. In calculating the price to book ratio we began by
observing the current market price per share for Cracker Barrel and its competitors. The
price per share and book value per share were found on Yahoo Finance on November
2, 2009. Cracker Barrel‟s restated book value of equity per share was calculated by
52
Accounting Glossary. http://www.accountingglossary.net/definition/375-Price/Book_Ratio_P/B. December 7, 2009
178
taking the restated book value of equity and dividing it by the number of shares
outstanding. Next we divided price per share by book value of equity per share, and
took an average of the competitors P/B ratio. Denny‟s was left out of the industry
average because it had a negative P/B ratio. We then multiplied the industry average by
Cracker Barrel‟s BPS in order to calculate their price per share. A share price of $15.90
is lower than the stated market price of $32.74, meaning that the company is
overvalued according to this method. The restated computed price was $14.74, which
means the company is still overvalued.
Dividends/Price (D/P)
The dividend yield is the return on investment for a stock.53 This method of
comparables takes into account the cash flow that investors receive from investment.
However, not every company pays dividends so there is a possibility some firms could
be left out of this method. The following is the dividend/price ratio for Cracker Barrel
and its competitors.
53
Investopedia. http://www.investopedia.com/terms/p/pegratio.asp. December 7, 2009.
Dividends/Price
PPS DPS D/P Industry Avg. Computed
PPS
CBRL 32.74 0.80 0.02 0.03 26.67
CBRL Restated 32.74 0.80 0.02 0.03 26.67
Denny's 2.16 -
DineEquity 20.76 -
Darden 30.41 1.00 0.03
Bob Evan's 26.12 0.64 0.02
Brinker 12.60 0.44 0.03
179
The dividend to price ratio can be found by dividing a company‟s dividends per
share by their price per share. The price per share and dividends per share for Cracker
Barrel and its competitors were found on Yahoo Finance. Next we divided dividend per
share by the price per share to come up with the D/P ratio. A D/P average for Cracker
Barrel‟s competitors was then calculated to be .03. Denny‟s and Dine Equity were left
out because they did not have any dividends paid out to shareholders.
To compute Cracker Barrel‟s share price using this approach we took their
dividends per share and divided it by the industry average. Cracker Barrel‟s as stated
and restated computed price per share was $26.67. Compared to the market share
price of $32.74, the computed PPS using this method suggest that the company is
overvalued.
Price Earnings Growth
The price earnings growth (PEG) method is “used to determine a stock's value
while taking into account earnings growth.”54 This method uses the information we
gathered from Yahoo Finance for the trailing P/E ratio. Since we already know the
trailing P/E ratio and the five years growth for the company we are able to calculate the
PEG ratio. The PEG ratio calculation is P/E divided by the five years growth.
54
Investopedia. http://www.investopedia.com/terms/p/pegratio.asp. December 7,2009.
180
Price Earnings Growth
P/E Growth-5
years
PEG EPS Industry Avg. Computed
PPS
CBRL 11.33 9.89 2.89 1.08 30.90
CBRL Restated 5.00 2.47 1.08 13.31
Denny's 10.81 19.00 0.44
DineEquity - 10.00 0.93
Darden 11.61 12.40 0.89
Bob Evan's - 8.67 1.39
Brinker 16.89 8.64 1.11
Once you have the PEG ratio for the other firms in the industry you can calculate
the industry average PEG. If there are any outliers they must be removed; in this model
Denny‟s is an outlier and was removed from the average. Once you have the PEG
industry average you can calculate the computed price per share. This is done by
multiplying the five year growth times the EPS times the PEG industry average. We
found the computed price per share to be $30.90 and the restated price per share to be
$13.31. This method tells analysts that the as stated computed price per share is fairly
valued and the restated price per share is overvalued.
Price/EBITDA
This method is found by finding the price/earnings before interest, taxes,
depreciation, and amortization (EBITDA) ratio. In order to find the market cap we
found the number of shares outstanding for each company and the stock price on
November 2, 2009 and multiplied them together. We then collected the EBITDA
numbers from Yahoo Finance for the other firms in the industry. Cracker Barrel‟s
EBITDA was found on our stated and restated income statements by taking net income
and adding back interests, taxes, depreciation, and amortization.
181
Price/EBITDA
Market
Cap
EBITDA P/EBITDA Industry
Avg.
EBITDA/Shares Computed
PPS
CBRL 743.94 208.97 3.56 3.59 9.20 33.02
CBRL
Restated
743.94 172.50 4.31 3.59 7.59 27.25
Denny's 208.67 91.27 2.29
DineEquity 364.97 392.57 0.93
Darden 4245.74 922.90 4.60
Bob Evan's 810.20 194.10 4.17
Brinker 1291.22 389.74 3.31
Once the market cap and EBITDA are known it allows for the computation of the
Price/EBITDA ratio, which is market cap divided by EBITDA. This allowed us to find the
industry average, after removing the outlier (DineEquity), for the Price/EBITDA ratio,
which was 3.59. After finding the industry average, the EBITDA/Shares ratio must be
computed. This is EBITDA divided by the total number of shares outstanding. Finally,
you multiply the industry average times the EBITDA/Shares ratio to calculate the
computed price per share. We found the as stated computed price per share to be
$33.02 and the restated computed price per share to be $27.25. According to this
method Cracker Barrel is fairly valued as stated, and they are overvalued when their
financial statements were restated.
Price/Free Cash Flow
This ratio measures a company‟s market price to its free cash flows. Free cash
flows (FCF) represent the cash that a company is able to generate after laying out the
182
money required to maintain or expand its asset base.55 In order to compute a price for
Cracker Barrel using this method, we will need to take an industry average to come up
with an estimate price for the company.
Price/Free Cash Flow
Market
Cap
FCF P/FCF Industry Avg. Computed
PPS
CBRL 743.94 155.08 4.80 4.77 32.57
Denny's 208.67 30.14 6.92
DineEquity 364.97 146.03 2.50
Darden 4245.74 221.10 19.20
Bob Evan's 810.20 55.09 14.71
Brinker 1291.22 263.83 4.89
The companies‟ market capitalization was taken off of Yahoo Finance on
November 2, 2009. Free cash flow is computed by taking a firm‟s cash flow from
operations and adding or subtracting out its cash flows from investing. The cash flows
used were taken off of each of the companies‟ most recent 10-K. We then took each
company‟s market capitalization and divided it by their free cash flow to come up with
their P/FCF ratio. Next, we took an average of Cracker Barrel‟s competitors and came
up with an industry average of 4.77. Darden and Bob Evans were outliers so they were
not included in the industry average.
To compute a share price using this method we multiplied the industry average
by Cracker Barrel‟s market capitalization, and then divided it by the number of shares
outstanding. The numbers of shares outstanding are 22,722,685. Our computed price
of $32.57 a share is very close to the market price per share of $32.74, meaning that
the company is fairly valued according to the method.
55
Investopedia. http://www.investopedia.com/terms/p/pegratio.asp. December 7, 2009
183
Enterprise Value/EBITDA (EV/EBITDA)
This method of comparables gives a measure of the value of a firm compared to
earnings before interest, taxes, depreciation, and amortization. The reasons why
analysts use this method is because it does not take a company‟s capital structure into
account, and because it ignores the effects of non-cash items such as amortization and
depreciation.56 The following are the results of Cracker Barrel‟s price per share using
this method.
The enterprise value and earnings before interest, tax, depreciation, and
amortization (EBITDA) for each company were found on Yahoo Finance. Cracker
Barrel‟s restated EBITDA was calculated by taking the net income on our restated
income statement and adding back restated interest, tax, depreciation, and
amortization. We divided the enterprise value by EBITDA for each of the competitors in
the industry, and calculated an industry average of 5.7.
56
Money Terms. http://moneyterms.co.uk/ev_ebitda/. December 7,2009.
EV/EBITDA
EV EBITDA EV/EBITDA Industry Avg. Computed
PPS
CBRL 1492.46 208.97 5.70 4.13
CBRL
Restated
2268.52 172.50 5.70 -23.80
Denny's 494.41 91.27 5.42
DineEquity 2470.05 392.57 6.29
Darden 5971.16 922.90 6.47
Bob Evan's 1091.04 194.10 5.62
Brinker 1837.23 389.74 4.71
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We then multiplied the industry average by Cracker Barrel‟s EBITDA to calculate
their new enterprise value. Next, we added back cash of $11,609,000, subtracted out
book value of liabilities of $1,109,559,000, and divided by the number of shares
outstanding to compute Cracker Barrel‟s price per share. These numbers were found in
the financial statements of Cracker Barrel‟s 10-K for 2009. The same process was used
to calculate the restated price. The as stated and restated computed prices per share
for Cracker Barrel were $4.13 and -$23.80 respectively. According to this method
Cracker Barrel is overstated.
Conclusion
The method of comparables is a quick, simple approach in valuing a firm. The
value of a firm using the method of comparables is derived by computing industry
averages. Due to this, there are no theories or analyst opinions that add value to this
valuation process. According to the method of comparables, we concluded that Cracker
Barrel‟s current price per share is overvalued. We will not be emphasizing the results of
the method of comparables because it is not the best approach in valuing a firm.
Instead, we will be focusing on intrinsic valuation models.
Intrinsic Valuation Models
Intrinsic valuation models have the ability to give a much more accurate
description of a firm‟s value than the method of comparables shown in the previous
section. These models‟ descriptive power can be attributed to the use of forecasted
financials in order to find a time consistent model price. After this is performed, a
sensitivity analysis is applied to the financial data. This analysis implements varying
growth rates and cost of equity or WACC estimates in order to see how slight changes
affect the model prices. Included in this section are the discounted dividends,
discounted free cash flows, residual income, long run residual income, and abnormal
growth valuations. These intrinsic valuations give anywhere from 5% up to 95%
185
explanatory power of the firm‟s value and therefore hold heavy weight when analyzing
a company.
Discounted Dividends Valuation
The discounted dividends valuation “expresses the value of the firm‟s equity as
the present value of forecasted future dividends”57. Out of all the models we use to
value Cracker Barrel, the discounted dividends model explains the least about the
company‟s value. The reason for this is that the model derives value strictly from the
firm‟s dividend payments, hardly touching any core financial data reported by the firm.
The basis for understanding the price given in this model is that it is the per share
forecasted price of investing in the company based solely on dividends. This price only
yields about 5% explanatory power of the firm‟s value.
There are two main inputs for the discounted dividends model: the cost of
equity, 𝐾𝑒 , and forecasted dividends. Both of these inputs play a vital role in the
accuracy of this model. Due to the small amount of inputs this model is very unstable.
The slightest changes in either growth rates or cost of equity can drastically change the
model price, which discredits the effectiveness of the model. In theory this model
works, but in actuality it lacks feasibility. In reality, dividends almost never grow at a
constant rate and sometimes companies refrain from paying dividends at all.
In order to value Cracker Barrel using the discounted dividends model, we had to
find the forecasted dividends per share. To do this we took the dividends per share in
2009 and grew them at a rate of eight cents per year. We then needed to get the
present value factor for each year so that the values of each year‟s dividends will be
time consistent. After that we multiplied the forecasted dividends per share by the
present value factor for each year. We then estimated the dividends per share in
perpetuity for 2020 to be $2.00 based on the trend of dividends per share in prior
years. This number was then divided by the initial cost of equity minus the perpetuity
57
Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements. Thomson South-Western. 2008.
186
growth rate to find the present value of the perpetuity. The present value of the
perpetuity then needed to be discounted back to year zero by multiplying it by the
present value factor in year 2019. In order to find the model price as of 7/31/2009, the
date in which the Cracker Barrel 10-K‟s financials are base on, the time consistent
forecasted dividends per share and the time consistent terminal value of the perpetuity
were added together. From there, the model price needed to be grown by three months
so that the model price is time consistent with our observed price date of 11/2/09. To
do this we multiplied the model price as of 7/31/09 by(1 + 𝐾𝑒)(3
12). After all of these
calculations we found the time consistent model price to be $29.34 per share. This
indicated that Cracker Barrel‟s the observed price on 11/2/09 of $32.74 per share is
overvalued.
Discounted Dividends Model
Growth rates 0 0.017 0.033 0.05 0.067 0.084 0.101
Cost of Equity
0.05 34.3 47.11 82.55
0.07 23.31 28.05 36.49 60.24 353.22
0.09 17.35 19.59 22.91 29.34 32.74 151.63
0.1127 13.27 14.38 15.86 18.26 22.45 31.6 67.35
0.13 11.17 11.87 12.76 14.09 16.14 19.7 27.44
0.15 9.39 16.43 9.83 10.36 11.1 12.15 13.74
0.17 8.07 11.8 8.35 8.68 9.13 9.73 10.56
Undervalued Fair Valued Overvalued
Model Price > 36.01 36.01 > Model Price > 29.47 29.47 > Model Price
The table above is a sensitivity analysis. Its purpose is to show how sensitive the
model price is to small variances in growth rates and the cost of equity. When finding
the time consistent model price mentioned earlier we used a growth rate of 5% and a
cost of equity of 9%. From the table above it can be observed that the discounted
dividends valuation is highly sensitive to any variances. That being said, this model may
not be giving an accurate assessment of value for Cracker Barrel.
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Discounted Free Cash Flows Model
The discounted free cash flow model arrives at the value of a firm‟s equity by
combining two different values: the present value of the free cash flow perpetuity and
the present value of the forecasted free cash flows. After combining the two present
values, the book value of debt and preferred stock is subtracted to find the firm‟s
market value of equity. The market value of equity is then divided by the amount of
shares to find the price per share. We grew this share price by 3/12 multiplied by the
annual WACC(BT) to make it time consistent with the observed share price on
November 2nd. This model has a higher explanatory power (10-20%) than the
discounted dividends model, but still maintains a high level of variance. This is due to
the fact that the free cash flow perpetuity is many years into the future, which can
cause cash flow projections to be grossly misstated.
The forecasted cash flows to be discounted can be found by subtracting the cash
flow from investing activities (CFFI) from the cash flows from operations (CFFO). This
can be done for a small number of years, usually 5-10, into the future. For our analysis
we forecasted cash flows for the next 10 years. The cash flows are then multiplied by
the present value factor, which incorporates the firm‟s before tax WACC. The actual
present value factor is found by the formula 1/(1 + WACCbt)^n), where WACCbt is the
firm‟s forecasted before tax weighted average cost of capital, and n is the number of
years the cash flow will be discounted.
The perpetuity present value is found by first determining a “seed value” for the
perpetuity. This value is a cash flow forecast that follows the trend of the last few years
of the 10 year free cash flow forecasts. This seed value is then divided by the
perpetuity growth rate (WACCbt – g). This yields the present value of the perpetuity at
a point 10 years in the future, which must then be discounted back to time zero.
Multiplying the present value of the perpetuity by the present value factor of year ten
will give the value of the future cash flow perpetuity at time zero.
188
The sensitivity analysis of the discounted free cash flows model uses inputs of
the growth rate and the weighted average cost of capital. The growth rate is required
to be greater than one and less than the cost of capital. These rates are increased or
decreased to produce different outcomes that are compared to the time consistent
price. Comparing the prices allows an analyst to determine whether a firm‟s share price
is overvalued or undervalued according to the model. The model works under an
assumption that a firm‟s free cash flows will continue to grow forever, which is almost
certainly not attainable.
Discounted Free Cash Flows Model
Perpetuity Growth
0 0.017 0.033 0.05 0.067 0.084 0.101
WACC
0.04 200.1 334.99 1060.39
0.06 111.6 151.34 234.49 614.36
0.08 67.91 84.79 111.83 172.17 390.3
0.103 39.11 46.89 57.67 76.24 112.4 213.1 2026.64
0.12 25.16 29.94 36.15 45.87 61.81 92.8 179.26
0.14 13.26 16.14 19.68 24.83 32.37 44.49 67.18
0.16 4.49 6.31 8.47 11.45 15.52 21.41 30.69
Undervalued Fair Valued Overvalued
Model Price > 36.01 36.01 > Model Price > 29.47
29.47 > Model Price
Using a 10 percent analyst‟s view, a model price between $29.47 and $36.01 is
deemed fairly valued. According to the model, Cracker Barrel‟s stock price is
undervalued. The cells that are blacked out represent negative values. The substantial
volatility of the discounted free cash flow model is clearly depicted in our results. When
using lower WACCbt values, prices skyrocket as the perpetuity growth rate increases.
The inherent volatility of results and relatively low explanatory power of this model will
be considered when we apply the results to our overall valuation.
189
Residual Income
The residual income valuation model presents a very accurate estimate of a
firm‟s current value. It boasts an explanatory power from 70% to 90%, much higher
than the other intrinsic models. This is a result of the model focusing more on the book
value of equity of the firm, as opposed to the terminal value of the perpetuity. This
results in a more short term view of the value of the company. Putting a larger weight
on the firm‟s current financial standing makes the model less susceptible to forecast
errors, which are likely to be large in future years. The residual income model is also
much less sensitive to changes in the growth rate of the perpetuity. However, the
model is not accurate in forecasting and tends to consistently state firm‟s stock prices
as overvalued.
To set up this model, an analyst must first forecast net income and dividends
figures 10 years into the future. In our model, we grew net income by 3% in the first
year, followed by 4% the next year. The remaining years were held at a constant 5%
growth rate. Dividends were forecasted to grow by 8 cents per share each year, based
on analysis of previous dividend trends. The firm‟s book value of equity can then be
forecasted through the same amount of years. To accomplish this, the difference
between year 1‟s forecasted net income and forecasted dividends is added to the firm‟s
latest reported book value of equity (year zero book value of equity). This process is
repeated to forecast the book value of equity to 10 years.
The firm‟s annual residual income is then computed for each of the forecasted
years by subtracting the forecasted “benchmark” income from the forecasted net
income. The benchmark income is derived by multiplying the previous year‟s book value
of equity by the firm‟s initial cost of equity. We found this initial cost of equity to be
11.27%. A positive annual residual income signals that the firm created value in that
year, while a negative annual residual income indicates the firm destroyed value in that
year.
190
Each year‟s residual income forecast must then be calculated in present value
terms by multiplying the residual income by a present value factor. The present value
factor for each year is found by dividing 1 by 1 plus the initial cost of equity raised to
the year the present value factor is found. In formula form, (1/(1+initial ke)^n). Adding
together each year‟s present value yields the total present value of the year-by-year
residual income, which will be used to calculate the market value of equity for the firm.
Next, the terminal value of the perpetuity, another component of the market
value of equity, must be found. Like in the discounted free cash flows model, a seed
value for the perpetuity must be created. Because our forecasted annual residual
income numbers were decreasing, we continued that trend into year 2020 to determine
the seed value. We multiplied year 2019‟s annual RI by 1 minus the present value
factor of the same year to give us 2020‟s seed value for the perpetuity of $22.16. This
seed value was then divided by the initial cost of equity minus the perpetuity growth
rate to find the present value of the perpetuity. The present value at year 2019 must
then be discounted back to time zero by multiplying the present value by the year 2019
present value factor.
Now the firm‟s market value of equity can be calculated. The time zero published
book value of equity added to the total present value of the year-by-year residual
income figures plus the terminal value of the perpetuity will yield the market value of
equity at year end. Divide the market value of equity by the total number of shares to
find the residual income model price at fiscal year end. For our analysis, we again
multiplied this share price by 1 plus the initial cost of equity raised to the (3/12) power
to find a time consistent price. Cracker Barrel‟s fiscal year end was 3 months prior to
the date we used to observe the share price.
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Residual Income Model - As Stated
Perpetuity Growth
-0.1 -0.2 -0.3 -0.4 -0.5 -0.6 -0.7
Cost of Equity
0.05 38.52 34.91 33.36 32.5 31.96 31.58 31.3
0.07 30.68 28.66 27.73 27.2 26.85 26.61 26.43
0.09 24.9 23.79 23.25 22.93 22.72 22.57 22.46
0.1127 20.01 19.49 19.23 19.07 18.96 18.88 18.82
0.13 17.15 16.89 16.75 16.67 16.61 16.56 16.53
0.15 14.5 14.43 14.39 14.36 14.34 14.33 14.32
0.17 12.41 12.43 12.45 12.46 12.47 12.47 12.48
Undervalued Fair Valued Overvalued
Model Price > 36.01
36.01 > Model Price > 29.47
29.47 > Model Price
Residual Income Model - Restated
Perpetuity Growth
-0.1 -0.2 -0.3 -0.4 -0.5 -0.6 -0.7
Cost of Equity
0.05 32.91 29.83 28.51 27.78 27.31 26.99 26.75
0.07 26.39 24.64 23.83 23.37 23.07 22.86 22.71
0.09 21.56 20.58 20.1 19.82 19.63 19.5 19.4
0.1127 17.46 16.98 16.74 16.59 16.48 16.41 16.36
0.13 15.05 14.8 14.66 14.57 14.52 14.47 14.44
0.15 12.82 12.72 12.67 12.63 12.61 12.59 12.58
0.17 11.04 11.04 11.03 11.03 11.03 11.03 11.03
Undervalued Fair Valued Overvalued
Model Price > 36.01
36.01 > Model Price > 29.47
29.47 > Model Price
The above charts represent the sensitivity analyses of the residual income model
using Cracker Barrel‟s reported numbers as well as with our restated figures. We once
again used a 10% analyst‟s position in valuing the firm based on the residual income
model. This means that a model price above $36.01 indicates the firm is undervalued,
while a model price under $29.47 indicates the firm is overvalued. Anything in between
the range shows the firm is fairly valued.
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Both the as-stated and restated models indicate that Cracker Barrel‟s stock is
overvalued except for extremely low costs of equity. Using restated figures shows the
stock to be slightly more overvalued than with as-stated numbers. The low sensitivity to
growth rates of the residual income model is clearly shown in our results. For each cost
of equity, prices remain stable across each growth rate of the perpetuity.
At the initial cost of equity we derived for Cracker Barrel of 11.27%, the model
yields a stock price just above half of the observed share price. These results are a
definite cause for concern as the residual income model holds such a high explanatory
power. The results of this model will have a significant impact on our overall valuation
of the firm.
Abnormal Earnings Growth (AEG) Valuation
“Under this approach, the value of a firm‟s equity is expressed as the sum of its
current book value and the present value of forecasted abnormal earnings.”58 Abnormal
earnings are the difference between a firm‟s market value and book value. The three
inputs in the model are dividends reinvested (DRIP), cumulative dividend earnings, and
normal earnings. In theory, the abnormal earnings growth model should give similar
results to the residual income model. This is true because abnormal earnings growth in
a given year is equal to its change in residual income. Because the AEG model is
considered to be the “ugly cousin” to the residual income model, it is implied that the
AEG model also has an explanatory power of about 70%. We will discuss in this section
the steps taken in calculating a model price for Cracker Barrel using the AEG valuation.
The first step in the model is to calculate dividends reinvested. The DRIP
implements an assumption that an investor will reinvest their dividends based on the
cost of equity return. Total dividends reinvested can be found by multiplying the cost of
equity (Ke) by the total amount of dividends paid out from the previous year. The DRIP
was calculated for the next nine years by using our forecasted dividend payments, and
a cost of equity of 11.27%.
58
Palepu
193
After the DRIP was found, the next step in the model was to calculate the
cumulative earnings. There is a direct and indirect component to cumulative wealth.
The direct component is net income, which is the shareholder‟s claim to earnings. The
indirect component is the dividend reinvestment from shareholders. We calculated each
year‟s forecasted cumulative dividend earnings for the next nine years by taking that
year‟s net income and adding to it the DRIP, which is the previous year‟s total dividends
multiplied by the cost of equity.
The third step in the AEG model was to find Cracker Barrel‟s “benchmark” normal
earnings for the next nine years. The “benchmark” normal earnings used is an
assumption that net income would grow by the cost of equity. To calculate normal
earnings we took the net income from the previous year and multiplied it by one plus
the cost of equity. This was repeated for the next nine years.
After cumulative dividend earnings and normal earnings have been computed,
we can calculate AEG. The AEG for the next nine years was calculated by taking
cumulative dividend earnings and subtracting normal earnings for each year. Since AEG
is equal to the change in residual income, we compared our calculated AEG to the
change in residual income to ensure that our calculations were correct. Both numbers
were the same, so we concluded that our AEG was correct. Next, we had to get the
present value of each year‟s AEG. To get the present value we discounted back AEG by
multiplying it by the formula 1/(1 + 𝐾𝑒)𝑡 . Once each year‟s AEG was discounted back to
the year 2009, the total present value of AEG was computed by adding up the present
value of each year‟s AEG.
The next step was to find the terminal value of the perpetuity. In order to do so
we had to come up with a seed value for AEG in year ten. Looking at the most recent
years‟ AEG, we came up with a seed value of 3.33 stated and 1.93 restated. We then
found the present value of the perpetuity by dividing the seed value by (Ke – growth
rate). Then we had to discount back the perpetuity by the present value factor for the
year 2019.
194
The last step was to calculate the time consistent implied price per share. To do
so we took our forecasted net income in 2010 and subtracted out the present values of
the total AEG and the terminal value. This gave us the total average net income of the
perpetuity. Next, we divided the average net income of the perpetuity by the number of
shares outstanding to calculate the average earnings per share of the perpetuity. The
average EPS of the perpetuity was then multiplied by the cost of equity to compute an
intrinsic value of $20.88 stated and $18.87 restated. We then had to grow our intrinsic
values three months forward to get a time consistent price, because our fiscal year end
was at the end of July and our observed share price was at the beginning of November.
In order to do so we multiplied the intrinsic value price per share by one plus the cost
of equity raised to 3/12 power. The following graphs show the sensitivity analysis for
the as stated and restated AEG models.
AEG As Stated Perpetuity Growth
Sensitivity
to change
in Cost of
Equity
-0.1 -0.2 -0.3 -0.4 -0.5 -0.6 -0.7
0.05 78.41 75.14 73.73 72.95 72.46 72.12 71.86
0.07 46.24 45.91 45.76 45.68 45.62 45.58 45.55
0.09 30.81 31.31 31.55 31.7 31.8 31.86 31.91
0.1127 21.44 22.13 22.49 22.71 22.85 22.96 23.04
0.13 17.14 17.8 18.15 18.37 18.52 18.63 18.71
0.15 13.81 14.38 14.7 14.9 15.04 15.14 15.22
0.17 11.54 12.01 12.28 12.46 12.58 12.68 12.75
Undervalued Fair Valued Overvalued
Model Price > 36.01 36.01 > Model Price > 29.47 29.47 > Model Price
195
We used negative growth rates in the AEG model in order to restore earnings
back to equilibrium. The sensitivity analysis for the as stated AEG shows that with a 9%
cost of equity Cracker Barrel‟s stock is fairly valued. A lower cost of equity will result in
the company‟s stock being undervalued, and any cost of equity above 9% results in the
company being overvalued. As for the restated AEG, when the cost of equity is 7% or
lower, the firm is undervalued. Any cost of equity of 9% or above results in the
company‟s share price being overvalued. Since our estimated cost of equity is 11.27%,
according to the AEG model, Cracker Barrel is overvalued as stated and restated.
Long Run Return On Equity Residual Income Model
The long run return on equity (ROE) residual income model is like the residual
income model except that it takes into account a firms dividends when calculating the
market value of equity. In order to calculate this new model a different formula must be
created, which is:
𝑀𝑉𝐸0 = 𝐵𝑉𝐸0 + 𝐵𝑉𝐸0 𝑅𝑂𝐸 − (𝐵𝑉𝐸0 ∗ 𝐾𝑒)
𝐾𝑒 − 𝑔
As seen from the equation, this model is sensitive to changes in ROE, Cost of Capital
(Ke), and growth. For this reason, this model is helpful in determining if a firm is fairly
valued.
AEG Restated Perpetuity Growth
-0.1 -0.2 -0.3 -0.4 -0.5 -0.6 -0.7
Sensitivity
to change
in Cost of
Equity
0.05 68.05 64.77 63.37 62.59 62.1 61.75 61.5
0.07 40.74 40.09 39.8 39.63 39.52 39.44 39.38
0.09 27.5 27.66 27.74 27.79 27.82 27.84 27.86
0.1127 19.38 19.78 19.99 20.11 20.2 20.26 20.31
0.13 15.6 16.02 16.25 16.38 16.48 16.55 16.6
0.15 12.65 13.03 13.24 13.38 13.47 13.54 13.59
0.17 10.62 10.94 11.13 11.25 11.33 11.39 11.44
Undervalued Fair Valued Overvalued
Model Price > 36.01 36.01 > Model Price > 29.47
29.47 > Model
Price
196
To use the equation the company‟s seed value for the ROE must be found. We
found the forecasted ROE to be:
1 2 3 4 5 6 7 8 9 10 11
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
ROE As Stated
52.9% 39.4% 32.1% 27.6% 24.4% 21.9% 20.1% 18.6% 17.4% 16.3% 15.53%
ROE Restated
47.55% 37.20% 31.20% 27.37% 24.56% 22.41% 20.71% 19.33% 18.19% 17.23% 16.37%
In this graph the seed value ROE is the perpetuity starting in year 2020, which is
15.53%. After finding the forecasted ROE you find the percentage change in ROE to
find the growth. We found our growth percentage to be -5.57%. Once these numbers
have been calculated you can test the sensitivity to changes in the model. In our model
we used 2% intervals for ROE and growth to see the price sensitivity. For the cost of
equity we did 3% intervals to see the price sensitivity in the model.
In order to see price sensitivity we changed two variables and held one constant.
In the first set of tables we held the growth rate constant; for the as stated it was -
5.57% and for the restated it was -5.03%. Then we changed the ROE and Ke to see
the price sensitivity.
Cost of Equity
As Stated Change In ROE
0.1 0.12 0.14 0.1553 0.18 0.2 0.22
0.05 8.25 9.31 10.37 11.18 12.49 13.55 14.61
0.07 6.97 7.86 8.76 9.45 10.55 11.45 12.34
0.09 6.04 6.82 7.59 8.19 9.14 9.92 10.7
0.1127 5.25 5.93 6.60 7.12 7.95 8.63 9.3
0.13 4.78 5.4 6.01 6.48 7.24 7.85 8.47
0.15 4.34 4.89 5.45 5.88 6.56 7.12 7.68
0.17 3.97 4.48 4.99 5.38 6.01 6.52 7.03
Undervalued Fair Valued Overvalued
Model Price > 36.01
36.01 > Model Price > 29.47
29.47 > Model Price
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Cost of Equity
Restated Change In ROE
0.1 0.12 0.14 16.4 0.18 0.2 0.22
0.05 8.39 9.51 10.63 11.97 12.86 13.98 15.09
0.07 7.03 7.97 8.9 10.02 10.77 11.71 12.64
0.09 6.06 6.86 7.67 8.63 9.28 10.09 10.89
0.1127 5.25 5.94 6.63 7.47 8.03 8.73 9.42
0.13 4.75 5.39 6.02 6.78 7.29 7.92 8.55
0.15 4.3 4.87 5.44 6.13 6.59 7.16 7.73
0.17 3.93 4.45 4.97 5.6 6.02 6.54 7.06
Undervalued Fair Valued Overvalued
Model Price > 36.01
36.01 > Model Price > 29.47
29.47 > Model Price
In the second set of tables we held the return on equity constant; the as stated
was 15.53% and the restated was 16.4%. Then we changed the variables for growth
and Ke to see the price sensitivity.
Cost of Equity
As Stated Change In Growth
0.01 -0.01 -0.03 -0.0557 -0.07 -0.09 -0.11
0.05 21.95 16.65 13.99 12.06 11.34 10.59 10.02
0.07 14.7 12.54 11.25 10.19 9.77 9.31 8.95
0.09 11.08 10.08 9.42 8.83 8.59 8.31 8.09
0.1127 8.67 8.26 7.96 7.68 7.56 7.42 7.3
0.13 7.45 7.27 7.13 6.99 6.93 6.86 6.8
0.15 6.41 6.39 6.36 6.34 6.33 6.32 6.31
0.17 5.64 5.7 5.75 5.8 5.83 5.86 5.88
Undervalued Fair Valued Overvalued
Model Price > 36.01
36.01 > Model Price > 29.47
29.47 > Model Price
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Cost of Equity
Restated Change In Growth
0.01 -0.01 -0.03 -0.0503 -0.07 -0.09 -0.11
0.05 21.56 16.24 13.58 11.97 10.92 10.16 9.59
0.07 14.44 12.24 10.92 10.02 9.4 8.93 8.57
0.09 10.88 9.84 9.14 8.63 8.27 7.98 7.74
0.1127 8.52 8.06 7.72 7.47 7.28 7.12 6.99
0.13 7.32 7.03 6.92 6.78 6.67 6.59 6.51
0.15 6.3 6.23 6.17 6.13 6.09 6.06 6.04
0.17 5.54 5.56 5.58 5.6 5.61 5.62 5.63
Undervalued Fair Valued Overvalued
Model Price > 36.01
36.01 > Model Price > 29.47
29.47 > Model Price
For the final set of tables we held the cost of capital constant; for both the as
stated and restated it was 11.27%. Then we changed the ROE and growth to see the
price sensitivity of the model.
Change In Growth
As Stated Change In ROE
0.09 0.11 0.13 0.1553 0.17 0.19 0.21
0.01 4.78 5.97 7.16 8.67 9.55 10.74 11.94
-0.01 5 6 6.99 8.26 8.99 9.99 10.99
-0.03 5.15 6.01 6.87 7.96 8.59 9.45 10.31
-0.0557 5.3 6.03 6.76 7.68 8.22 8.94 9.67
-0.07 5.37 6.04 6.71 7.56 8.05 8.72 9.39
-0.09 5.44 6.05 6.65 7.42 7.86 8.47 9.07
-0.11 5.51 6.06 6.61 7.3 7.71 8.26 8.81
Undervalued Fair Valued Overvalued
Model Price > 36.01
36.01 > Model Price > 29.47
29.47 > Model Price
199
Change In Growth
Restated Change In ROE
0.1 0.12 0.14 16.4 0.18 0.2 0.22
0.01 4.98 6.09 7.19 8.52 9.41 10.51 11.62
-0.01 5.09 6.02 6.95 8.06 8.8 9.72 10.65
-0.03 5.18 5.97 6.77 7.72 8.36 9.16 9.95
-0.0503 5.24 5.94 6.63 7.47 8.03 8.73 9.42
-0.07 5.29 5.91 6.53 7.28 7.78 8.4 9.02
-0.09 5.33 5.89 6.45 7.12 7.57 8.13 8.69
-0.11 5.36 5.87 6.38 6.99 7.4 7.91 8.42
Undervalued Fair Valued Overvalued
Model Price > 36.01
36.01 > Model Price > 29.47
29.47 > Model Price
According to the model, the price is not overly sensitive to the change in cost of
equity and change in ROE or the change in growth and change in ROE. However, the
price is sensitive to change in growth and change in cost of equity; this can be seen in
the second set of tables. According to this model, Cracker Barrel is extremely
overvalued.
Analyst Recommendation
Through an in-depth examination of Cracker Barrel we have determined that its
stock price is overvalued. This is based upon an observed price per share of $32.74 on
November 2nd, 2009 and a 10% analyst‟s perspective. We reached this conclusion after
a thorough examination of the firm and its competitors in the restaurant industry. The
industry analysis allowed us to identify components of a successful firm in the
restaurant industry, as well as what threats a company might face. We were then able
to identify the key success factors that contributed to Cracker Barrel‟s value. Performing
an accounting analysis allowed us to determine the validity of Cracker Barrel‟s financial
statements. A thorough ratio analysis permitted us to compare Cracker Barrel‟s
performance to its competitors in the industry. From there we were able to forecast
200
Cracker Barrel‟s financial statements ten years into the future. This allowed us to gain a
models based valuation on the current stock price.
In our accounting analysis we found no indication of goodwill, and very little
amounts of research and development. These costs did not need to be restated.
However, the present value of Cracker Barrel‟s operating leases consisted of more than
10% of their long term debt. Because of this, we restated the financial statements to
include a capitalization the leases. The restated financial statements showed increased
liabilities and assets, while net income decreased. It is our opinion that these restated
financials showed a more clear depiction of Cracker Barrel‟s financial position.
Our financial analysis showed that Cracker Barrel was in a fairly strong financial
position compared to the industry. Although the firm mostly had below average liquidity
due to its retail sector, it was near industry average when we only examined restaurant
operations. We believe this is a safe estimate given that retail operations consist of only
around 20% of revenues and are a key component of Cracker Barrel‟s customer
experience.
However, the most heavily weighted factor of our analysis was the examination
of the intrinsic model valuations. All models except for the discounted free cash flows
model showed Cracker Barrel‟s stock price to be overvalued. We placed small
significance on this model due to its relatively low explanatory power and sensitivity to
perpetuity growth rates. The residual income model, one of the more accurate valuation
models, indicated overwhelmingly that Cracker Barrel‟s stock price was overvalued. In
addition, the AEG, long run return on equity residual income, and discounted dividends
models also clearly indicated an overvalued stock price.
Although the firm is not near any financial trouble and performed above average
in our ratio analysis, we placed more emphasis on the results of the intrinsic valuation
models. In nearly all models, the model price was clearly below the observed stock
price, using a 10% margin of safety. We believe that Cracker Barrel cannot sustain its
201
stock price in the long term. For this reason, we recommend that investors do not buy
stock in Cracker Barrel.
202
Appendices
Liquidity Ratios
Current Ratio
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 0.84 0.64 1.98 0.73 0.83 1
Bob Evans 0.33 0.3 0.52 0.51 0.22 0.37
Denny's 0.32 0.42 0.46 0.44 0.5 0.43
Darden 0.51 0.39 0.37 0.51 0.41 0.44
Dine Equity 1.82 1.14 1.22 1.14 1.06 1.28
Brinker International 1.06 0.73 0.49 1.21 0.87 0.87
Industry 0.81 0.6 0.61 0.76 0.61 0.68
Quick Asset Ratio
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 0.25 0.16 1.59 0.2 0.24 0.49
Bob Evans 0.19 0.17 0.34 0.37 0.12 0.24
Dennys 0.26 0.36 0.4 0.39 0.45 0.37
Darden 0.22 0.16 0.17 0.31 0.22 0.22
Dine Equity 1.81 1.13 1.22 1.1 1.02 1.26
Brinker International 0.96 0.61 0.41 1.15 0.8 0.79
Industry 0.69 0.49 0.51 0.66 0.52 0.57
Working Capital Turnover
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel -60.74 -20.89 6.87 -31.61 -54.1 -27.5
Bob Evans -12.18 -11.11 -20.56 -16.76 -6.8 -14.45
Dennys -10.36 -11.28 -13.62 -12.76 -14.17 -10.78
Darden -14.84 -8.28 -7.72 -10.52 -9.92 -11.23
Dine Equity 7.49 39.93 24.47 9.26 92.66 17.22
Brinker International 170.4 -32.05 -16.28 39.18 -59.82 27.68
Industry 28.1 -4.56 -6.74 1.68 0.39 1.69
Accounts Receivable Turnover
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 242.88 159.5 194.11 199.98 176.84 194.66
Bob Evans 89.32 99.29 98.25 80.65 87.06 90.91
Dennys 77.58 58.16 68.25 69.15 50.2 64.67
Darden 165.36 144.57 134.82 122.62 95.35 132.54
Dine Equity 8.09 7.97 7.67 4.2 13.68 8.32
Brinker International 97.74 86.01 79.01 87.8 80.97 86.31
Industry 87.61 79.2 77.6 72.88 65.45 76.55
203
Days Sales’ Outstanding
Days Sales’ Outstanding 2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 1.5 2.3 1.9 1.8 2.1 1.9
Bob Evans 4.1 3.7 3.7 4.5 4.2 4
Dennys 4.7 6.3 5.3 5.3 7.3 5.8
Darden 2.2 2.5 2.7 3 3.8 2.8
Dine Equity 45.1 45.8 47.6 86.9 26.7 50.4
Brinker International 3.7 4.2 4.6 4.2 4.5 4.3
Industry 12 12.5 12.8 20.8 9.3 13.5
Inventory Turnover
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel Without Retail 16.69 13.93 18.52 17.25 19.72 17.22
Cracker Barrel With Retail 5.54 5.02 5.5 5.15 4.96 5.24
Bob Evans 17.52 18.15 16.74 16.81 16.51 17.15
Dennys 91.09 94.97 95.35 120.55 104.51 101.29
Darden 19.63 17.4 22.28 20.32 23.71 20.67
Dine Equity 1541.68 395.88 526.43 22.98 98.88 517.17
Brinker International 26.89 21.79 28.79 41.87 33.94 30.65
Industry 339.36 109.64 137.92 44.51 55.51 137.39
Days’ Supply of Inventory
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 65.9 72.7 66.3 70.8 73.6 69.9
Bob Evans 20.8 20.1 21.8 21.7 22.1 21.3
Dennys 4 3.8 3.8 3 3.5 3.6
Darden 18.6 21 16.4 18 15.4 17.9
Dine Equity 0.2 0.9 0.7 15.9 3.7 4.3
Brinker International 13.6 16.8 12.7 8.7 10.8 12.5
Industry 11.4 12.5 11.1 13.5 11.1 11.9
Cash to Cash Cycle
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 67.4 75 68.2 72.6 75.6 71.8
Bob Evans 24.9 23.8 25.5 26.2 26.3 25.4
Dennys 8.7 10.1 9.2 8.3 10.8 9.4
Darden 20.8 23.5 19.1 20.9 19.2 20.7
Dine Equity 45.4 46.7 48.3 102.8 30.4 54.7
Brinker International 17.3 21 17.3 12.9 15.3 16.7
Industry 23.4 25 23.9 34.2 20.4 25.4
204
Profitability Ratios
Gross Profit Margin
2004 2005 2006 2007 2008
Five Year
Average
Cracker Barrel 67.0% 67.3% 68.2% 68.3% 67.6% 67.7%
Bob Evans 71.5% 69.6% 70.4% 70.9% 70.2% 70.5%
Dennys 21.3% 20.4% 21.4% 16.8% 25.0% 21.0%
Darden 22.0% 22.4% 11.5% 23.5% 22.5% 20.4%
Dine Equity 36.4% 38.9% 40.4% 37.0% 32.8% 37.1%
Brinker International 72.4% 71.7% 72.0% 72.1% 71.6% 72.0%
Industry 44.7% 44.6% 43.1% 44.0% 44.4% 44.2%
Operating Profit Margin
2004 2005 2006 2007 2008
Five Year
Average
Cracker Barrel 7.7% 7.7% 7.3% 7.2% 6.3% 7.2%
CBRL Restated 6.7% 4.0% 3.4% 3.5% 4.4%
Bob Evans 9.5% 4.6% 5.4% 5.9% 6.2% 6.3%
Dennys 5.6% 5.0% 11.1% 8.5% 8.0% 7.6%
Darden 6.7% 8.0% 9.6% 6.8% 5.6% 7.3%
Dine Equity 15.1% 20.4% 20.8% -0.6% -11.7% 8.8%
Brinker International 6.6% 5.8% 64.2% 7.9% 2.3% 17.4%
Industry 8.7% 8.8% 22.2% 5.7% 2.1% 9.5%
Net Profit Margin
2004 2005 2006 2007 2008
Five Year
Average
Cracker Barrel 4.70% 5.78% 5.24% 6.89% 2.75% 5.07%
CBRL Restated 2.47% 0.72% 2.07% -0.88% 1.10%
Bob Evans 6.01% 2.53% 3.46% 3.66% 3.73% 3.88%
Dennys -3.92% -0.75% 3.05% 3.34% 1.93% 0.73%
Darden 4.54% 5.51% 6.76% 3.62% 5.69% 5.22%
Dine Equity 9.31% 12.62% 12.75% -0.10% -9.57% 5.00%
Brinker International 4.07% 4.27% 5.12% 1.18% 1.22% 3.17%
Industry 4.00% 4.84% 6.23% 2.34% 0.60% 3.60%
205
Asset Turnover
2004 2005 2006 2007 2008
Five Year
Average
Cracker Barrel 1.79 1.53 1.45 1.40 1.88 1.61
CBRL Restated 1.31 1.13 1.08 1.47 1.25
Bob Evans 1.53 1.68 1.34 1.40 1.45 1.48
Dennys 1.89 1.96 1.94 2.12 2.01 1.99
Darden 1.88 1.90 1.70 1.85 1.73 1.81
Dine Equity 0.43 0.42 0.45 0.63 0.56 0.50
Brinker International 1.91 1.66 1.93 1.97 1.83 1.86
Industry 1.53 1.52 1.47 1.59 1.52 1.53
Return on Assets
2004 2005 2006 2007 2008
Five Year
Average
Cracker Barrel 8.4% 8.8% 7.6% 9.6% 5.2% 7.9%
CBRL Restated 3.2% 0.8% 2.2% -1.3% 1.2%
Bob Evans 9.2% 4.3% 4.6% 5.1% 5.4% 5.7%
Dennys -7.4% -1.5% 5.9% 7.1% 3.9% 1.6%
Darden 8.5% 10.5% 11.5% 6.7% 9.8% 9.4%
Dine Equity 4.0% 5.3% 5.8% -0.1% -5.4% 1.9%
Brinker International 7.8% 7.1% 9.9% 2.3% 2.2% 5.9%
Industry 4.4% 5.1% 7.5% 4.2% 3.2% 4.9%
Return on Equity
2004 2005 2006 2007 2008
Five Year
Average
Cracker Barrel 14.1% 14.5% 13.4% 53.6% 63.0% 31.7%
CBRL Restated 6.2% 1.8% 17.1% -23.7% 0.4%
Bob Evans 12.8% 5.9% 8.4% 8.6% 9.2% 9.0%
Dennys 12.2% 2.8% -11.4% -14.0% -8.0% -3.7%
Darden 19.0% 24.7% 26.6% 16.4% 18.4% 21.0%
Dine Equity 8.7% 12.9% 15.2% -0.2% 20.8% 11.5%
Brinker International 13.2% 15.9% 19.3% 4.8% 6.4% 11.9%
Industry 13.2% 12.4% 11.6% 3.1% 9.4% 9.9%
206
Capital Structure Ratios
Debt/Equity
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 0.64 0.76 4.56 11.15 13.16 6.06
Cracker Barrel Restated 0.92 1.26 6.64 17.26 18.52 8.92
Bob Evans 0.38 0.81 0.68 0.70 0.97 0.71
Denny's -2.89 -2.92 -2.98 -3.07 -2.99 -2.97
Darden 1.37 1.31 1.45 0.87 2.36 1.47
Dine Equity 1.42 1.62 1.66 -4.89 77.59 15.48
Brinker International 1.23 0.96 1.06 1.88 2.69 1.56
Industry 0.30 0.36 0.37 -0.90 16.12 3.25
Times Interest Earned
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 0.64 0.76 4.56 11.15 13.16 6.06
Cracker Barrel Restated 0.92 1.26 6.64 17.26 18.52 8.92
Bob Evans 0.38 0.81 0.68 0.70 0.97 0.71
Denny's -2.89 -2.92 -2.98 -3.07 -2.99 -2.97
Darden 1.37 1.31 1.45 0.87 2.36 1.47
Dine Equity 1.42 1.62 1.66 -4.89 77.59 15.48
Brinker International 1.23 0.96 1.06 1.88 2.69 1.56
Industry 0.30 0.36 0.37 -0.90 16.12 3.25
Debt Service Margin
2004 2005 2006 2007 2008 Five Year Average
Cracker Barrel 2003.65 1218.84 831.88 11.94 15.21 816.30
Bob Evans 34.14 32.51 37.06 37.88 4.66 29.25
Denny’s 0.54 10.67 4.96 4.02 3.34 4.71
Darden 40.22 12.95 3.63 18.93
Dine Equity 11.69 9.47 3.32 24.57 12.26
Brinker International 27.68 23.50 260.65 220.75 205.30 147.58
Industry 18.51 23.28 76.50 60.03 54.23 42.55
Altman's Z-Score
2005 2006 2007 2008 2009 Five Year Average
Cracker Barrel 4.09 2.66 2.74 2.65 2.80 2.99
Cracker Barrel Restated 2.83 1.93 1.95 1.98 1.96 2.13
Bob Evans 2.92 3.79 3.51 3.00 3.22 3.29
Denny's 0.21 0.90 0.79 0.00 0.48
Darden 3.19 3.06 2.52 2.28 2.35 2.68
Dine Equity 2.23 2.32 0.50 0.60 1.41
Brinker International 4.23 5.05 3.95 3.28 3.50 4.00
Industry 2.56 3.02 2.25 1.83 3.02 2.37
207
Growth Rates
Internal Growth Rate
2004 2005 2006 2007 2008 2009
Cracker Barrel 6.8% 7.2% 6.1% 8.8% 3.9% 3.6%
Bob Evans 7.0% 2.3% 3.2% 3.4% 3.9% -1.6%
Dennys -7.4% -1.5% 5.9% 7.1% 3.9%
Darden 8.0% 10.0% 9.5% 4.5% 7.2% 5.5%
Dine Equity 1.5% 3.0% 3.4% -2.5% -6.6%
Brinker International 7.8% 7.1% 8.7% 0.5% 0.4% 1.6%
Industry Avg. 3.4% 4.2% 6.1% 2.6% 1.7% 1.8%
Sustainable Growth Rate
2004 2005 2006 2007 2008 2009
Cracker Barrel 11.2% 12.7% 34.0% 106.3% 54.9% 33.4%
Bob Evans 9.7% 4.2% 5.3% 5.8% 7.7% -3.1%
Dennys 14.0% 2.8% -11.8% -14.6% -7.8%
Darden 19.0% 23.1% 23.2% 8.4% 24.2% 17.3%
Dine Equity 3.7% 7.8% 9.1% 9.9% -520.6%
Brinker International 17.3% 13.9% 17.9% 1.3% 1.3% 4.7%
Industry Avg. 12.7% 10.4% 8.8% 2.2% -99.0% 6.3%
208
Operating Leases Restated Financial Statements
Balance Sheet
ASSETS
2004 2005 2006 2007 2008 2009
Adjusted Adjusted Adjusted Adjusted Adjusted Adjusted
Current Assets:
Total current assets 203040 190483 653830 200281 220639 198325
Property and Equipment:
Buildings under capital leases 3289 3289 3289 3289 3289 3289
Leasehold improvements 193859 228859 149061 165472 183729 200704
Assets Under Capitalized Lease Rights (Net) 241168 432774 489788 353459 325535 416718
Total 1743482 2096822 1905162 1853688 1897351 1989156
Less: Accumulated depreciation and amortization of capital leases 383741 445750 432870 481247 526576 570662
Property and equipment - net 1359741 1651072 1472292 1372441 1370775 1418494
Other Assets 20367 30767 44963 45767 47824 45080
Total 1676872 1966046 2171085 1618489 1639238 1661899
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Total current liabilities 242235 295345 330533 274669 264719 264962
Long-term Debt 185138 212218 911464 756306 779061 638040
Capital lease obligations (net) 241168 432682 508074 368952 334382 426690
Interest rate swap liability 0 0 0 0 39618 61232
Other Long-term Obligations 36225 48411 55128 67499 83147 89610
Deferred Income Taxes 98770 107310 81890 62433 54330 55655
Total Long Term Liabilities 561301 800621 1556556 1255190 1290538 1271227
803536 1095966 1887089 1529859 1555257 1536189
Commitments and Contingencies (Note 10)
Shareholders' Equity:
48,769,368 shares issued and outstanding 488 466 309 237 223 227
Additional paid-in capital 13982 0 4257 0 731 12972
Accumulated other comprehensive (loss) 0 0 -4529 -8988 -27653 -44822
Retained earnings 858866 869614 283959 97381 110680 157333
Total shareholders' equity 873336 870080 283996 88630 83981 125710
Total 1676872 1966046 2171085 1618489 1639238 1661899
209
Income Statement
Restated Income Statement
2004 2005 2006 2007 2008 2009
Adjusted Adjusted Adjusted Adjusted Adjusted Adjusted
Total revenue 2380947 2567548 2219475 2351576 2384521 2367285
Cost of goods sold 785703 847045 706095 744275 773757 764909
Gross profit 1595244 1720503 1513380 1607301 1610764 1602376
Labor & other related expenses 880617 939849 832943 892839 909546 916256
Impairment and store closing charges 0 0 5369 0 877 2088
Other store operating expenses 405139 447506 384442 410131 422293 421594
Op. Lease Expense -30156 -30174 -35634 -29044 -30294
Depreciation Expense, Operating Leases 12231 21634 26629 19695 18443
Store operating income 309488 351073 299166 313336 287397 274289
General and administrative 126501 130986 128830 136186 127273 120199
Operating income 182987 220087 170336 177150 160124 154090
Interest expense 8444 26526 49031 83936 75564 73940
Interest income 5 96 764 7774 185 0
Income before income taxes 174548 193657 122069 100988 84745 80150
Provision for income taxes 62663 66925 44854 40498 28212 24105
Income from continuing operations 111885 126732 77215 60490 56533 56045
Income from discontinued operations net of tax 0 0 20790 86082 250 -31
Net income 111885 126732 98005 146572 56783 56014
210
3 Month Regression
3 Month Treasury Bill
Beta Adjusted R2 B ub B lb Ke Ke low Ke Up
72 0.90092 0.14006 1.40785 0.39399 0.10607 0.06552 0.14663
60 0.98494 0.17458 1.52196 0.44793 0.11280 0.06983 0.15576
48 0.95320 0.15996 1.56147 0.34493 0.11026 0.06159 0.15892
36 0.86592 0.15189 1.51866 0.21317 0.10327 0.05105 0.15549
24 0.86571 0.13517 1.70329 0.02814 0.10326 0.03625 0.17026
24 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.415655 R Square 0.172769 Adjusted R
Square 0.135168 Standard
Error 0.129327 Observations 24
ANOVA
df SS MS F Significance
F Regression 1 0.076849 0.076849 4.594758 0.04338 Residual 22 0.367959 0.016725
Total 23 0.444808
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.016509 0.026997 0.6115 0.547136 -0.03948 0.072497 -0.03948 0.072497 X Variable 1 0.865714 0.403871 2.143539 0.04338 0.028136 1.703292 0.028136 1.703292
211
36 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.419665 R Square 0.176118 Adjusted R
Square 0.151886 Standard
Error 0.107773 Observations 36
ANOVA
df SS MS F Significance
F Regression 1 0.084418 0.084418 7.268061 0.010835 Residual 34 0.394908 0.011615
Total 35 0.479326
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.009959 0.018097 0.550317 0.5857 -0.02682 0.046736 -0.02682 0.046736 X Variable 1 0.865919 0.321194 2.695934 0.010835 0.213173 1.518665 0.213173 1.518665
48 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.421707 R Square 0.177836 Adjusted R
Square 0.159963 Standard
Error 0.103546 Observations 48
ANOVA
df SS MS F Significance
F Regression 1 0.106682 0.106682 9.949934 0.002833 Residual 46 0.493206 0.010722
Total 47 0.599888
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.012404 0.015002 0.826794 0.412622 -0.01779 0.042602 -0.01779 0.042602 X Variable 1 0.953201 0.302186 3.154352 0.002833 0.344932 1.561469 0.344932 1.561469
212
72 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.390087 R Square 0.152168 Adjusted R
Square 0.140056 Standard Error 0.092708 Observations 72
ANOVA
df SS MS F Significance
F Regression 1 0.10798 0.10798 12.5635 0.000706 Residual 70 0.601633 0.008595
Total 71 0.709613
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.006211 0.010926 0.568486 0.571525 -0.01558 0.028003 -0.01558 0.028003 X Variable 1 0.90092 0.254174 3.544503 0.000706 0.393986 1.407854 0.393986 1.407854
60 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.434248 R Square 0.188572 Adjusted R
Square 0.174581 Standard
Error 0.094674 Observations 60
ANOVA
df SS MS F Significance
F Regression 1 0.120814 0.120814 13.47889 0.000527 Residual 58 0.519865 0.008963
Total 59 0.640679
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.008201 0.012237 0.670225 0.505375 -0.01629 0.032696 -0.01629 0.032696 X Variable 1 0.984942 0.268277 3.671361 0.000527 0.447927 1.521957 0.447927 1.521957
213
One Year Regression
1 Year Treasury Bill
Beta Adjusted R2 B ub B lb Ke Ke low Ke Up
72 0.90092 0.14033 1.40731 0.39452 0.10607 0.06556 0.14659
60 0.98422 0.17469 1.52065 0.44779 0.11274 0.06982 0.15565
48 0.95220 0.16001 1.55974 0.34467 0.11018 0.06157 0.15878
36 0.86480 0.15183 1.51682 0.21277 0.10318 0.05102 0.15535
24 0.86536 0.13529 1.70225 0.02846 0.10323 0.03628 0.17018
24 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.415794 R Square 0.172884 Adjusted R
Square 0.135288 Standard
Error 0.129318 Observations 24
ANOVA
df SS MS F Significance
F Regression 1 0.0769 0.0769 4.598457 0.043303 Residual 22 0.367908 0.016723
Total 23 0.444808
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.016761 0.02702 0.620333 0.541412 -0.03927 0.072797 -0.03927 0.072797 X Variable 1 0.865356 0.403542 2.144401 0.043303 0.028461 1.70225 0.028461 1.70225
214
36 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.4196 R Square 0.176064 Adjusted R
Square 0.15183 Standard
Error 0.107776 Observations 36
ANOVA
df SS MS F Significance
F Regression 1 0.084392 0.084392 7.265337 0.010848 Residual 34 0.394934 0.011616
Total 35 0.479326
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.010123 0.018105 0.559152 0.579723 -0.02667 0.046917 -0.02667 0.046917 X Variable 1 0.864797 0.320838 2.695429 0.010848 0.212775 1.516819 0.212775 1.516819
48 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.421763 R Square 0.177884 Adjusted R
Square 0.160012 Standard
Error 0.103544 Observations 48
ANOVA
df SS MS F Significance
F Regression 1 0.10671 0.10671 9.953159 0.002829 Residual 46 0.493178 0.010721
Total 47 0.599888
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.012579 0.015007 0.838234 0.406234 -0.01763 0.042786 -
0.01763 0.042786 X Variable 1 0.952204 0.301821 3.154863 0.002829 0.34467 1.559738 0.34467 1.559738
215
60 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.434374 R Square 0.18868 Adjusted R
Square 0.174692 Standard
Error 0.094668 Observations 60
ANOVA
df SS MS F Significance
F Regression 1 0.120884 0.120884 13.48848 0.000525 Residual 58 0.519795 0.008962
Total 59 0.640679
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.008417 0.012239 0.687711 0.494376 -0.01608 0.032916 -
0.01608 0.032916 X Variable 1 0.984221 0.267985 3.672666 0.000525 0.44779 1.520652 0.44779 1.520652
72 Slice SUMMARY OUTPUT
Regression Statistics Multiple R 0.390437 R Square 0.152441 Adjusted R
Square 0.140333 Standard
Error 0.092693 Observations 72 ANOVA
df SS MS F Significance
F Regression 1 0.108174 0.108174 12.59014 0.000697 Residual 70 0.601439 0.008592
Total 71 0.709613
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.006437 0.010925 0.589154 0.557655 -0.01535 0.028226 -0.01535 0.028226 X Variable 1 0.900918 0.253904 3.548259 0.000697 0.394522 1.407314 0.394522 1.407314
216
Two Year Regression
2 Year Treasury Bill
Beta Adjusted R2 B ub B lb Ke Ke low Ke Up
72 0.90227 0.14061 1.40890 0.39564 0.10618 0.06565 0.14671
60 0.98466 0.17474 1.52125 0.44807 0.11277 0.06985 0.15570
48 0.95237 0.16000 1.56003 0.34471 0.11019 0.06158 0.15880
36 0.86480 0.15171 1.51710 0.21251 0.10318 0.05100 0.15537
24 0.86651 0.13538 1.70426 0.02877 0.10332 0.03630 0.17034
24 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.415903 R Square 0.172975 Adjusted R
Square 0.135383 Standard
Error 0.129311 Observations 24
ANOVA
df SS MS F Significance
F Regression 1 0.076941 0.076941 4.601383 0.043242 Residual 22 0.367867 0.016721
Total 23 0.444808
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.016959 0.027038 0.62722 0.536971 -0.03911 0.073031 -0.03911 0.073031 X Variable 1 0.866513 0.403953 2.145084 0.043242 0.028766 1.704261 0.028766 1.704261
217
36 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.419457 R Square 0.175944 Adjusted R
Square 0.151707 Standard
Error 0.107784 Observations 36
ANOVA
df SS MS F Significance
F Regression 1 0.084335 0.084335 7.259349 0.010878 Residual 34 0.394992 0.011617
Total 35 0.479326
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.010198 0.01811 0.563115 0.577052 -0.02661 0.047002 -0.02661 0.047002 X Variable 1 0.864801 0.320972 2.694318 0.010878 0.212507 1.517095 0.212507 1.517095
48 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.421753 R Square 0.177876 Adjusted R
Square 0.160003 Standard
Error 0.103544 Observations 48
ANOVA
df SS MS F Significance
F Regression 1 0.106706 0.106706 9.952605 0.00283 Residual 46 0.493183 0.010721
Total 47 0.599888
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.012634 0.015008 0.841816 0.404246 -0.01758 0.042845 -0.01758 0.042845 X Variable 1 0.952373 0.301883 3.154775 0.00283 0.344714 1.560033 0.344714 1.560033
218
60 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.434424 R Square 0.188724 Adjusted R
Square 0.174736 Standard
Error 0.094665 Observations 60
ANOVA
df SS MS F Significance
F Regression 1 0.120911 0.120911 13.49231 0.000524 Residual 58 0.519767 0.008962
Total 59 0.640679
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.008512 0.01224 0.695436 0.489559 -0.01599 0.033014 -0.01599 0.033014 X Variable 1 0.984659 0.268067 3.673188 0.000524 0.448066 1.521253 0.448066 1.521253
72 Slice SUMMARY OUTPUT
Regression Statistics Multiple R 0.390783 R Square 0.152711 Adjusted R
Square 0.140607 Standard
Error 0.092678 Observations 72 ANOVA
df SS MS F Significance
F Regression 1 0.108366 0.108366 12.61646 0.000689 Residual 70 0.601247 0.008589
Total 71 0.709613
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.006578 0.010924 0.602158 0.549014 -0.01521 0.028365 -0.01521 0.028365 X Variable 1 0.902272 0.25402 3.551965 0.000689 0.395644 1.4089 0.395644 1.4089
219
Seven Year Regression
7 Year Treasury Bill
Beta Adjusted R2 B ub B lb Ke Ke low Ke Up
72 0.90094 0.14009 1.40782 0.39406 0.10608 0.06553 0.14663
60 0.98101 0.17359 1.51759 0.44443 0.11248 0.06955 0.15541
48 0.94947 0.15919 1.55692 0.34201 0.10996 0.06136 0.15855
36 0.86193 0.15057 1.51454 0.20932 0.10295 0.05075 0.15516
24 0.86677 0.13486 1.70623 0.02731 0.10334 0.03618 0.17050
24 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.415302 R Square 0.172475 Adjusted R
Square 0.134861 Standard
Error 0.12935 Observations 24
ANOVA
df SS MS F Significance
F Regression 1 0.076718 0.076718 4.585313 0.043577 Residual 22 0.36809 0.016731
Total 23 0.444808
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.017906 0.027147 0.659594 0.51636 -0.03839 0.074206 -0.03839 0.074206 X Variable 1 0.866769 0.40478 2.141335 0.043577 0.027307 1.706232 0.027307 1.706232
220
36 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.418143 R Square 0.174844 Adjusted R
Square 0.150574 Standard
Error 0.107856 Observations 36
ANOVA
df SS MS F Significance
F Regression 1 0.083807 0.083807 7.204316 0.011156 Residual 34 0.395519 0.011633
Total 35 0.479326
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.0108 0.018153 0.594958 0.555811 -0.02609 0.047691 -0.02609 0.047691 X Variable 1 0.861931 0.321126 2.684086 0.011156 0.209323 1.514538 0.209323 1.514538
48 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.420809 R Square 0.17708 Adjusted R
Square 0.15919 Standard
Error 0.103594 Observations 48
ANOVA
df SS MS F Significance
F Regression 1 0.106228 0.106228 9.898504 0.002899 Residual 46 0.49366 0.010732
Total 47 0.599888
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.013133 0.015031 0.873722 0.386808 -0.01712 0.04339 -0.01712 0.04339 X Variable 1 0.949466 0.301783 3.146189 0.002899 0.342008 1.556923 0.342008 1.556923
221
60 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.433127 R Square 0.187599 Adjusted R
Square 0.173592 Standard
Error 0.094731 Observations 60
ANOVA
df SS MS F Significance
F Regression 1 0.120191 0.120191 13.3933 0.000547 Residual 58 0.520488 0.008974
Total 59 0.640679
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.009016 0.012257 0.735532 0.46498 -0.01552 0.033551 -0.01552 0.033551 X Variable 1 0.981013 0.268059 3.659686 0.000547 0.444434 1.517592 0.444434 1.517592
72 Slice SUMMARY OUTPUT
Regression Statistics Multiple R 0.390131 R Square 0.152202 Adjusted R
Square 0.140091 Standard
Error 0.092706 Observations 72 ANOVA
df SS MS F Significance
F Regression 1 0.108005 0.108005 12.56687 0.000705 Residual 70 0.601608 0.008594
Total 71 0.709613
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.007183 0.010932 0.657072 0.513289 -0.01462 0.028986 -0.01462 0.028986 X Variable 1 0.900943 0.254146 3.544978 0.000705 0.394064 1.407822 0.394064 1.407822
222
Ten Year Regression
10 Year Treasury Bill
Beta Adjusted R2 B ub B lb Ke Ke low Ke Up
72 0.89918 0.13974 1.40573 0.39262 0.10593 0.06541 0.14646
60 0.97869 0.17310 1.51486 0.44252 0.11230 0.06940 0.15519
48 0.94734 0.15879 1.55424 0.34043 0.10979 0.06123 0.15834
36 0.85999 0.15012 1.51213 0.20784 0.10280 0.05063 0.15497
24 0.86563 0.13458 1.70478 0.02648 0.10325 0.03612 0.17038
24 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.414976 R Square 0.172205 Adjusted R
Square 0.134578 Standard
Error 0.129371 Observations 24
ANOVA
df SS MS F Significance
F Regression 1 0.076598 0.076598 4.576641 0.043758 Residual 22 0.36821 0.016737
Total 23 0.444808
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.018212 0.027186 0.669907 0.509888 -0.03817 0.074594 -0.03817 0.074594 X Variable 1 0.86563 0.404631 2.139309 0.043758 0.026477 1.704783 0.026477 1.704783
223
36 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.41761 R Square 0.174398 Adjusted R
Square 0.150116 Standard
Error 0.107885 Observations 36
ANOVA
df SS MS F Significance
F Regression 1 0.083594 0.083594 7.182084 0.01127 Residual 34 0.395733 0.011639
Total 35 0.479326
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.011014 0.018169 0.606192 0.548413 -0.02591 0.047939 -0.02591 0.047939 X Variable 1 0.859986 0.320898 2.679941 0.01127 0.207844 1.512129 0.207844 1.512129
48 Slice SUMMARY OUTPUT
Regression Statistics Multiple R 0.420348 R Square 0.176692 Adjusted R
Square 0.158794 Standard
Error 0.103619 Observations 48 ANOVA
df SS MS F Significance
F Regression 1 0.105996 0.105996 9.87218 0.002933 Residual 46 0.493893 0.010737
Total 47 0.599888
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.013321 0.015041 0.885632 0.380422 -0.01696 0.043598 -0.01696 0.043598 X Variable 1 0.947339 0.301508 3.142003 0.002933 0.340435 1.554243 0.340435 1.554243
224
60 Slice SUMMARY OUTPUT
Regression Statistics
Multiple R 0.432563 R Square 0.187111 Adjusted R
Square 0.173096 Standard
Error 0.094759 Observations 60
ANOVA
df SS MS F Significance
F Regression 1 0.119878 0.119878 13.35045 0.000557 Residual 58 0.520801 0.008979
Total 59 0.640679
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.009206 0.012265 0.750582 0.455939 -0.01534 0.033756 -0.01534 0.033756 X Variable 1 0.978692 0.267854 3.653827 0.000557 0.442524 1.51486 0.442524 1.51486
72 Slice SUMMARY OUTPUT
Regression Statistics Multiple R 0.389693 R Square 0.151861 Adjusted R
Square 0.139744 Standard
Error 0.092725 Observations 72 ANOVA
df SS MS F Significance
F Regression 1 0.107762 0.107762 12.53361 0.000715 Residual 70 0.60185 0.008598
Total 71 0.709613
Coefficients Standard
Error t Stat P-value Lower 95% Upper 95%
Lower 95.0%
Upper 95.0%
Intercept 0.007388 0.010936 0.67553 0.501564 -0.01442 0.029199 -0.01442 0.029199 X Variable 1 0.899177 0.253985 3.540284 0.000715 0.392621 1.405734 0.392621 1.405734
225
Method of Comparables
Trailing P/E
PPS EPS P/E Trailing Industry Avg. CBRL PPS
CBRL 32.74 2.89 11.32 12.59 36.42287
CBRL Restated 32.74 2.47 12.59 31.03578
Denny's 2.16 0.21 10.33
DineEquity 20.76 -4.63 -
Darden 30.41 2.75 11.06
Bob Evan's 26.12 -0.09 -
Brinker 12.60 0.77 16.36
Forecasted P/E
PPS EPS 1yr Out P/E Forecasted Industry Avg. CBRL PPS
CBRL 32.74 3.16 9.91 31.32
CBRL Restated 32.74 2.63 9.91 26.06
Denny's 2.16 8.61
DineEquity 20.76 10.54
Darden 30.41 10.44
Bob Evan's 26.12 10.46
Brinker 12.60 9.50
Price To Book
PPS BPS P/B Industry Average CBRL PPS
CBRL 32.74 5.97 5.49 2.66 15.90
CBRL Restated 32.74 5.53 5.92 2.66 14.74
Denny's 2.16 -1.52 -
DineEquity 20.76 4.34 4.79
Darden 30.41 12.01 2.53
Bob Evan's 26.12 19.36 1.35
Brinker 12.60 6.34 1.99
Dividends/Price
PPS DPS D/P Industry Avg. CBRL PPS
CBRL 32.74 0.80 0.02 0.03 26.67
CBRL Restated 32.74 0.80 0.02 0.03 26.67
Denny's 2.16 -
DineEquity 20.76 -
Darden 30.41 1.00 0.03
Bob Evan's 26.12 0.64 0.02
Brinker 12.60 0.44 0.03
226
Price Earnings Growth
P/E Growth-5 PEG EPS Industry Avg. CBRL PPS
CBRL 11.33 9.89 2.89 1.08 30.90
CBRL Restated 5.00 2.47 1.08 13.31
Denny's 10.81 19.00 0.44
DineEquity - 10.00 0.93
Darden 11.61 12.40 0.89
Bob Evan's - 8.67 1.39
Brinker 16.89 8.64 1.11
Price/EBITDA
Market Cap EBITDA P/EBITDA Industry Avg EBITDA/Shares CBRL PPS
CBRL 743.94 208.97 3.56 3.59 9.20 33.02
CBRL Restated 743.94 172.50 4.31 3.59 7.59 27.25
Denny's 208.67 91.27 2.29
DineEquity 364.97 392.57 0.93
Darden 4245.74 922.90 4.60
Bob Evan's 810.20 194.10 4.17
Brinker 1291.22 389.74 3.31
Price/Free Cash Flow
Mkt Cap FCF P/FCF Industry Avg. CBRL PPS
CBRL 743.94 155.08 4.80 4.77 32.57
Denny's 208.67 30.14 6.92
DineEquity 364.97 146.03 2.50
Darden 4245.74 221.10 19.20
Bob Evan's 810.20 55.09 14.71
Brinker 1291.22 263.83 4.89
EV/EBITDA
EV EBITDA EV/EBITDA Industry Avg. CBRL PPS
CBRL 1492.46 208.97 5.70 4.13
CBRL Restated 2268.52 172.50 5.70 -23.80
Denny's 494.41 91.27 5.42
DineEquity 2470.05 392.57 6.29
Darden 5971.16 922.90 6.47
Bob Evan's 1091.04 194.10 5.62
Brinker 1837.23 389.74 4.71
227
Intrinsic Valuation Models
Discounted Dividends
Discounted Dividends Approach WACC(AT) 0.11 Kd 0.05 Ke 0.1127Perp
Relevant Valuation Item 0 1 2 3 4 5 6 7 8 9 10 11
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
DPS (Dividends Per Share) 0.88 0.96 1.04 1.12 1.20 1.28 1.36 1.44 1.52 1.6 2.00
PV Factor 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422
PV YBY (Year by Year) Div Payments 0.807 0.808 0.803 0.793 0.780 0.763 0.744 0.723 0.700 0.676
Perp Growth
Total PV of YBY divs 7.60 Sensitivity to change in K(e)0 0.017 0.033 0.05 0.067 0.084 0.101
TPV TV Perp (Present Value of Terminal Value Perpatuity21.12 0.05 34.3 47.11 82.55 50.00
Model Price 7/31/09 28.72 0.07 23.31 28.05 36.49 60.24 353.22
Time Consisent Price 29.34 0.09 17.35 19.59 22.91 29.34 32.74 151.63
0.1127 13.27 14.38 15.86 18.26 22.45 31.6 67.35
Observed Share Price (11/2/09) 32.74 0.13 11.17 11.87 12.76 14.09 16.14 19.7 27.44
Initial Cost of Equity (You Derive) 0.09 0.15 9.39 16.43 9.83 10.36 11.1 12.15 13.74
Perpetuity Growth Rate (g) 0.05 0.17 8.07 11.8 8.35 8.68 9.13 9.73 10.56
Hi Fairly valued 36.014
Low Fairly valued 29.466
Undervalued Fair Valued Overvalued
Model Price > 36.01 36.01 > Model Price > 29.4729.47 > Model Price
228
Discounted Free Cash Flow
Discounted Free Cash Flow WACC(BT)0.105 Kd 0.0542 Ke 0.11
0 1 2 3 4 5 6 7 8 9 10 11
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Cash Flow From Operations (Millions) 179 185 192 202 212 222 233 245 257 270
Cash Flow From Investing Activities -62 -20 -26 -27 -29 -30 -32 -33 -35 -36
FCF Firm's Assets 117 165 166 174 183 192 202 212 223 234 246
PV Factor (WACC(BT)) 0.91 0.82 0.75 0.68 0.61 0.56 0.50 0.46 0.41 0.38
PV YBY Free Cash Flows 106 135 124 118 112 107 102 97 92 88
Perp Growth
Total PV YBY FCF 1080.74 Sensitivity to change in WACC(BT)0 0.017 0.033 0.05 0.067 0.084 0.101
FCF Perp 1737.97 0.04 200.1 334.99 1060.39 4632
Market Value of Assets (7/31/09) 2818.71 0.06 111.6 151.34 234.49 614.36
Book Value Debt & Preferred Stock $1,110 0.08 67.91 84.79 111.83 172.17 390.3
Market Value of Equity $1,709.16 0.103 39.11 46.89 57.67 76.24 112.4 213.1 2026.64
divide by Shares to Get PPS at 12/31 $75.22 0.12 25.16 29.94 36.15 45.87 61.81 92.8 179.26
Time consistent Price (11/2/09) 76.24 0.14 13.26 16.14 19.68 24.83 32.37 44.49 67.18
Oberved Share Price (11/2/09) 32.74 0.16 4.49 6.31 8.47 11.45 15.52 21.41 30.69
WACC(BT) 0.103
Perp Growth Rate 0.05
Undervalued Fair Valued Overvalued
Model Price > 36.01 36.01 > Model Price > 29.47 29.47 > Model Price
229
Residual Income As Stated
WACC(AT) 0.105 Kd 0.0542 Ke 0.113
All Items in Millions of Dollars
0 1 2 3 4 5 6 7 8 9 10 11
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Net Income (Millions) 72 74 77 81 85 89 93 98 103 108
Total Dividends (Millions) 20 22 24 25 27 29 31 33 35 36
Book Value Equity (Millions) 136 187 239 293 348 405 465 528 593 661 733
Annual Normal Income (Benchmark) 15.28 21.11 26.98 32.98 39.20 45.68 52.42 59.47 66.83 74.54
Annual Residual Income 56.44 52.77 49.85 47.70 45.51 43.27 40.97 38.60 36.14 33.57 22.16
PV Factor 0.899 0.808 0.726 0.652 0.586 0.527 0.474 0.426 0.382 0.344
YBY PV RI 50.73 42.62 36.19 31.12 26.68 22.80 19.40 16.43 13.82 11.54
change in Residual Income -3.68 -2.91 -2.15 -2.19 -2.24 -2.30 -2.37 -2.46 -2.56
ROE 52.9% 39.4% 32.1% 27.6% 24.4% 21.9% 20.1% 18.6% 17.4% 16.3% 15.53%
Percent Change in ROE -25.4% -18.6% -14.1% -11.7% -9.9% -8.5% -7.4% -6.6% -5.9% -5.57%
%value
Book Value Equity (Millions) 136 31% 0.6553
Total PV of YBY RI 271.32 61% Perp Growth
Terminal Value Perpetuity 35.81 8% Sensitivity to change in Cost of Equity-0.1 -0.2 -0.3 -0.4 -0.5 -0.6 -0.7 104.18
MVE 12/31/09 442.75 100% 0.05 38.52 34.91 33.36 32.5 31.96 31.58 31.3
Divide By Shares 22.723 0.07 30.68 28.66 27.73 27.2 26.85 26.61 26.43
Model Price on 12/31/09 19.48 0.09 24.9 23.79 23.25 22.93 22.72 22.57 22.46
Time consistent Price (11/2/09) 20.01 0.1127 20.01 19.49 19.23 19.07 18.96 18.88 18.82
0.13 17.15 16.89 16.75 16.67 16.61 16.56 16.53
Oberved Share Price (11/2/09) 32.74 0.15 14.5 14.43 14.39 14.36 14.34 14.33 14.32
Initial Cost of Equity (You Derive) 0.1127 0.17 12.41 12.43 12.45 12.46 12.47 12.47 12.48
Perpetuity Growth Rate (g) -0.1
change in Residual Income -3.68 -2.91 -2.15 -2.19 -2.24 -2.30 -2.37 -2.46 -2.56
Undervalued Fair Valued Overvalued
Model Price > 36.01 36.01 > Model Price > 29.47 29.47 > Model Price
230
Residual Income Restated
WACC(AT) 0.105 Kd 0.0542 Ke 0.1127
All Items in Millions of Dollars
0 1 2 3 4 5 6 7 8 9 10 11
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Net Income (Millions) 60 62 64 67 71 74 78 82 86 90
Total Dividends (Millions) 20 22 24 25 27 29 31 33 35 36
Book Value Equity (Millions) 126 165 205 246 287 331 376 423 472 523 577
Annual Normal Income (Benchmark) 14.17 18.65 23.13 27.68 32.39 37.28 42.35 47.64 53.16 58.94
Annual Residual Income 45.61 42.92 40.90 39.55 38.20 36.85 35.48 34.08 32.64 31.16 20.56
PV Factor 0.899 0.808 0.726 0.652 0.586 0.527 0.474 0.426 0.382 0.344
YBY PV RI 40.99 34.66 29.69 25.80 22.40 19.42 16.80 14.50 12.49 10.71
change in Residual Income -2.69 -2.02 -1.35 -1.35 -1.35 -1.37 -1.40 -1.44 -1.49
ROE 47.5% 37.2% 31.2% 27.4% 24.6% 22.4% 20.7% 19.3% 18.2% 17.2% 16.37%
Percent Change in ROE -21.8% -16.1% -12.3% -10.3% -8.8% -7.6% -6.7% -5.9% -5.3% -5.03%
%value
Book Value Equity (Millions) 126 33% 0.6553
Total PV of YBY RI 227.45 59% Perp Growth
Terminal Value Perpetuity 33.23 9% Sensitivity to change in Cost of Equity-0.1 -0.2 -0.3 -0.4 -0.5 -0.6 -0.7 96.678
MVE 12/31/09 386.39 100% 0.05 32.91 29.83 28.51 27.78 27.31 26.99 26.75
Divide By Shares 22.723 0.07 26.39 24.64 23.83 23.37 23.07 22.86 22.71
Model Price on 12/31/09 17.00 0.09 21.56 20.58 20.1 19.82 19.63 19.5 19.4
Time consistent Price (11/2/09) 17.46 0.1127 17.46 16.98 16.74 16.59 16.48 16.41 16.36
0.13 15.05 14.8 14.66 14.57 14.52 14.47 14.44
Oberved Share Price (11/2/09) 32.74 0.15 12.82 12.72 12.67 12.63 12.61 12.59 12.58
Initial Cost of Equity (You Derive) 0.1127 0.17 11.04 11.04 11.03 11.03 11.03 11.03 11.03
Perpetuity Growth Rate (g) -0.1
Undervalued Fair Valued Overvalued
Model Price > 36.01 36.01 > Model Price > 29.47 29.47 > Model Price
231
Long Run ROE Residual Income As StatedBooke Value of Equity 125.71 As Stated
Return on Equity 16.4% 0.1 0.12 0.14 0.1553 0.18 0.2 0.22
Percent change in ROE -5.03% 0.05 8.25 9.31 10.37 11.18 12.49 13.55 14.61
Cost of Equity 11.27% 0.07 6.97 7.86 8.76 9.45 10.55 11.45 12.34
Market value of Equity 165.0169 0.09 6.04 6.82 7.59 8.19 9.14 9.92 10.7
Divide by shares 22.72269 0.1127 5.25 5.93 6.60 7.12 7.95 8.63 9.3
Model Price on 12/31/09 7.26 0.13 4.78 5.4 6.01 6.48 7.24 7.85 8.47
Time consistent Price 7.46 0.15 4.34 4.89 5.45 5.88 6.56 7.12 7.68
Observed Share Price $32.74 0.17 3.97 4.48 4.99 5.38 6.01 6.52 7.03
Overvalued
As Stated
0.01 -0.01 -0.03 -0.0557 -0.07 -0.09 -0.11
0.05 21.95 16.65 13.99 12.06 11.34 10.59 10.02
0.07 14.7 12.54 11.25 10.19 9.77 9.31 8.95
0.09 11.08 10.08 9.42 8.83 8.59 8.31 8.09
0.1127 8.67 8.26 7.96 7.68 7.56 7.42 7.3
0.13 7.45 7.27 7.13 6.99 6.93 6.86 6.8
0.15 6.41 6.39 6.36 6.34 6.33 6.32 6.31
0.17 5.64 5.7 5.75 5.8 5.83 5.86 5.88
Overvalued
As Stated
0.09 0.11 0.13 0.1553 0.17 0.19 0.21
0.01 4.78 5.97 7.16 8.67 9.55 10.74 11.94
-0.01 5 6 6.99 8.26 8.99 9.99 10.99
-0.03 5.15 6.01 6.87 7.96 8.59 9.45 10.31
-0.0557 5.3 6.03 6.76 7.68 8.22 8.94 9.67
-0.07 5.37 6.04 6.71 7.56 8.05 8.72 9.39
-0.09 5.44 6.05 6.65 7.42 7.86 8.47 9.07
-0.11 5.51 6.06 6.61 7.3 7.71 8.26 8.81
29.47 > Model Price
Change In ROE
Change In Growth
36.01 > Model Price > 29.47Model Price > 36.01 29.47 > Model Price
29.47 > Model Price
Fair ValuedUndervalued
Fair ValuedUndervalued
Sensitivity to
change in Cost
of Equity
Model Price > 36.01 36.01 > Model Price > 29.47
Sensitivity to
change in Cost
of Equity
Change In
Growth
Change In ROE
36.01 > Model Price > 29.47Model Price > 36.01
OvervaluedFair ValuedUndervalued
232
Long Run ROE Residual Income RestatedBooke Value of Equity 125.71 Restated
Return on Equity 16.4% 0.1 0.12 0.14 16.4 0.18 0.2 0.22
Percent change in ROE -5.03% 0.05 8.39 9.51 10.63 11.97 12.86 13.98 15.09
Cost of Equity 11.27% 0.07 7.03 7.97 8.9 10.02 10.77 11.71 12.64
Market value of Equity 165.0169 0.09 6.06 6.86 7.67 8.63 9.28 10.09 10.89
Divide by shares 22.72269 0.1127 5.25 5.94 6.63 7.47 8.03 8.73 9.42
Model Price on 12/31/09 7.26 0.13 4.75 5.39 6.02 6.78 7.29 7.92 8.55
Time consistent Price 7.46 0.15 4.3 4.87 5.44 6.13 6.59 7.16 7.73
Observed Share Price $32.74 0.17 3.93 4.45 4.97 5.6 6.02 6.54 7.06
Restated
0.01 -0.01 -0.03 -0.0503 -0.07 -0.09 -0.11
0.05 21.56 16.24 13.58 11.97 10.92 10.16 9.59
0.07 14.44 12.24 10.92 10.02 9.4 8.93 8.57
0.09 10.88 9.84 9.14 8.63 8.27 7.98 7.74
0.1127 8.52 8.06 7.72 7.47 7.28 7.12 6.99
0.13 7.32 7.03 6.92 6.78 6.67 6.59 6.51
0.15 6.3 6.23 6.17 6.13 6.09 6.06 6.04
0.17 5.54 5.56 5.58 5.6 5.61 5.62 5.63
Restated
0.1 0.12 0.14 16.4 0.18 0.2 0.22
0.01 4.98 6.09 7.19 8.52 9.41 10.51 11.62
-0.01 5.09 6.02 6.95 8.06 8.8 9.72 10.65
-0.03 5.18 5.97 6.77 7.72 8.36 9.16 9.95
-0.0503 5.24 5.94 6.63 7.47 8.03 8.73 9.42
-0.07 5.29 5.91 6.53 7.28 7.78 8.4 9.02
-0.09 5.33 5.89 6.45 7.12 7.57 8.13 8.69
-0.11 5.36 5.87 6.38 6.99 7.4 7.91 8.42
29.47 > Model Price
Change In ROE
Change In Growth
36.01 > Model Price > 29.47Model Price > 36.01
Fair ValuedUndervalued
OvervaluedFair ValuedUndervalued
Sensitivity to
change in Cost
of Equity
Model Price > 36.01 36.01 > Model Price > 29.4729.47 > Model Price
29.47 > Model Price
Sensitivity to
change in Cost
of Equity
Change In
Growth
Change In ROE
36.01 > Model Price > 29.47Model Price > 36.01
OvervaluedFair ValuedUndervalued
Overvalued
233
Abnormal Earnings Growth As Stated
WACC(AT) 0.105 Kd 0.0542 Ke 0.1127
0 1 2 3 4 5 6 7 8 9 10 11
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Net Income (Millions) 72 74 77 81 85 89 93 98 103 108
Total Dividends (Millions) 20 22 24 25 27 29 31 33 35 36
Dividends Reinvested at 11.27% (Drip) $2.25 $2.46 $2.66 $2.87 $3.07 $3.28 $3.48 $3.69 $3.89
Cum-Dividend Earnings $76.13 $79.29 $83.34 $87.58 $92.02 $96.67 $101.55 $106.65 $112.01
Normal Earnings $79.81 $82.21 $85.50 $89.77 $94.26 $98.97 $103.92 $109.12 $114.57
Abnormal Earning Growth (AEG) ($3.68) ($2.91) ($2.15) ($2.19) ($2.24) ($2.30) ($2.37) ($2.46) ($2.56) ($3.33)
PV Factor 0.80768836 0.72588151 0.6523605 0.586286 0.526904 0.4735364 0.4255742 0.3824699 0.3437313
PV of AEG ($2.97) ($2.11) ($1.41) ($1.28) ($1.18) ($1.09) ($1.01) ($0.94) ($0.88)
Residual Income Check Figure -3.68 -2.91 -2.15 -2.19 -2.24 -2.30 -2.37 -2.46 -2.56
-26.3621842
Core Net Income 71.73 Perp Growth
Total PV of AEG ($12.88) Sensitivity to change in Cost of Equity-0.1 -0.2 -0.3 -0.4 -0.5 -0.6 -0.7
Continuing (Terminal) Value 0.05 78.41 75.14 73.73 72.95 72.46 72.12 71.86
PV of Terminal Value ($5.39) 0.07 46.24 45.91 45.76 45.68 45.62 45.58 45.55 ($15.67)
Total PV of AEG 0.09 30.81 31.31 31.55 31.7 31.8 31.86 31.91
Total Average Net Income Perp (t+1) $53.47 0.1127 21.44 22.13 22.49 22.71 22.85 22.96 23.04
Dividends 22.72269 0.13 17.14 17.8 18.15 18.37 18.52 18.63 18.71
Divide by shares to Get Average EPS Perp 2.35 0.15 13.81 14.38 14.7 14.9 15.04 15.14 15.22
0.17 11.54 12.01 12.28 12.46 12.58 12.68 12.75
Capitalization Rate (perpetuity) $0.11
Intrinsic Value Per Share (12/31/2009) $20.88
time consistent implied price 11/2/2009 21.44
Nov 2, 2009 Observed Price 32.74Ke 0.1127
g -0.1
Undervalued Fair Valued Overvalued
Model Price > 36.01 36.01 > Model Price > 29.47 29.47 > Model Price
234
Abnormal Earnings Growth Restated
WACC(AT) 0.105 Kd 0.0542 Ke 0.1127
0 1 2 3 4 5 6 7 8 9 10 11
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Net Income (Millions) 60 62 64 67 71 74 78 82 86 90
Total Dividends (Millions) 20 22 24 25 27 29 31 33 35 36
Dividends Reinvested at 11.27% (Drip) $2.25 $2.46 $2.66 $2.87 $3.07 $3.28 $3.48 $3.69 $3.89
Cum-Dividend Earnings $63.82 $66.49 $69.89 $73.46 $77.20 $81.11 $85.20 $89.49 $93.99
Normal Earnings $66.51 $68.51 $71.25 $74.81 $78.55 $82.48 $86.60 $90.93 $95.48
Abnormal Earning Growth (AEG) ($2.69) ($2.02) ($1.35) ($1.35) ($1.35) ($1.37) ($1.40) ($1.44) ($1.49) ($1.93)
PV Factor 0.80768836 0.72588151 0.65236 0.586286 0.526904 0.473536 0.425574 0.38247 0.343731
PV of AEG ($2.17) ($1.46) ($0.88) ($0.79) ($0.71) ($0.65) ($0.59) ($0.55) ($0.51)
Residual Income Check Figure
-19.2767358
Core Net Income 59.77 Perp Growth
Total PV of AEG ($8.33) Sensitivity to change in Cost of Equity-0.1 -0.2 -0.3 -0.4 -0.5 -0.6 -0.7
Continuing (Terminal) Value 0.05 68.05 64.77 63.37 62.59 62.1 61.75 61.5
PV of Terminal Value ($3.13) 0.07 40.74 40.09 39.8 39.63 39.52 39.44 39.38 ($9.09)
Total PV of AEG 0.09 27.5 27.66 27.74 27.79 27.82 27.84 27.86
Total Average Net Income Perp (t+1) $48.32 0.1127 19.38 19.78 19.99 20.11 20.2 20.26 20.31
Dividends 22.72269 0.13 15.6 16.02 16.25 16.38 16.48 16.55 16.6
Divide by shares to Get Average EPS Perp 2.13 0.15 12.65 13.03 13.24 13.38 13.47 13.54 13.59
0.17 10.62 10.94 11.13 11.25 11.33 11.39 11.44
Capitalization Rate (perpetuity) $0.11
Intrinsic Value Per Share (12/31/2009) $18.87
time consistent implied price 11/2/2009 19.38
Nov 2, 2009 Observed Price 32.74Ke 0.1127
g -0.1
36.01 > Model Price > 29.47 29.47 > Model Price
Undervalued Fair Valued Overvalued
Model Price > 36.01
235
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http://www.answers.com/topic/cbrl-group-inc
3. Richard Gibson. “A New Recipe.” Wall Street Journal. July 13, 2009.
4. Julie Jargon. “Restaurants Look Beyond Chicken Fingers.” Wall Street Journal.
September 1, 2009.
5. Lorri Mealey. “Restauranting FAQs.” About.com.
http://restaurants.about.com/od/openingarestaurant/a/Restaurant_FAQs.htm
6. Brett Arends. “Will The Recovery Boost Restaurant Stocks?” Wall Street Journal.
August 13, 2009.
7. Yahoo Finance. Cracker Barrel Old Country Store. (CBRL)
http://finance.yahoo.com/q/co?s=CBRL
8. AHN Staff. “U.S. Restaurants Adjust Menu Price, Size to Reflect Higher Cost of
Food Ingredients.” October 29, 2008. All Headline News.
http://www.allheadlinenews.com/articles/7012830379#ixzz0RHTmJRL8
9. Jim Woods. “Consumers Show Little Appetite for Restaurants.” Seeking Alpha.
January 14, 2009.
http://seekingalpha.com/article/114572-consumers-show-little-appetite-for-
restaurants
10. Katy McLaughlin. “Macaroni Grill‟s Order: Cut Calories, Keep Customers.” Wall
Street Journal. September 16, 2009.
11. Cracker Barrel Annual Report. 2008.
12. Cracker Barrel 10 – K. 2008.
13. Diana Ransom. “Can They Really Make Money Off the Dollar Menu?” Wall Street
Journal. May 21, 2009.
14. Julie Jargon. “Denny‟s Tries Night-Owl Vibe.” Wall Street Journal. June 30,
2009.
15. Connor Dougherty. “Restaurant Traffic Declines Worldwide.” Wall Street
Journal. August 25, 2009.
16. The Darden Menu. Fast Company. July 1, 2009.
17. Cracker Barrel FAQ. http://investor.crackerbarrel.com/faq.cfm?expand=true
18. Pelepu & Healy. Business Analysis and Valuation. Using Financial Statements.
Thomson South-Western. 2008.
19. Cracker Barrel 10 – K. 2004-2009.
20. Jones, Charles. Investments: Analysis and Management. 9th Ed. 2003
21. Ibbotson and Associates, Stocks, Bonds, Bills, and Inflation (2006).
1
22. Economic Research Federal Reserve Bank of St. Louis
http://research.stlouisfed.org/fred2/series/GS10?cid=115
23. Machon, Michael. “Banking on Financial Ratios”
http://www.bdo.ca/library/publications/agriculture/articles/Accounting_Financial_
Ratios.cfm
24. DineEquity 10-K, 2008
25. Ward, Peter. Cash-to-Cash is What Counts. Via
http://www.vitalentusa.com/learn/cash_to_cash.php
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December 7, 2009
