Biglari Holdings 2016 Annual Meeting Notes: Steak 'n Shake

| About: Biglari Holdings (BH)

Summary

As Biglari Holding's largest fully owned company, Steak 'n Shake has a large effect on the overall success of the company.

2015 was another successful year for the chain, which generated over $30mil in free cashflow for Biglari to reallocate.

In this installment, I cover all the questions related to SNS and Western Sizzlin, BH's other fully owned chain.

...say I bought an item for 80 cents. I found that by pricing it at $1.00 I could sell three times more of it than by pricing it at $1.20. I might make only half the profit per item, but because I was selling three times as many, the overall profit was much greater.

- Sam Walton (p 25 of Sam Walton: Made in America)

When Sardar Biglari first took control at Steak 'n Shake in August 2008, he took Sam's advice to heart, cutting prices back to level's not seen since 2000. In the 8 years since, prices have remained the same. The result has been 29 straight quarters of same-store sales increases, the best record in the industry.

Steak n Shake is just one of the reasons that I am a big fan Biglari Holdings (NYSE:BH). In this installment of my 2016 annual meeting notes, I cover all the meeting questions that were related to Steak n Shake and BH's other owned restaurant chain, Western Sizzlin. If you've missed my other installments, here is a link to the first one. Now let's dive into the questions:

Q: Animal cruelty is a huge issue. Steak n Shake suppliers currently use cage chicken eggs are you going to change that.

A: We have no current plans to switch to cage free eggs. When making decisions on supplies we follow customer demand and US laws. Customers have not yet demanded that we switch to cage free, so we will continue to source from the cheapest sources of quality eggs.

Q: Chipotle (NYSE:CMG) has had some big issues over the past's months. What have you learned from them? The stock is down over 40%, yet still valued at 30 x earnings, why?

A: We've been keenly concerned about food-borne illnesses for years - it's a big risk. Thus we've continually taken actions to lower our risk. For one, we don't locally source our produce. In terms of the current valuation, important to note that PE ratios do not equal value.

Q: What do you expect Steak n Shake's long-term Capex to be?

A: As a whole, the restaurant industry is at about 7.6% Capex. Ours will always be low by conventional standards. Previous management had opened too many stores before we showed up, making it extremely easy to cut expenditures. Important to note that we do not defer maintenance capex - in fact, we are making our stores more inviting. I remember visiting one of our locations in October 2008, there was a single couple in the store, freezing, with no music playing or anything else to add any ambiance. We worked hard to fix store experience we prefer to save money in ways that don't impact the customer experience. For example, we have our own maintenance department, which we absolutely love. Will also spend money to fix a fryer, instead of buying a new one. The goal is to save a dollar and then pass it through to our customers. Had we simply cut our capex in 2008, the company would be bankrupt.

Good example of our willingness to spend capex if it is productive is at Western Sizzlin. In the summer of 2014 we went down to Parkersburg, Virginia to bid on a Western sizzling unit that was under foreclosure. We ended up buying it for $1 million, and the CFO found a bank willing to loan the money at 3.5%. That unit generated $250,000 in profit last year, which is being used to pay down the revolver as possible.
Phil Cooley - we only open new Steak n Shake stores to cede an area. Were excited to be expanding into the Middle East.

Q: Danny Meyer, the founder of Shake Shack (NYSE:SHAK), has said that his inspiration was Steak n Shake. Is the earnings growth driver for Biglari Holdings restaurants?

A: There are two ways to generate high returns on investment:

Either have a strong brand equity allows you to charge more for your product…

or if your product is a commodity, you have to be the low-cost producer.

Many companies like to think that they have brand equity, but they don't. By operating Steak n Shake efficiently, we're able to be priced low enough to take share from other competitors. Steak n Shake is a brand for everyone.

Q: Is the franchising business finally generating a profit?

A: Over the past five years, we've spent about $33 million developing our franchising business. In 2011 franchise revenue was 4 million. In 2015, it was $13.8 million. In 2016, we estimate it will be $16 million. Our margin on those revenues about 50%, so we already see this is being a good investment.

Our international franchising operations will continue to sustain losses until we reach 50 - 60 units. At this point, our infrastructure is in place. Over the past few years so managed to improve upon the unit costs of an individual franchise.

We should also note that diversifying our revenue stream at Steak n Shake is a great way to lower risks.

Q: With minimum-wage rates likely going up across the country, have you considered moving to a counter service model in order to reduce labor costs.

A: We're already doing some counter service in locations like airports and college campuses. We aren't too concerned about any minimum wage increases, as they will affect the entire industry. Given our focus on controlling other costs, increased minimum wages may actually end up being an advantage to us.

Q: How many franchises can you open annually?

A: Franchise openings tend to be lumpy, as we don't have any set schedule. We expect seven international openings over the next eight weeks; Toulouse, Normandy, Nantes, Lake Garda. We expect more net openings in 2016. One of our more successful stores is in Marseille. Last year it did over $3 million in revenue, $400,000 profit. Initial investment was only $1.2 million.

In 2008, Steak n Shake's average unit volume was about $1.4 million. It's up to over $1.9 million now. Initially, our issues were on the investment side; the denominator was too high. Over the past couple years, we reduce the total cost including land to $1.7 million. If the franchise can generate sales of $1.9 million, average profit to the franchise owner is about $320,000. The top quartile of franchises now generate $2.5 million of revenue/$500,000 profit annually.

Q: Why keep any company-owned stores? Why not sell them to franchisees?

A: We favor owning a good percentage of stores so that we can prove that we have the same goals. In 2010, the average unit had $1.6 million in revenues and an 18% profit margin, or $289,000. By keeping our prices and costs down, in 2015 the average unit had increased revenue to $1.9 million. Operating margin fell to 17%, but the additional revenue meant that total profit was $320,000. As a comparison, a double cheeseburger + fries + drink are the same price today as they were 16 years ago.

The profit potential is huge if they can get their unit volumes up higher. When we look at all our units, there is tremendous value in the top tier versus the bottom tier. Our top quartile sought 8% same-store sales growth, while our bottom quartile saw slight losses. One of our takeaways is that it may be worth paying for more full-time employees.

Q: Why are you not trying to expand Western Sizzlin?

A: it would be too costly to do so, because there is too much variability in the franchising agreements with the individual franchisees at Western Sizzlin. Thus, we are happy to simply deal with them as is and collect the operating cash flows.

Takeaways

As I noted at the beginning of the piece, I'm a big fan of the method Biglari has used to turn around Steak n Shake. By cutting out unproductive spending on new stores and instead focusing on improving results at existing stores, Biglari was able to save Steak n Shake from potential bankruptcy and turn it into a consistent free cash producer.

Steak n Shake 2000 2008 2015
Revenue $402mil $606mil $800mil
Owned Stores 296 429 417
Revenue/Store $1.36mil $1.41mil $1.92mil
Total Earnings $18.6mil $(23)mil $24.6mil
Operating Cashflow $38.9mil $24.4mil $47.6mil
Cap Ex $73.5mil $31.4mil $8.4mil
Click to enlarge

Some might argue that Biglari is cutting current spending at the expense of future profits, but as he's described, they aren't skimping on any maintenance capex, only unproductive new store capex. Instead, they are pursuing a franchising strategy that has resulted in lower short term earnings, but generates steady long term revenues with 50% margins. Since ramping up the franchising program, the company has added 76 new franchise locations, more than double the amount in 2008. The cash saved from not building these new stores has instead been used for more productive purposes.

At the time Biglari took over as CEO of Steak n Shake in August 2008, the market cap of the company was about $200mil; a number that was down to under $100mil three months later as the financial crisis kicked into gear. Over the next 7 years, Steak n Shake was able to distribute $330mil to Biglari Holdings for reallocation.

I haven't devoted much time to Western Sizzlin, but will highlight a point from page 7 of the 2015 annual letter:

In 2015, Western sent Biglari Holdings $3.1 million of cash, a healthy improvement over 2014. The Western team did an outstanding job by wringing out more cash. Biglari Holdings purchased Western in March 2010 for a net purchase price of $21.7 million. Since then, an aggregate of $16.3 million has been paid to Biglari Holdings.

In 2011 and 2012, a large portion of those distributions ($241mil) were used by Biglari to purchase 20% of Cracker Barrel (NASDAQ:CBRL), as he saw that the company had a great brand, but poor management. Biglari spent about $50/share on that 20% stake; a stake that is now worth triple his initial purchase price and pays BH a 9% dividend on their cost.

Investments into the franchising business have reduced Steak n Shake's operating earnings over the past few years due to the fact that they are considered expenses, instead of being depreciated/amortized if they were capital expenses. This has the effect of reducing short term income, but boosting in in the longer term, given that there won't be any amortization in the future.

As the franchising business scales, I think there will be many people surprised at the coming operating income increases at Steak n Shake over the next few years.

In my next installment, I'll cover questions related to BH's most recently purchased wholly owned companies, First Guard and Maxim.

I look forward to your questions and comments.

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Disclosure: I am/we are long BH.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.