Activist investor Sardar Biglari, CEO of Biglari Holdings (NYSE:BH) and the operator of both the Steak 'n Shake and Western Sizzlin restaurant chains, picked up another 2% stake in rival Cracker Barrel Old (Nasdaq:CBRL), according to the latest regulatory filing. Biglari now owns 13.3% of a company he believes is poorly run and lacking accountability to shareholders. In December, Cracker Barrel shareholders blocked Biglari's bid to gain a seat on its board. While it's impossible to know whether Biglari could do a better job running Cracker Barrel, investors need to realize that Biglari wouldn't be after Cracker Barrel if it didn't see value in the Tennessee chain. For this reason and several others, I suggest you look beyond the trees to see the forest; Cracker Barrel's not so bad after all.

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Long-Time Owner

Are you familiar with the Homestead Small Company Stock Fund? Morningstar gives it a five-star rating and it's easy to see why. With 47 stocks and an annual turnover of just 4%, it knows its holdings are inside out. Take Cracker Barrel, for instance. The fund's held the stock for more than a decade, increasing the number of shares held from 21,500 at the end of 2001 to 131,600 at the end of September 2011. It represents the third largest holding for the fund behind iShares' Russell 2000 Value Index ETF (ARCA:IWN) and the Triumph Group (NYSE:TGI). Since its stock hasn't split since 2001, the 110,100 additional shares were all purchased on the open market, 78,500 of them in 2011 alone. When one of the best small-cap funds available increases its holdings by almost 150% in the past year, you have to think the three managers that run the fund see Cracker Barrel's potential. I'd go as far as to suggest they probably know more about the company than Mr. Biglari.

The Truth About Cracker Barrel

Sardar Biglari's 10-page opus written for Cracker Barrel shareholders in November 2011, was an incredibly lengthy treatise outlining the many so-called weaknesses of its current management. While it's been hashed about a fair bit in the press, I thought I'd look at some of Biglari's concerns.

Why Seven Years?

According to Biglari, Cracker Barrel hasn't been the same since its late founder, Danny Evins, retired as chairman in 2004. He puts the blame squarely on the shoulders of the current chairman, Michael Woodhouse. What's interesting about Biglari's argument is that Woodhouse was CEO from August 2001, meaning Woodhouse and Evins worked together in the C-Suite for a three-year stretch before Evins moved aside. Woodhouse, however, gets no recognition from Biglari for those three years in charge, as if Evins was holding his hand the whole time. Furthermore, Woodhouse actually joined the company in December 1995 as chief financial officer, and would have been an important part of any success or failure the company achieved in the years between 1995 and 2001. Conveniently placing all the success of Cracker Barrel with the founder is an easy way to curry favor with long-time shareholders, but it just isn't accurate. (For more, see Earning Forecasts: A Primer.)

Return on Capital Expenditures

Biglari makes a big deal about Cracker Barrel's capital allocation record between 2005 and 2011. He suggests that Cracker Barrel's cumulative capital expenditures over this seven-year period were $615 million, while operating income shrank by $1.6 million to $167.2 million. He then goes on to show what a great job he's done since leading Steak 'n Shake's turnaround in 2009. While it's true its customer traffic, revenues and profits have all improved, it's unfair to compare his relatively short three-year record to Woodhouse's seven years.

If you take the last seven years for both companies, you will see that for every dollar in capital expenditures, Cracker Barrel generated $26.67 in revenue, while Biglari Holdings (formerly Steak 'n Shake) generated just $14.34. In terms of operating income, Biglari generated 60 cents in operating income per $1 in capital expenditures compared to $1.83 for Cracker Barrel. Mr. Biglari can argue all he wants about the lack of growth, but from where I sit, Cracker Barrel, not Biglari, seems to be the better allocator of capital. Cracker Barrel might not be growing by leaps and bounds, but I can definitely see why Homestead has owned its stock for more than a decade. Cracker Barrel's revenues and earnings over the long haul have been extremely consistent. Let's see where Biglari is in another four years.

Operating Income Per Store

Biglari points out in his letter to shareholders that since 2005, Cracker Barrel's operating income per store has declined from $319,000 in 2005 to $277,000 in 2011. Worse still, its operating profit per store in 1998 was a whopping $462,000, which is mismanagement of the highest order he contends. Go ask Starbucks (Nasdaq:SBUX) or McDonald's (NYSE:MCD) what happens to operating income per store when you increase the number of locations by 70% over a 13-year period. Chances are good both average revenues per store and profits per store will drop slightly as geographical areas get saturated. It's an inevitable part of expansion.

The Bottom Line

Biglari spends about half his letter discussing share repurchases and why they are a better capital investment at this time than building new restaurant units. He's probably correct to suggest that Cracker Barrel is better off abstaining from store openings, when it clearly is in need of some operational tweaking. However, to suggest those savings should be piled into share repurchases might be self-serving. In my opinion, share repurchases rarely affect the price movement of stocks, up or down. Secondly, the repurchase of shares beyond $65 million, as set by the board, would simply make it easier for Biglari to take control of the company. Fewer shares outstanding equals a larger piece of the pie. In the end, Cracker Barrel's not perfect, but it's a stronger company than Biglari would have you believe. Its stock will do just fine without him. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.
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