Steak N Shake Begins to change in FYQ3
Here it is folks, the first quarter for Steak N Shake, under the watch of Sardar Biglari, is now in the books.
Instead of me giving you all the quotes, you might as well just go ahead and read the press release. There are too many great quotes for me to choose one or two.
Basically, Biglari is doing with Steak N Shake exactly what he told shareholders he planned to do. Here’s how I’d sum up the release:
- They plan to close 12 stores in FY Q4.
- Cash flow from operations totaled almost $10mm for the quarter, with $4.7mm in capital expenditures due to the roll out of a new point of sale system, CFFO $23mm for the 9 months.
- Capex from here on out will be mostly maintenance capex. (aka a huge slowdown from past levels)
- GAAP Net loss was $9.8mm, but there were $8.7mm (net of tax) of non cash impairments and $7.8mm of depreciation in that figure.
- Cut debt by $20mm. Without including capital leases, total debt stands at ~$27mm
- Now managing business for creating shareholder wealth.
- Shareholder letter to be issued in the next 60 days with discussion of future plans, in lieu of a conference call there will be an “Investor Day” in the next 3 mos.
Obviously, all of this is just terrific news for shareholders. In the first 3/4 of the year, the co. was able to generate $23mm in operating cash flow. Once you bring capex down to maintainence level (which is about $9mm annually according to previous management), they are on track for a good $22mm in free cash flow ($23/.75 = $31mm - 9mm = $22mm) on the year.
The first two quarters weren’t under Biglari though, and at least part of the 3rd quarter indeed was, so let’s take this quarter as representative of the normal quarter under Biglari before major operational or cost improvements. For an EV of about $240mm, you get a $30mm run-rate in depressed free cash flow ($10mm x4 - $10mm = $30mm) . Within the next year or two, it’s pretty easy to see SNS generating $45 - 50mm in free cash flow annually, merely assuming some cost reductions and operational improvements, giving shareholders a 21% yield on today’s enterprise value.
Let us say that Steak N Shake can generate $45mm in free cash flow, a number they’ve achieved in the past several times under very poor management. (Remember this is based on a $9mm in maintainence capital expenditures, not the crazy level of empire building that previous management was so hell bent on completing.) Given $45mm in annual free cash flow, the company would then generate $90mm in free cash flow in the 2009-2010 period.
Let’s say the company takes $65mm of that to buy back shares, again likely given Biglari’s penchant for share buybacks, and the rest to reduce debt. Assuming an average buy price of $8.50, the company could buy back about $7.6mm shares, bringing the share count down to about $20.6mm from the current $28.2mm. We can safely say that debt would be near zero after paying down $25mm worth.
What’s a fair multiple? I’d venture 6x pre-tax free cash flow, $70mm assuming a 35% tax rate, would bring the valuation to $420mm. (This is less than 10x after tax).
On our newly minted 20.6mm shares, what are our shares then worth? $20/share, almost a triple from today’s price.
Now, you can quibble a little with my math or some of my assumptions, tell me they can’t possibly do it, whatever you like. Regardless, I haven’t been very aggressive here. But I’m not assuming growth, any major new sources of cash, a management miracle, or anything where I’d say “well, that’s a stretch.” All I’m saying is Biglari continues the now-in-process turnaround and allows SNS to regain the former level of cash inflows and doesn’t blow it with stupid cash outflows, assumptions that would realistically allow for $45mm in free cash flow. $420mm intrinsic value is still about than 2/3 of annual revenues, as a “sanity check” on our valuation.
The main point is that even if SNS isn’t ultimately worth $20/share, the company sure won’t be worth $7 1/2. If management does anything above and beyond bringing costs and capex down to reasonable levels, well then CHOO CHOO; the gravy train is comin’ down the tracks. Margin of safety at its best..
Addenum 08/12/08
There has been some discussion about a few sale-leaseback transactions that SNS engaged in during the quarter. The deal is that some debt covenants were almost blown, on a revolving credit line that SNS currently has, a 5% credit line, and a Senior Note at 8.5%. Now, due to deterioration in the business (thanks Alan!), Biglari moved quickly to remedy that in a way that is beneficial in the short term, and not so beneficial (from a pure economics standpoint) in the long term.
What Biglari did was to sell 10 restaurant properties and lease them back, which generates short term cash flow. However, the leases they now pay are at a capitalization rate of 8 of 9% annually, not so good in comparison to 5% on the credit line they just reduced. So it seems the company paid down much of the line of credit (5%) by doing the sale-leaseback transactions. This was most likely due to how close SNS came to blowing the covenants, which would have resulted in some terrible things for sharehoders.
So how does this affect our valuation? Above, I gave the company $30mm in annual cash flow right now without much operational improvement. If we look at the minimum lease payments we just added, $25mm ( check the Q), and divide the length of the new leases, 20 years, we get about $1.25mm in new annual lease payments. So our current FCF comes down by an equivalent amount less the interest expense we will be spared, $900k.
Now, you say, why would Biglari have basically refinanced down a 5% credit line, $18mm worth at a great rate, or 900k in annual expense, to add rent expense of $1.25mm and no inclusion in property appreciation?? Well, thus are the troubles of having debt when you’re in a distressed operating state. They needed to bring down the amount on the credit line and improve their balance sheet to keep from blowing a covenant and being placed into Ch. 11. To finish first, you must first finish. So while these transactions might not seem to be for our long - term gain, they really are because Biglari had to keep SNS afloat to get to the long term.
With $29mm in annual free cash flow and the ability to deals such as this one, I think we can be confident that SNS will be ok. Just know that for the time being, bringing down the debt load (the $9mm left on the facility and $17mm on an 8.5% note) is priority number one, before any deals or buybacks will begin.
Disclosure: Long SNS and WEST.
Hey Jeff, INoticed something allittle disturbing in note 8 fourth paragraph down. It says SNS cannot buyback shares or issue cash dividends. It wasnt clear to me if that was temporary due to conenant viation or if it lasts until the debt is payed off. Any thoughts?
Hey Jeff, INoticed something allittle disturbing in the 10Q note 8 Borrowings fourth paragraph down. It says SNS cannot buyback shares or issue cash dividends. It wasnt clear to me if that was temporary due to covenant violation or if it lasts until the debt is payed off. Any thoughts?
Travis: The inability of paying dividends/buying back shares is related to a credit facility that they use… if debt is paid of, then it won’t be of issue.
Jeff: Did your 20 dollar a share estimate include the underlying value of the real estate that SNS sits on? With roughly 150 places on real estate that is owned, lets say that they refranchise only those units for 1 million a piece (which is pretty dag on conservative), and in turn buy back stock at current levels-without your buyback assumptions, that takes the market cap down to around 90 million with no debt. In addition to this, they will have around 300 corporate stores and over 100 franchised ones.
Granted, this is a totally hypothetical situation (especially since I am saying that they refranchise, and use the cash to buy back shares without the market taking much notice………. basically what I am getting at is that I think your 20 dollar a share estimate is really conservative; and coincidentally, needs no “sanity check”.
thanks ragnar. could you point out where this language is in the new amendment? I read through the whole sleep inducing gathering if legalese but was unable to find the relavent passage. I suppose since we’re only talking 24 million it shouldn’t be an issue. they can likely pay that off in a quarter or two with sale leasebacks proceeds.
So ragnar, I generally think of using the real estate in that fashion as a parallel story to the ongoing cash flows I expect SNS to produce. My assumptions above were just: bring costs back down, cut capex, improve gross margin, how much cash flow comes out? $40-$50mm is very doable and very reasonable.
On another track, they could use the real estate to create some wealth, which they’ve already begun doing with sale-leaseback transactions, selling land parcels, etc. I haven’t factored that into the assumptions I put forth above.
A few things though.
One, there’s no way they’d refranchise every single unit they own, it just wouldn’t happen unless we think about a very long time frame. You might want to assume “x per year” will be refranchised. Also, a sizeable piece of REO will be sold or liquidated, not refranchised, so you have to factor that in, as well.
Lastly, you can’t ignore the lease obs. they owe on that real estate. So saying $1mm x # of refranchised restauarants would ignore (unless you factored it into that number) the capital lease obligations. It’s like if I sold you a car with a lease on it for the full market price of the car, plus you’re paying my lease! Wouldn’t work, obviously. So the EV wouldn’t necessarily go down to $90mm.
Good thoughts though, and maybe I’ll present the real estate case another time.
Is it an undisputable fact that the optimal way to run a restaurant company is to own none of the land or building? ie therefore they should sell everything they own, and buy back stock? That seems to be the argument. I realize there are short term benefits to address liquidity and spur the price. Also one could say that you should be a pure play operator generating a cash stream from your burgers and shakes but just wondering if this is the case, why does McDonalds continue to own significant real estate? Cant one make the case that paying 5% for debt vs 8,5% for leaseback makes sense esp if it is “good” real estate that may have the ability to appreciate over time while we’re selling all those shakes and burgers?
Just wondering thoughts of others and whether it is fair to assume that the right thing to do is sell all the existing assets of this company.
Wow! That was close. I never thought debt that ammounted to less than 10% of assets would have conenants I had to worry about. Hopefully the lesson wasn’t so painless that I have to learn it again in the future.
Hogan, as a shareholder I would like to see any sale leasbacks looked at in terms of cost of capital. As you point out and Jeff mentions above Sale leasebacks can be costlier than other forms of debt and we clearly want the cheapest leverage possible. For me the real estate is only important in that it give my valuation a solid floor in the event of liquidation.
Its NOT an undisputed fact that owning land and buildings is the optimal way to go.
When companies argue that, its because they justify it by saying their cash on cash returns from building new stores is higher than the cost of leasing and therefore they get more bang for their buck that way.
But, every few years, those companies take writedowns for closures and restructuring.
Biglari thinks he can invest money at a higher long term rate than the 8-9% plus the appreciation that the lan/building have in the long term.
That remains to be seen.
When a stock loses 2/3 of its value as SNS did from when he bought it, it kind of throws a monkey wrench on the long term return calculations.
Im long SNS and WEST but less willing than you to blindly believe that Biglari is the next Warren Buffett.
Sardar is finding out its easy to criticize from the outside but then when he gets in office, he too can be criticized and for good reason.
(Exactly HOW long has he been searching for President now ?)
Its time to quit blaming the old regime. Biglari doesnt get a free 2 year pass for buying at $15.
Director RISK sells 20,000 shares
RISK J FRED DIR 08/13/2008 Form 4 S D (20,000) $7.712 61,958
I realize he is as old as dirt and will soon be replaced. But, I also find it hard to believe he needs the money for burial expenses.
So, this sale concerns me.
I just want to clear a few things up here.
These sale leaseback transactions do not represent Biglari saying “I can invest at higher rates.” He paid down a 5% credit line with 8-9% money. That’s not saying “Hey, I’m so good, I don’t need all of this cheap money, give me some more expensive money instead!”
What that means is that, from a liquidity standpoint, Biglari needed to pay down that 5% credit line, because they almost blew the covenants underlying the loan. In the Q they point to SNS being allowed a quarterly “stay” on that credit line and the 8.5% Senior Notes, basically giving them 3 mos. to regain compliance with the covenants. They might have been put into Chapter 11 without these actions. So Hogan, the decision to do these things was necessary it seems, not a long term strategic move.
By doing some S-L transactions, which generate short term liquidity but are more expensive in the long term (8-9% vs. 5%), SNS is saying they needed the cash immediately to pay down other debt. It was merely a “debt shuffling.”
The optimal mix between REO and a pure-pay franchising company is probably somewhere in between. It would be to our benefit if SNS maintained the most valuable real estate underlying the best run restaurants, because we as shareholders would see the best returns. Of course, that all depends on how good of a sale price we could find for the real estate or on what terms we could turn it into a franchise. At some price, every sale is a good sale.
The company is surely not out to sell “all of the existing assets,” but the ones that would most benefit them either in the short term for necessary liquidity, or the long term to pull capital out of underperforming locations. In general, a franchising model has much higher ROIC than owning all of the restaurants. But don’t make it “one or the other” 100% REO or 100% franchising.
Secondly, Biglari has been Chairman for two months now. That’s not an incredibly long period of time, and trust me, if anyone is looking hard for a President, Biglari and Co. are the ones. They own 15% of the company, so their money is at stake here too. The “old regime” was in place for 5-10 years. The “new regime” has had 2 months. Are you ignoring the asset sales, slowdown in G+A spending, and debt restructuring? Tell me this, if Biglari wasn’t in there do you think the former Chairman and CEO would have completed the necessary transactions to keep SNS from being pushed into bankruptcy? I’m not so sure.
So Biglari has full allowance to blame the old regime because they are the ones that did all of the damage, not him. The last quarter was spent healing the wounds they created. All of that capital spending from Gilman and Co. doesn’t look so hot when they are running out of cash to pay the bills. SNS shareholders should be thanking Biglari about now.
Biglari also bought SNS last year in the mid-low teens. Not sure where “2 year free pass” is coming from.
Lastly, I’m not “blindly believing” anything. First off, I only compared some of Biglari’s traits to Buffett. I never once said that Biglari would be the next Buffett. I plainly stated in a prior article that he was in fact NOT the next Buffett, but that being small and flexible would allow WEST to earn better returns than a modern day Berkshire.
Regarding the sale, if you agree that he’ll soon be out soon, than we have absolutely no clue what he’d need money for. I’m not in the business of trying to figure out what old, nearly retired directors might be selling for. Now, if Biglari and anyone else from the 13-D group start selling, then you might have course to be worried.
20,000 shares from an old director? Noise. They can sell for any hundred of reasons. They buy for one reason: make money.
Agree it is somewhere in between - just challenging the original analysis that seemed to indicate selling most hard assets and buying back stock. Besides the banks won’t let them just go willy nilly buying back hundreds of millions worth of stock, so unless your view is that they don’t need a corporate revolver (even unfunded in your analysis that they pay off debt) then they are going to have to do something else with that money , or at least part of it.
In regards to the buyback, I’ll post here what I responded to a similar post on Seeking Alpha:
“I know that SNS can’t buy back shares yet. However, I’ll bet those credit lines are #1 in line to be paid off with all of their restrictive covenants now in place. This should happen in the next 2 quarters or so. At that point, the buying can, and most likely will, begin. I started the buyback scenario in 2009 if you look above:
“Given $45mm in annual free cash flow, the company would then generate $90mm in free cash flow in the 2009-2010 period.
Let’s say the company takes $65mm of that to buy back shares, again likely given Biglari’s penchant for share buybacks, and the rest to reduce debt. Assuming an average buy price of $8.50, the company could buy back about $7.6mm shares, bringing the share count down to about $20.6mm from the current $28.2mm. “”
Biglari does not want to have to comply with convenants like these ones, I promise you that. Debt will be the first to go as well as strengthening overall capital structure and keeping the free cash flowing. When the covenants are out of the way, he will buy stock at these prices.
Jeff,
Are you planning on attending the SNS Investor Day on November 11th in Indianapolis? I may take a trip down if I have time. Would you mind if I along with others in attendance share our notes on your blog? If not, I will try to find another forum.
Best,
Roman
Roman,
I anticipate that I will not be attending, unfortunately. One person has already contacted me about posting notes and I said I’d love to post them. Feel free to send yours along as well and I may just edit them together to find the most complete set, and give credit to all contributors.
Thanks!
Jeff