This year, the Western Sizzlin's (OTCPK:WEST) annual meeting was important, meaningful, and interesting as ever... Fortunately, I was able to attend the meeting of the company that is going to be rolled into my Steak 'n Shake (SNS) investment (unless these idiots somehow screw it up). Not only did I get to enjoy several days in NYC, but I also got the chance to meet and converse with a number of other value investors; which in and of itself was awesome.
Since Noise Free Investing has already published their own set of notes, I will add in some commentary to my own. Anytime that I use 'quotes' they are as close as possible (keep in mind, my notes were hand written and recording devices were not allowed).
The meeting started with what seems to be customary quip from Sardar Biglari, who held up his 1-liter bottle of Coca-Cola while saying something to the effect of 'Warren Buffett would be proud!'. Following was a PowerPoint presentation that outlined the recent history of WEST. When going over the presentation, it was noted that without the Friendly's deal, 'who knows where we would be right now.' The presentation also displayed how the company is organized.
Ironically, the annual meeting was held the on the 2 year anniversary of the day that Biglari and Cooley journeyed to Indianapolis to meet with the management of SNS in effort to try to develop a plan to unlock value for the company's shareholders... Who would have thought that 9 months after letting Jeff Blade and Alan Gilman know that they intended to launch a proxy battle, that they would be elected to the board in the kind of landslide (74%) that would even make Barack Obama feel like a loser? Furthermore, who would have thought that just 2 years after such intentions were made clear, that WEST, the micro cap of micro caps, would be merging with SNS!?!
Needless to say, upon taking control of the company, costs have been cut, quality of product/experience has improved, the balance sheet/brand are healthier than ever, and the company is throwing off cash like crazy.
And now, my notes...
Margins: Sardar said that the company doesn't really look for gross margins, but rather, a great product- not wanting to make it 'less functional by tweaking'. As examples, the burger buns and tomatoes are changing for the better. Obviously, this is a company that would rather sell more, make a little less, and have increased sales to more than make up the difference. Phil Cooley, ever the teacher added that when gross margins decrease, either the price is decreasing or the cost per unit is increasing- competition generally teaches that price will come down.
SNS is a great example of using cost efficiencies to boost sales- the have also done so while lowering prices. Not even Chipotle (NYSE:CMG), once the poster child for a growing restaurant chain, is trying to raise prices; me personally, I was pretty upset when that happened- the price of my Vegetarian Fajita Burrito has jumped in price roughly 20% in the past year... and yes, I am cheap enough that I eat there a lot less over it. :( But need I digress.
Hedging: The company does not hedge it's input products. Sardar stated that he didn't feel that the insurance you pay for by hedging is worth it. He also openly admitted that hedging prices wasn't in his circle of competence by saying 'I know what I am good at and what I am not good at'. He added that if you would have gotten a consensus for the future prices of various commodities last summer and compared with them now, that you would probably be surprised with what would be shown.
Franchisees Under Preforming: Mainly, the reason for the franchised SNS's not preforming up to expectations is due to their unwillingness to change. I can't say that is entirely irrational for them act in such a way.
The way that I see it, when management changes, that will make the franchisees nervous. Furthermore, it seems that if management changed to a 30 year old who launched a proxy fight, ousted a bunch of the higher ups that you knew at corporate, then after all of that, one of the company's historically largest franchisees resigns from the board after publishing a nasty letter, and then the young hot shot tells you that 'we are repositioning the brand; there will be new promotions, food, and pricing'; you would be nervous to risk your nest egg... However, Biglari did imply that they are coming around, since they needed to be convinced with company results first (as they had heard similar talk of promotions from previous management). He added that had the company been all franchised, that the turnaround would have been a lot harder. Furthermore, he views consistency as something that is quite important for the company, citing Coca-Cola (NYSE:KO) and McDonald's (NYSE:MCD) as examples that they need to follow. Really, I am hoping that they can get the brand into the minds of people like GEICO has managed to.
Phil noted that both WEST and SNS have seemed to buck the trend when it comes to franchisees out preforming company stores. Generally, one would speculate that an owner operator would care for his baby in a way that a manager never could. Being entrepreneurs, they would run the midnight oils to make sure that everything is up to par. But again, he is hopeful for the future.
New Stores/Refranchising: It looks as if the company will be keeping most of it's corporately held stores, though, it will refranchise them 'if the deal is right'. An example that was given was that of selling off a location in a tertiary market, as part of a great franchise development agreement. While not going into the specific geographic regions that expansion will take place in, there has recently been a new franchisee that will be opening a store in Richmond, VA. Sardar also said that he had show the plans for the new prototype stores that will be self service and in strip mall centers (these plans were developed much faster than were originally expected at the 2009 SNS annual meeting- where pictures were expected to be available in a year).
Sardar also said that he had been surprised with how resilient the brand has been. He was sure to say that Western Sizzlin, as a brand, is over 50 years old and that SNS is now 75- they have staying power and have merely hit a rough spot. As always, he wouldn't disclose what he valued the company at, but did say 'I love the cash flows.'
Future of the Holding Company: Since SNS is now a holding company, all of the subsidiaries will be throwing off cash for Biglari to allocate in the greenest pastures. While unable to comment on the specifics of the cost efficiencies that WEST and SNS would have as a combined entity, he blanketly said that when 2 public companies become 1, that they will have lower back office costs, fewer costs associated with being public, and also lower marketing expenses. He made sure to say that the company needed to be as efficient as possible, adding that they have done away with a ton of unnecessary expenditures (such as ineffective consultants that did work which should have been in house). While there is still work to be done, they have gotten a great start. With this said, it seems apparent that he will be focusing more of his attention on capital allocation and that the upper level managers now have a good handle on things.
It seems that the time is coming near for significant capital deployment. Biglari doesn't see investments taking place outside of the US, since there are so many opportunities domestically. While not focusing on one particular industry, it seems apparent that they will go wherever they can in order to get the best risk adjusted returns.
Activism: While they would rather not be activists and get great returns, it was recognized that often time, the greatest return comes from buying under preforming assets. The bottom line seems to be that if SNS can increase returns by being activists, then they will do it. Phil said that "No one is more surprised than me that Sardar became CEO.'
Sardar quipped that he was 'the accidental CEO'.
In regards to future investments, it was noted that 'there are a number of small companies that we could take over, though, due to ownership we are uninterested, since we would want to allocate their free cash flows.' Furthermore, Sardar stated that 'we will be in the insurance industry.' They are waiting for the right size of company and the right deal, saying that capital can evaporate quickly if you bet wrong. He added that ' just because you have the money, doesn't mean that you should do it... you need the right people to be partners with.'
Lessons Learned: The most important things that Biglari has seen is a reinforcement of ideas; specifically, the need for a strong balance sheet and liquidity. The levels of debt for the company were too high and had to be reduced. "Cash is king, and valuation his queen." Phil was shocked at how long it took for the financial crisis to unfold in the past several years.
On the note of debt; I will add that the company is now paying virtually nothing to borrow money- significantly less than 1/2 the level of interest just a few months ago.
Extracting Value From Real Estate: While the company does like to be in the real estate business, due to the flexibility that it can give you, it all depends on valuation. An example that Biglari gave was that the company recently sold a property at a 5% cap rate and in turn, deployed the money into a property with a 10% cap rate.
Loop Property in San Antonio: While stating that San Antonio has weathered the real estate market quite well, Biglari seemed optimistic about the future of the property for the company. Most people had thought that the area was void for a reason, they may actually get an extra acre-acre and a half out of the property by working with the local government. Despite this and the potential to have to build a bridge for access, they feel that they underpaid for the property, in part, by not paying for this potential. They may have to pay 1/2-1 million dollars to build a bridge to gain access the property and are also exploring various options in regard to the upcoming debt payment on the property.
Capex: While cap ex is currently around $5 million per year, it may grow a small amount in the coming years. Certainly not get to the excessive levels of the past! Cooley pointed out that spending a bunch to grow a brand, while potentially illogical, does make sense (in a sympathetic way) under the following pattern: there is a belief that companies must grow to hire the right people, since they want to be part of a growing company with the chance to climb the corporate ladder. This can lead to a philosophy of 'well, we know this industry really well, so lets grow!' Then, it will eventually manifest into a goal of expanding at particular rates every year/quarter- regardless of the profitability of such growth.
Woodgrill Buffet: While looking to expand the concept, it requires a great operator to run one; Cooley saying that the operator is the scarce resource. In addition, it is expensive to start. As a result, they only want owner operators that are great, letting them grow as much as they can handle (they will do the same with SNS franchisees too). Phil spoke of his love for the concept, adding 'if you walk into one and are not hungry, you are going to eat... they are great!'
When asked about the Express location, we learned that they took that operation over from a franchisee that was experiencing financial trouble. Furthermore, the location was just off of an interstate exit; with miles driven decreasing for the past 2 years, it was a death nail for the store. With it ultimately failing, they admitted that they had done poorly, and decided to cut their losses.
Shareholder Letter: When asked, Sardar gave his second most forceful answer of the day (the most, coming up): 'I will write a letter. I owe shareholders a letter every year.' He also stated that the reason for the letter not coming out was because of the uncertainty and the timing of the merger agreement.
ITEX: When asked about ITEX (OTCPK:ITEX), Sardar leaned into the mic and gave a very force full, on the verge of angry 'I have no comment on ITEX.' I can't say that I blame him either; while I have not been upset with the company's results on a relative basis, I have been disappointed with the results on an absolute basis.
Phil spoke of the Associated Press article on bartering for health care that mentioned ITEX. While proclaiming that the fundamentals continue to be good, he felt that the company was under covered. Since this wouldn't be a typical Ragnar Is A Pirate post without something about the government sucking, here is my libertarian-esque link of the day- Bartering: the way of the libertarian!
Raising of Capital for Investments: While John Linnartz is raising capital for Mustang, Western Investments is not.
After The Meeting: After questions, 30-40 of us ventured downstairs to the closing bell of the NASDAQ for a quick ceremony and photo op.
While I was briefly talking with Jonathan Dash after the meeting (in the middle of Times Square of all places), I asked if he knew where the annual meetings would take place when the merger is finalized (as Indianapolis, the HQ of SNS, is a lot closer to me than NYC). I was shocked with the answer- "We don't know yet; we will take a look at where the shareholder base is and figure out where the meeting would have the least economic effect on them..." I was stunned.
And that's when it hit me... This isn't just closing under preforming stores, taking 1/2 of a square inch of red ink off of 'to go' cups, changing from sliced to grape tomatoes on salads, or negotiating better terms with suppliers and lenders; this is a method of cost cutting that directly goes to the core of my philosophy as a value investor. The question I asked is one that no one could prepare a scripted answer for-especially on the very day that the intent to merge WEST and SNS was announced. I am delighted to be partners in this great and growing business with them.
Disclosure: Long SNS and ITEX/Do your own research before buying any sort of security I talk about/This is not investment advice/insert your favorite blanket warning here _________...